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Ch04-HospitalsHealthcareSystems.pdf

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Al l ri gh ts r es er ve d. M ay n ot b e re pr od uc ed i n an y fo rm w it ho ut p er mi ss io n fr om t he p ub li sh er , ex ce pt f ai r us es p er mi tt ed u nd er U .S . or a pp li ca bl e co py ri gh t la w.

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THE U.S. HEALTHCARE

SYSTEM Origins, Organization and

Opportunities

J O E L I. S H A L O W I T Z , M D , M B A

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C H A P T E R

4 HOSPITALS AND

HEALTHCARE SYSTEMS

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82 The U.S. Healthcare System

BIRON.

And what to me, my love? and what to me?

ROSALINE.

You must be purged too, your sins are rack’d,

You are attaint with faults and perjury:

Therefore if you my favour mean to get,

A twelvemonth shall you spend, and never rest,

But seek the weary beds of people sick . . .

BIRON.

A twelvemonth! well; befall what will befall,

I’ll jest a twelvemonth in an hospital.

—William Shakespeare, Love’s Labour’s Lost, Act 5, Scene 2

A BRIEF HISTORY OF WESTERN HOSPITALS

For a great part of recorded history, care of the ill and injured has been provided in either the patient’s home or where the “healer” practiced his/her art. The word “hospital” comes from the Latin hospes (host); its usage referring to a place to care for sick and injured is rather modern. In fact, the Oxford English Dictionary (OED) gives the first definition to the oldest meaning of the word and current usage to its third reference:

1. A house or hostel for the reception and entertainment of pilgrims, travelers, and strangers; a hospice. Hence, one of the establishments of the Knights Hospitallers . . .

3a. An institution or establishment for the care of the sick or wounded, or of those who require medical treatment. (The current sense.) Such institutions are either public or private, free or paying, —or combined, —general or special with respect to the diseases treated.

The ancestor of Western1 hospitals is generally considered to be the temples of Asclepius (Aesculapius in Latin),2 the Greek god of medicine and healing. While a temple at Titanus

1Considerable evidence exists for ancient institutions in the Middle East and India; however, their relationship to the foundations of healthcare institutions in the United States is not as direct. Therefore, the focus here will be on Western institutions. 2The Staff of Aesculapius (a single snake wound around a staff) often signifies the profession of medicine. For example, this symbol is on the logo of the American Medical Association. Medicine is often erroneously represented by the caduceus, which is two snakes wound around each other and separated by a staff; this symbol belongs to Hermes (Mer- cury), the messenger and god of commerce. The U.S. military uses the caduceus as a designation for its healthcare personnel.

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Hospitals and Healthcare Systems 83

is said to have existed since 1134 BCE,3 the cult of Aesculapius was founded in the fifth century BCE in Epidaurus (Greece) before spreading to other sites around the Greek and Roman empires.4 Patients went to a temple and slept there overnight, often with the aid of a soporific, such as opium.5 In the morning, the temple priests would interpret dreams and recommend cures. Evidence also exists that actual procedures were performed there: “Three large marble boards dated to 350 BC preserve the names, case histories, complaints, and cures of about 70 patients who came to the temple with a problem and shed it there . . . such as the opening of an abdominal abscess or the removal of traumatic foreign material.”6

These temple practices were adopted by the Romans as that empire grew. The first per- manently constructed secular hospitals (valetudinaria) were built as parts of Roman forts in strategic locations in order to treat sick and injured soldiers. The first valetudinarium was built about 100 BCE at Carnuntum (near Vienna).7 In addition to these permanent struc- tures, field hospitals were also established closer to combat lines. What is noteworthy about these places of care is that they were administered by junior military officers (optio vale- tudinarii) rather than physicians or priests; thus, these officers were the first lay hospital administrators.

The establishment of hospitals for general public use originated with the spread of Chris- tianity, particularly after Roman Emperor Galerius’ Edict of Serdica (Edict of Toleration) in 311 CE ordered religious tolerance for Christians. As the religion became more prevalent, shelters (xenodochia) for travelers and for messengers between bishops were established. These shelters were primarily housed in monasteries, where care for the poor and sick was also provided. The word “xenodochia” became synonymous with what we now would call a hospital.8 Further, these monasteries grew herbs and medicinal plants, becoming the foun- dation of the first hospital-based pharmacies.

The First Council of Nicaea in 325 CE encouraged further diffusion of these institutions when it ordered the construction of a hospital in every cathedral town. In order to abolish pagan competition from the still-extant Aesculapian temples, in 331 CE Constantine ordered their closure.

Until this time, hospitals had been set up with religious or governmental sponsorship. The first privately funded hospital is generally recognized to have been established in 390 CE

3Dates will be referenced here in the format of archaeological scholarship. BCE refers to before the common era and CE refers to the common era: BC and AD, respectively. When no suffix appears, the date is CE. 4MacEachern, M. T. (1949). Hospital organization and management (2nd ed.). Berwyn, IL: Physicians Record. 5Askitopoulou, H., Konsolaki, E., Ramoutsaki, I. A., & Anastassaki, M. (2002). Surgical cures by sleep induction as the Asclepieion of Epidaurus. In J. C. Diz, A. Franco, D. R. Bacon, J. Rupreht, & J. Alvarez (Eds.), The history of anesthesia: Proceedings of the fifth international symposium. Elsevier Science B.V., International Congress Series, 1242, 11–17. 6MacEachern, M. T. (1949). Hospital organization and management (2nd ed.). op. cit. 7Retief, F. P., & Cilliers, L. (2005). The evolution of hospitals from antiquity to the renaissance. Acta Theologica Supple- mentum, 7, 213–232. 8The place in the monastery where the monks cared for the sick may have been the same rooms set aside for their own brothers. The place was called the infirmarium, from whence we get the word “infirmary,” another term that has been used for “hospital.”

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84 The U.S. Healthcare System

by a penitent, wealthy Roman woman named Fabiola (later, St. Fabiola) who became a dis- ciple of St. Jerome. (This type of facility is now sometimes called a voluntary hospital, after the voluntary nature of contributions to establish it.) According to St. Jerome’s eulogy for Fabiola: “Et primo omnium νo𝜎oκoμϵ̃ıν instituit, in quo aegrotantes colligeret de plateis et consumpta languoribus atque inedia miserorum membra refoveret.” [And first of every- one, established a nosocomiun in which she brought together the sick from the streets, to restore the wretched whose limbs were consumed by disease of weakness and destroyed by starvation.]9 Fabiola thus also founded a tradition of religious women caring for the sick in hospitals.

After the fall of Rome in 476 and the beginning of the so-called Dark Ages, monastic stewardship of hospitals continued for the next six to seven centuries.

Religion continued to be the dominant influence in the proliferation of hospitals during the Middle Ages, and their establishment accelerated during the Crusades. Starting at the end of the 11th century, hospitals and orders of knights were established throughout Europe to care for the sick and injured on the path to and from Jerusalem. One of the most famous is the Hospitallers of the Order of St. John, which founded a hospital in the Holy Land for 2,000 patients in 1099. The order has come down to us today as the St. John Ambulance Corps in Britain and some of its former colonies.

These institutions received further stimulus in 1198 when Pope Innocent III encouraged establishment of Hospitals of the Holy Spirit (Santo Spirito) in major towns. Some of their cost was covered by church-levied commercial taxes.10

Hospitals as places of learning and patient care by nonreligious medical practition- ers started in the 12th and 13th centuries with several events. First, a church edict of 1163 forbade clergy from performing operations where blood was shed. This action eliminated many centuries of clerical practice, though administration of medications was still allowed. Into this void stepped a few skilled surgeons with university training; but it was mostly less well educated barber surgeons who bled patients, lanced abscesses, and removed teeth.11 Second, schools of medicine were established and affiliated with hospitals. Finally, this age was the dawn of medical licensure, when a physician was required to show competence by examination before local medical school professors or appointees of the towns. Training to obtain this competence was partially achieved in hospitals.

The Western system most relevant to American hospitals is that of the United Kingdom (particularly England and Scotland). Like most of Europe, until the 16th century, British hospitals were primarily religious institutions run by monks. When Henry VIII established

9St. Jerome: Ad Oceanum De Morte Fabiolae. Epistula lxxvii. Retrieved November 15, 2011 from http://www.perseus .tufts.edu/hopper/text?doc=Perseus%3Atext%3A2008.01.0566%3Aletter%3D77 The Greek word translates as “noso- comiun,” a term for a small Roman-type hospital. From this word we derive “nosocomial,” which refers to conditions or events that occur in a hospital (e.g., nosocomial infections). Source of the Latin translation is Professor Heather Vincent, Eckerd College. 10MacEachern, M. T., Hospital organization and management. op. cit. 11The red-striped barber pole, simulating blood running down an arm, is a reminder of their trade.

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Hospitals and Healthcare Systems 85

the Church of England, he also eliminated the monasteries. MacEachern12 describes what happened next:

The previous years of association with the Catholic Church caused hospitals to be objects of spoliation by the crown, and Henry VIII ordered them to be given over to secular uses or destroyed. The sick were turned into the streets. Conditions became so intolerable that the Londoners petitioned the king to return to them one or two of the buildings for the care of patients, pledging financial support. Henry acceded and restored St. Bartholomew’s in 1544 . . . but in other parts of England, hospitals were forced to close their doors . . . In fact, twenty-three of the principle counties had no general hospitals until 1710.

After that time, privately funded, charity hospitals started to be built, most notably, the Westminster Hospital in 1719, Guy’s Hospital in 1724, and the London Hospital in 1740. Admission to such hospitals often required the patient to obtain a ticket from a trustee testi- fying to the bearer’s good character.

Following the European pattern, religious sponsorship was responsible for the first hos- pitals in the Western Hemisphere;13 however, the British secular hospital system is the one that early settlers brought with them to what would become the United States.

In 1663, a hospital for soldiers was established on Manhattan Island, apparently the first such institution on American soil. The first nonmilitary American hospital is considered to be the Philadelphia General Hospital (1732), descended from an almshouse founded in 1713 by William Penn for the benefit of Quakers. New York’s Bellevue Hospital (now affiliated with New York University) was founded in 1736 and holds the claim to be America’s oldest public hospital. The legal and structural prototype for subsequent institutions, however, is the Pennsylvania Hospital in Philadelphia, the first incorporated hospital in the United States. This hospital, which still operates as part of the University of Pennsylvania, was established with the help of Benjamin Franklin (who also contributed to its design). It received its charter from the English king in 1751 and opened to the public in 1755. As was the case with the London Hospital, moral worthiness and political connections often determined who could be admitted. According to Rosenberg:14

One of the fundamental motivations in founding America’s first hospitals was an unques- tioned distinction between the worthy and unworthy poor . . . Thus, it was only natural that the Pennsylvania Hospital should, in the late 18th century, have demanded a written testimo- nial from a “respectable” person attesting to the moral worth of an applicant before he or she could be admitted to a bed.

12MacEachern, M. T., Hospital organization and management. op. cit. 13The first hospital in the Americas was the Hospital San Nicolás de Bari in Santo Domingo. It was authorized on Decem- ber 29, 1503, by Fray Nicolás de Ovando, Spanish governor and colonial administrator (1502–1509). Like its European counterparts, it was also affiliated with a church (the first built of stone in the Americas). Due to earthquakes in the 19th century, it is now in ruins. The earliest, still-extant hospital in the Americas was founded in 1524 by Conquistador Hernán Cortés: the Immaculate Conception Hospital, now the Hospital de Jesús Nazareno in Mexico City. 14Rosenberg, C. R. (1987). The care of strangers, the rise of America’s hospital system. New York: Basic Books, p. 19.

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86 The U.S. Healthcare System

Establishment of other hospitals in major cities followed. They included public, sec- ular institutions (e.g., Massachusetts General Hospital, established in 1811); nonreligious organizations for the benefit of certain nationalities (e.g., New York’s French Hospital, estab- lished in 1809); and specialty hospitals (e.g., the Boston Lying-In, established in 1832 [now part of Brigham & Women’s Hospital in Boston]). Religious hospitals began to proliferate in the 19th century. Particularly noteworthy are Catholic systems that are still prominent, such as those founded by the Sisters of Mercy and Daughters of Charity. Because of reli- gious discrimination, Jewish hospitals started to appear in the mid-19th century, often with names like Jewish Hospital, Mount Sinai, and Beth Israel.15 Among other functions, these institutions provided a place for Jewish physicians, who were barred from medical staffs else- where, to practice medicine.16 Racial issues also contributed to hospital development in the United States. Care of African Americans was established around three organizational mod- els: general hospitals with a segregated ward (The Georgia Infirmary, 1832); demographically determined, black-controlled hospitals (Freedmen’s Hospital, in Washington, DC, 1863); and black-founded hospitals (Provident Hospital and Training School in Chicago, 1891). In addi- tion to providing a site for care, these hospitals were also the place black physicians could practice medicine, as they were excluded from segregated hospital staffs elsewhere.

Despite the long history of these institutions, until the 20th century, not much could be done for patients in hospitals that could not also be accomplished at home. The simple reason was that medical science was not yet sufficiently advanced. In fact, hospitals were still places mostly poor people went for care; the “best” care was delivered at home. Exhibit 4.1 sum- marizes some of the scientific developments that enabled hospitals to become the preferred and higher quality centers for medical attention.

EXHIBIT 4.1. Some Technologies That Consolidated Care in Hospitals

■ Anesthesia. Crawford Long, MD, used diethyl-ether anesthesia for the first time on 30 March 1842 to remove

a neck tumor of a patient in Jefferson, Georgia. Anesthesia allowed longer and safer surgeries.

■ Radiology. W. C. Roentgen, MD, published Über eine neue Art von Strahlen (On a New Kind of Rays) in the

Sitzungsberichte der Physikalisch-Medizinischen Gesellschaft in Germany in January 1896. His work heralded

the practice of radiology.

■ Blood banking. In 1901, Karl Landsteiner identified three blood groups, A, B, and O (which he called C),

and found that transfusions between persons with the same type did not cause agglutination of red blood

cells (a transfusion reaction that can be fatal).a Based on this finding, the first successful blood transfusion

was performed by Reuben Ottenberg at Mount Sinai Hospital in New York in 1907. While the problem of

incompatibility had been clarified, transfusions were not helpful unless a person was on hand who could

15The first Jewish hospitals in the United States were the Jewish Hospital in Cincinnati (1850) and the Jews’ Hospital in New York City (1855), later renamed Mt. Sinai. 16Katz, R. (2008). Continuing their mission, Jewish hospitals continue to invest in philanthropy. The Forward (June 18). Retrieved May 2, 2018 from http://www.forward.com/articles/13591

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Hospitals and Healthcare Systems 87

donate enough blood of the same type as that of the patient. In 1915, Richard Lewisohn, also at Mount Sinai

Hospital, used sodium citrate to keep blood from coagulating, and Richard Weil demonstrated the feasibility

of refrigerated storage of anticoagulated blood. Two years later, during World War I, Oswald Hope Robertson

used these storage techniques to found what is recognized as the first blood bank.

■ Laboratory. Diagnostic laboratory tests (particularly examination of urine) were performed in ancient Egypt.

Physicians conducted simple tests at the patient’s bedside while more complex ones were carried out in a

chemistry lab. It was only after the mid-20th century, with advent of sophisticated and expensive automated

analyzers, that hospital laboratories were the main focus of such studies.

Examination of tissue removed from a patient for diagnostic purposes took on clinical significance only

after the latter half of the 19th century, when special stains were developed to identify different normal and

abnormal cellular structures. The tissue processing was carried out in a hospital laboratory. Subsequent intro-

duction of immunochemical and electron microscopic studies consolidated the role of the hospital laboratory

in high-technology diagnostics.

■ Professional nursing. While Dr. Valentine Seaman at New York Hospital is credited with establishing the first

nursing school in the United States (1798), it was in 1872 that the first permanent school was founded at

the New England Hospital for Women in Boston.b The nursing schools that were created after that time were

hospital based and had varying amounts of lecture and scientific content; however, they were all founded on

the professional teachings of Florence Nightingale. The Yale School of Nursing, established in 1923, claims to

be “the first school within a university to prepare nurses under an educational rather than an apprenticeship

program.”c Professional nursing enables high-quality and technologically enabled attention for critically ill

patients, promoting the hospital as a preferred, and often essential, site for provision of care.

■ Aseptic technique. The importance of cleanliness while performing surgery (particularly hand washing) was

known since Ignaz Semmelweis introduced the concept in Vienna in 1847. The scientific basis for this practice

was not known until the 1860s, when Louis Pasteur formulated the germ theory of disease. British surgeon

Joseph Lister pioneered antiseptic surgery and dressing treatments using carbolic acid in the mid-1860s.d

Despite the demonstrated benefits of these theories and practices, physicians were very slow to adopt anti-

septic methods, making hospitals very dangerous places to have surgery or deliver a baby. In fact, even after

Lister presented his scientific findings in Philadelphia at the U.S. Centennial in 1876, many prominent Amer-

ican surgeons were still skeptical of the benefits of his practices. It was only after the 1880s that antiseptic

surgery became widespread.e

■ Teaching hospitals. While not all hospitals serve as teaching facilities for medical students and those studying

specialties after graduation (residents), the emergence of institutions serving that purpose enhanced the

reputation of all hospitals as a safe, high-quality place to obtain care. Although a few such establishments

existed in the late 19th century (such as the Hospital of the University of Pennsylvania), it was the newly

built Johns Hopkins Hospital (1889), modeled on European teaching institutions, that set the standard. The

proliferation of teaching hospitals dates from 1910, when Abraham Flexner published his highly influential

report that reformed medical school teaching.f Prominent examples built at that time include Peter Bent

Brigham Hospital (Harvard) and Barnes Hospital (Washington University).

a In 1939, Landsteiner and colleagues discovered another category of blood types (the Rh factor) that was causing unexplained reactions in patients receiving blood from a donor with a compatible ABO match.

b Goodnow, M. (1916). Outlines of nursing history. Philadelphia: W.B. Saunders. c Yale School of Nursing (2018). About YSN. Retrieved May 2, 2018 from http://nursing.yale.edu/about-ysn

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88 The U.S. Healthcare System

d Lister, J. (1867). Illustrations of the antiseptic system of treatment in surgery. The Lancet 90, 668–669. e Millard, C. (2011). Destiny of the republic: A tale of madness, medicine and the murder of a president. NY: Doubleday. The author claims that President Garfield would have survived his assassination attempt were it not for his physician’s unsterile probing of his wound, which led to the massive infection that eventually killed him. Aseptic techniques were widely adopted thereafter in the United States.

f Ludmerer, KM. (1983). The rise of the teaching hospital in America. Journal of the History of Medicine and Allied Sciences 38, 389–414. Flexner, A. (2002). Medical education in the United States and Canada. From the Carnegie Foundation for the Advancement of Teaching, Bulletin 4, 1910 Bulletin of the World Health Organization, 80, 594–602.

AMERICAN HOSPITAL EXPANSION IN THE 20TH CENTURY

By the early 1900s, hospitals were well established as a desired place for care; their pay- ment sources, however, started to change over the next 50 years.17 Early in the 20th century, these institutions were still largely philanthropic organizations whose trustees were more than a governing board; they were the financial backers and administrators. With the emer- gence of commercial insurance in the 1930s and beyond, hospitals started to make more of their money from that source, and the organizational culture shifted from charity care to more of a for-profit model. This trend accelerated after World War II with a substan- tial increase in coverage by private insurance. In addition to changes in financing, a need arose for construction of more hospital beds,18 particularly in rural areas. Subsequent gov- ernment policy to correct this problem was directed at both encouraging construction of more hospitals and adding more beds to existing institutions, thus promoting community hospitals as the centers of the healthcare system. The hope was also that with more rural community hospitals, physician supply in these areas would increase. Hospitals, however, were concerned about how they were going to pay for this construction, especially given the looming possibilities of national health insurance.19 They also faced the threat of expan- sion of government hospital capacity, thus increasing competition with the private sector. In order to ensure a funding source and continued strength of the private sector, hospitals lob- bied the federal government for subsidies. According to Rosemary Stevens, “the instigating force for the hospital construction bill was George Bugbee, the AHA’s [American Hospital Association’s] executive director.”20 Bugbee successfully garnered bipartisan support for

17For more details about these events, see the section in Chapter 6, “Origins and Current Status of Private Health Insurance in the United States.” 18Rufus Rorem highlighted this maldistribution as early as 1930 in The Public’s Investment in Hospitals (Chicago: Uni- versity of Chicago Press). Action to address the problem only came after July 1944, when the U.S. Surgeon General, Dr. Thomas Parran, told the Senate Subcommittee on Wartime Health and Education that 1,200 U.S. counties with a popula- tion over 15,000 persons had no recognized hospital facilities. He estimated that 419,400 new and replacement beds were needed. The testimony was covered in JAMA 125 (12): 856–857, 1944. 19President Roosevelt included such a possibility in his “Second Bill of Rights Message,” as part of his January 11, 1944, State of the Union Speech when he stated that every family has “the right to adequate medical care and the opportunity to achieve and enjoy good health.” He reinforced this message in his January 1945 budget message to Congress. Also in 1945, the Wagner-Murray-Dingell bill included a proposal for a national insurance plan. 20Stevens, R. (1989). In sickness and in wealth, American hospitals in the twentieth century. New York: Basic Books.

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Hospitals and Healthcare Systems 89

passage in August 1946 of the Hospital Survey and Construction Act (Public Law [P.L.] 79–95), called the Hill-Burton Act, after its sponsors, Senators Lister Hill (D-Alabama) and Harold H. Burton (R-Ohio).21 It is important to note that the act (passed in the Truman admin- istration) originally had a universal insurance coverage provision, which was eliminated because of anticipated costs.22 The Hill-Burton program required states to conduct hospi- tal need assessments, formulate construction plans, and build the facilities by contributing $2 for every $1 of federal money.23 Preference was given to rural facilities and university hospitals that served as referral centers; only governmental and nonprofit facilities were eligible. Funds were also available under this program for other types of healthcare organiza- tions, including skilled-nursing facilities, rehabilitation facilities, nursing schools, and public health centers.

In exchange for funding, recipients had two obligations. First, all facilities were required by the Community Service Assurance of Title VI of the Public Health Service Act “to make services provided by the facility available to persons residing in the facility’s service area without discrimination on the basis of race, color, national origin, creed, or any other ground unrelated to the individual’s need for the service or the availability of the needed service in the facility.”24 Application of this requirement means that the facility must make emergency services available to all patients regardless of their ability to pay. Prior to the enactment of civil rights legislation, the “separate but equal” doctrine was acceptable in fulfillment of this condition.

In addition to the community service requirement, many facilities were also subjected to the “uncompensated care provision.” In return for governmental financing, they were “required to develop an uncompensated care allocation plan, indicating the type of services available to persons unable to pay . . . [and] publish a notice of their obligation to provide free medical care in a local newspaper, post notices within their facility, and provide individual notices of the availability of free care to all patients.”25

The Public Health Service (PHS) determined the total amount of uncompensated care a hospital was required to pay back and prorated it over 20 years, starting with the date of completion of construction of the facility. At least once in 3 years, these institutions are required to report to the Department of Health and Human Services (DHHS) the amount of free care they provide. The PHS could also determine whether the facility can accelerate or extend its payback obligation. Each year, DHHS determines the poverty guidelines that

21Senator Burton was appointed to the Supreme Court before the bill was introduced. Much of the credit for its passage belongs to the other Ohio senator, Robert Taft. 22Mantone, J. (2005, August 15). The big bang: The Hill-Burton Act put hospitals in thousands of communities and launched today’s continuing healthcare building boom. Modern Healthcare, 15, 35, 6–7, 16 23The federal contribution portion increased in subsequent years. 24U.S. Office of Civil Rights. (2018). Medical treatment in Hill-Burton funded healthcare facilities. See this site for a full list of obligations. Retrieved May 2, 2018 from www.hhs.gov/ocr/civilrights/understanding/Hill-Burton 25Department of Health and Human Services Office of Inspector General. (1992, August). Public health service’s over- sight of the Hill-Burton program, 1.

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90 The U.S. Healthcare System

apply to pay-back of Hill-Burton obligations.26 Of note is that these requirements are very similar to the current community service requirements described below.

After the enactment of Hill-Burton, more than $4.6 billion in grants and $1.5 billion in loans were allocated to projects that led to the construction of or equipment for roughly 6800 health- care facilities in more than 4000 communities . . . The bulk of the funding was provided from 1960 to 1979, with $3.5 billion being issued. From 1980 to 1997, the last time money was issued, $200 million was allocated.27

As of December 2011, there were still 181 facilities in 40 states that had Hill-Burton obli- gations.28 Virtually all of these facilities are expected to pay back their obligations by 2020.

The results of this program have been somewhat mixed. The program did not achieve the goal of bringing more physicians to underserved areas; but, at best, “the program might have prevented the more deprived areas from falling even farther behind in the availability of doc- tors.”29 The program was more successful in stimulating hospital construction, particularly in poorer areas. “A nearly complete equalization of bed supplies had occurred by 1970 across states ranked in the lowest, middle and highest thirds for bed supplies in 1950.”30 This ben- efit was statistically significant even accounting for the country’s increase in affluence and the rapid emergence of private health insurance.

After the Hill-Burton Act, the second major financial impetus for hospital construction occurred in 1963 with the issuance of Internal Revenue Service (IRS) Revenue Ruling 63-20, 1963-1 C.B. 24. This ruling allowed private, nonprofit hospitals to issue tax-free bonds. (The implications for this benefit are explained below.) The conditions allowing issuance of such debt are explained in Exhibit 4.2.

EXHIBIT 4.2. IRS Conditions Allowing Issuance of Tax-Exempt Hospital Debt

According to the IRS, 63-20 corporations are formed under state nonprofit law for purposes of issuing obligations

on behalf of a political subdivision and must meet five criteria:

1. The corporation must engage in activities which are essentially public in nature.

2. The corporation must be one which is created under the state’s general nonprofit corporation law (and is

not organized for profit except to the extent of retiring indebtedness).

26For example, see: U.S. DHHS Program Policy Notice No. 11-02 (revision), March 1, 2011. 27Mantone, J. (2005, August 15). The big bang: The Hill-Burton Act put hospitals in thousands of communities and launched today’s continuing healthcare building boom. Modern Healthcare, 6–7, 16 28Health Resources and Services Administration. (2018). Hill-Burton facilities waiver and recovery. Retrieved from www .hrsa.gov./gethealthcare/affordable/hillburton/waiver.html 29Hochban, J., Ellenbogen, B., Benson, J., & Olson, R. M. (1981). The Hill-Burton program and changes in health services delivery. Inquiry, 18, 61–69. 30Clark, L. J., Field, M. J., Koontz, T. L., & Koontz, V. L. (1980). The impact of Hill-Burton: An analysis of hospital bed and physician distribution in the United States, 1950–1970. Medical Care, 18, 532–550.

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Hospitals and Healthcare Systems 91

3. The corporate income must not inure to any private person.

4. The state or political subdivision thereof must have a “beneficial interest” in the corporation while the

indebtedness remains outstanding and it must obtain legal title to the property of the corporation with

respect to which the indebtedness was incurred upon the retirement of such indebtedness.

5. The corporation must have been approved by the state or political subdivision thereof, either of which must

also have approved the specific obligations issued by the corporation.

The rules for determining whether the governmental unit has the requisite “beneficial interest” in the non-

profit corporation are:

1. The governmental unit must have exclusive beneficial possession and use of at least 95% of the fair market

value of the facilities; or

2. If the nonprofit corporation has exclusive beneficial use and possession of 95% of the fair market value of

the facilities, the governmental unit appoints 80% of the members of the board of the corporation and has

the power to remove and replace members of the board; or

3. The governmental unit has the right at any time to get unencumbered title and exclusive possession of the

financed facility by defeasing (paying off or providing for payment of) the bonds.31

The third financial spur to hospital growth came when the Medicare program became operational in 1966. Reimbursement for Medicare beneficiaries was based on the costs the hospitals incurred for taking care of them, including allocated capital expenditures and inter- est payment on debt.32 These payments made the tax-free financing of facility expansion even cheaper. As explained below, these payments lasted until 1985, when they were fully replaced by payments based on Diagnosis Related Groups (DRGs).

By the mid-1960s, three types of concerns arose from these sponsored expansion activi- ties. The first problem was the uncontrolled proliferation of facilities and lack of coordination of clinical programs. This coordination problem created a barrier to efficient delivery of ser- vices and posed an obstacle to tackling issues of national healthcare importance. (Note that this problem persists and is one of the reasons for Accountable Care Organizations [ACOs], described below.) To address this situation, Congress passed P.L. 89-749 on November 3, 1966: “An Act to amend the Public Health Service Act to assist in combating heart disease, cancer, stroke and related diseases.”33Among the purposes of this law was “[t]hrough grants, to encourage and assist in the establishment of regional cooperative arrangements among medical schools, research institutions, and hospitals for research and training (including con- tinuing education) and for related demonstrations of patient care in the field of heart disease,

31IRS. Introduction to Federal Taxation of Municipal Bonds, B16. Retrieved May 2, 2018 from https://www.irs.gov/pub/ irs-tege/teb_phase_1_course_11204_-3module_b.pdf 32For an amusing, but clear, explanation of how this financing worked, see: Fisher, G. R. (1979). The hospital that ate Chicago. New England Journal of Medicine, 301, 56–57. 33Public Laws Enacted During the Second Session of the Eighty-Ninth Congress of the United States. PL 89-749. Govern- ment Printing Office, pp. 1180–1190. November 3, 1966. Retrieved May 2, 2018 from http://uscode.house.gov/statutes/ pl/89/749.pdf

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https://www.irs.gov/pub/irs-tege/teb&uscore;phase&uscore;1&uscore;course&uscore;11204&uscore;-3module&uscore;b.pdf

http://uscode.house.gov/statutes/pl/89/749.pdf

https://www.irs.gov/pub/irs-tege/teb_phase_1_course_11204_-3module_b.pdf

92 The U.S. Healthcare System

cancer, stroke, and related diseases.” The grants established 56 Regional Medical Programs (RMPs), which were cooperative arrangements “among a group of public or nonprofit pri- vate institutions or agencies engaged in research, training, diagnosis, and treatment relating to heart disease, cancer, or stroke.” This law was refunded and renewed in 1970 with

new provisions [that] reflected an emphasis on primary care and regionalization of health care resources; added prevention and rehabilitation services; added kidney disease treatment programs; added authority for new construction; required review of RMP applications by Area-wide Comprehensive Planning agencies [emphasis added]; and emphasized health ser- vices delivery and human resource utilization.34

The National Health Planning and Resource Development Act of 1974, P.L. 93-641, consolidated RMPs with the Hill-Burton and Comprehensive Health Planning federal pro- grams. The main purpose of the new law was to mandate a nationwide program of state-based Certificate of Need (CON) reviews to evaluate the necessity for new facility expansion, par- ticularly projects that used federal funds. The object of CON regulations is to set criteria for expansion of health facilities in order to prevent their unregulated growth. The fear regula- tors had was that this type of growth caused healthcare costs to rise rapidly and prevented coordination and cooperation among existing organizations. By the late 1970s, all states had CON initiatives in place.

The second concern came from the hospital industry: fear about increased com- petition coming from new facilities. Because of this worry, states adopted hospital association-initiated CON reviews at the same time the federal government drafted its legislation. New York became the first state to enact a CON law in 1964, followed 5 years later by California, Connecticut, Maryland, and Rhode Island. Other states followed, linking their efforts with federally initiated health planning agencies.35

The results of reviews of these activities have been quite mixed, particularly because of the state-by-state differences in the types of institutions that are reviewed as well as the specific methodologies.

Several older studies concluded that CON regulations have either had minimal or no direct effect on healthcare expenditures. Recent studies have found that CON regulations appear to raise the volume of procedures and average cost for specific services like cardiac and cancer care, while other research indicates that states with CON laws have lower hospital prices and flat or reduced procedure volume for certain elective surgical procedures and cardiac care. Given these disparate findings, it is no surprise that the need for CON laws remains in dispute.36

34U.S. National Library of Medicine. The regional medical programs collection. Retrieved May 2, 2018 from http:// profiles.nlm.nih.gov/ps/retrieve/Narrative/RM/p-nid/94 35Congressional Budget Office. (1997, August). Expenditures for health care: Federal programs and their effects. Retrieved May 2, 2018 from https://www.cbo.gov/sites/default/files/95th-congress-1977-1978/reports/77doc566.pdf 36Yee, T., Stark, L. B., Bond, A. M., & Carrier, E. (2001, May). Health care certificate-of-need laws: Policy or politics? National Institute for Health Care Reform Research Brief 4.

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http://profiles.nlm.nih.gov/ps/retrieve/Narrative/RM/p-nid/94

https://www.cbo.gov/sites/default/files/95th-congress-1977-1978/reports/77doc566.pdf

Hospitals and Healthcare Systems 93

As a result of the questionable benefit of this process, the federal government with- drew its requirement for CON programs in 1986. Subsequently, 14 states dropped their requirements, leaving the remaining 36 states and the District of Columbia with some type of review process.37

The third problem was the rapidly rising hospital costs associated with filling all those newly constructed beds. The concern was stated most famously by Shain and Roemer and came to be known as Roemer’s Law: “[H]ospital beds that are built tend to be used.”38 As these authors go on to explain: “Before hospital insurance became common, family income largely determined which cases would go to hospitals. With widespread insurance, however, the kinds of cases that are hospitalized in any community reflect the number of beds pro- vided.” Both admission rates and lengths of stay accounted for the increased occupancies. The expanding utilization could not be explained just by the availability of beds in the com- munity; for example, the occupancy rate was not highest where bed supply (measured in beds per 1,000) was lowest, or vice versa. Nor could the increase be attributed to an increased inci- dence of disease or patients from more remote sites coming to these newly built or expanded facilities.39 While attention to this problem and proposed solutions came with the growing prominence of utilization review in the 1980s, more recent evidence indicates this problem persists.40

In the first decade of the 21st century, after a long lull in hospital construction, a flurry of activity occurred due to new programmatic opportunities, changing patterns in care, and the need to replace aging facilities. The differences between this more recent building surge and those of the past are twofold. First, the source of building funds has changed: more equity, less debt, and no major government sponsorship. According to the 2012 Health Facilities Management/American Society for Healthcare Engineering (HFM/ASHE) annual survey:

Organizations are relying less on bank loans and other debt to finance construction projects than at any time since the HFM/ASHE survey began in 2005. Just 17 percent are using debt, down from 20 percent a year ago, compared with 42 percent drawing on cash reserves . . . Use of tax-exempt bonds also is at its lowest in at least six years, accounting for just 21 percent of construction financing among survey respondents.41

The second difference is the types of construction have changed:

1. Newer hospitals have fewer beds than their predecessors and a higher ratio of intensive care beds to general medical/surgical beds.

37See the American Health Planning Association website for a current list of which states have CON programs and what they cover. Retrieved May 2, 2018 from http://www.ahpanet.org/matrix_copn.html 38Shain, M., & Roemer, M. I. (1959). Hospital costs relate to the supply of beds. Modern Hospitals, 92, 71–73, 168. 39Roemer, M. I. (1961). Bed supply and hospital utilization: A natural experiment. Hospitals, 35, 36–42. 40Delamater, P. L., Messina, J. P., Grady, S. C., WinklerPrins, V., & Shortridge, A. M. (2013, February 13). Do more hospital beds lead to higher hospitalization rates? A spatial examination of Roemer’s law. PLoS One. doi:10.1371/journal .pone.0054900 41Carpenter, D., & Hoppszallern, S. (2012). Time to build? Reform uncertainties drive financial scrutiny for new projects. Health Facilities Management, 25(2), 12–18, 20.

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94 The U.S. Healthcare System

2. More outpatient than inpatient facilities are being built. Recently, this construction has been in the form of urgent care centers (freestanding emergency departments) and physician offices.

3. More renovation than new construction.

The reason for these structural changes is the trend toward delivery of more care outside the hospital (outpatient care). More recent trends also include a surge in behavioral health facility construction and “resilient design” projects to help buildings withstand natural dis- asters.42

Regardless of the form these construction projects take, they all share one common theme: redesign of facilities around patient perceptions and needs. One of the earliest insti- tutions in this redesign trend was Northwestern Memorial Hospital, which completed a new facility in 1999. In describing the new focus for hospital design, then-CEO Gary Mecklen- burg said:

Health care today is a consumer service, no different from a whole host of oth- ers . . . consumers don’t want to go to a cold, sterile, unfriendly environment. Part of what drove the design of our building was the recognition that people wanted something different in the environment. We asked people what they thought about hospitals and they told us they didn’t like hospitals. People expected a different environment, different décor, a different delivery system.43

This consumer-driven approach has persisted. According to a 2016 report:

More than 86 percent of survey respondents said that patient satisfaction is “very impor- tant” in driving design changes to health facilities and/or services. Another 12 percent said patient satisfaction is “somewhat important” in driving changes. No respondents said patient satisfaction was “not at all important” in design.44

HOSPITAL DEFINITION AND CLASSIFICATIONS

Definition In addition to the OED description, the legal definition of a hospital varies from state to state. Exhibit 4.3 provides some examples. The common features are capabilities to provide overnight (or longer) care to two or more unrelated persons for a variety of

42Burmahl, B., & Morgan, J. (2018, March 7). Hospital Construction Survey: Resilient design takes center stage as a top project consideration for health care facilities. Health Facilities Management. Retrieved May 2, 2018 from https://www .hfmmagazine.com/articles/3291-hospital-construction-survey 43Weinstock, M. (2006). Taking stock. Interviews with Gary Mecklenburg and Anthony Barbato. Hospital and Health Networks, 80(9), 42–45. 44Hoppszallern, S., Vesely, R., & Morgan, J. (2016, February 3). Hospital Construction Survey: Patient experience drives design and construction. Health Facilities Management. Retrieved May 2, 2018 from https://www.hfmmagazine.com/ articles/1878-2016-hospital-construction-survey

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https://www.hfmmagazine.com/articles/1878-2016-hospital-construction-survey

Hospitals and Healthcare Systems 95

EXHIBIT 4.3. Examples of Legal Definitions of Hospitals

California

“General acute care hospital” means a hospital, licensed by the Department, having a duly constituted governing

body with overall administrative and professional responsibility and an organized medical staff which provides

24-hour inpatient care, including the following basic services: medical, nursing, surgical, anesthesia, laboratory,

radiology, pharmacy, and dietary services. A general acute care hospital shall not include separate buildings which

are used exclusively to house personnel or provide activities not related to hospital patients.

Illinois

“Hospital” means any institution, place, building, buildings on a campus, or agency, public or private, whether

organized for profit or not, devoted primarily to the maintenance and operation of facilities for the diagnosis

and treatment or care of two or more unrelated persons admitted for overnight stay or longer in order to obtain

medical, including obstetric, psychiatric and nursing, care of illness, disease, injury, infirmity, or deformity . . .

The term “hospital” does not include:

1. Any person or institution required to be licensed pursuant to the Nursing Home Care Act, the Specialized

Mental Health Rehabilitation Act, or the ID/DD Community Care Act;

2. Hospitalization or care facilities maintained by the State or any department or agency thereof, where such

department or agency has authority under law to establish and enforce standards for the hospitalization or

care facilities under its management and control;

3. Hospitalization or care facilities maintained by the federal government or agencies thereof;

4. Hospitalization or care facilities maintained by any university or college established under the laws of this

State and supported principally by public funds raised by taxation;

5. Any person or facility required to be licensed pursuant to the Alcoholism and Other Drug Abuse and Depen-

dency Act;

6. Any facility operated solely by and for persons who rely exclusively upon treatment by spiritual means

through prayer, in accordance with the creed or tenets of any well-recognized church or religious

denomination;

7. An Alzheimer’s disease management center alternative healthcare model licensed under the Alternative

Health Care Delivery Act; or

8. Any veterinary hospital or clinic operated by a veterinarian or veterinarians licensed under the Veterinary

Medicine and Surgery Practice Act of 2004 or maintained by a State-supported or publicly funded university

or college.

Massachusetts

“Hospital” means any institution in the Commonwealth of Massachusetts, however named, whether conducted

for charity or for profit, which is advertised, announced, established, or maintained for the purpose of caring for

persons admitted thereto for diagnosis or medical, surgical, or restorative treatment which is rendered within said

institution. This definition shall not include any hospital operated by the Commonwealth of Massachusetts or by

the United States.

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96 The U.S. Healthcare System

conditions. Because these features also describe such organizations as skilled nursing facilities, the laws say, in effect: It is a hospital unless it is not; that is, unless it is covered by another licensing law.45 The American Hospital Association will list a facility in its hospital guide if it is accredited by one of several organizations (see Chapter 9, “Quality”) or meets a long list of features about size (at least six beds) and operational require- ments (e.g., presence of a responsible governing authority, pharmacy, continuous nursing services, etc.).46

Ways Hospitals May Be Classified and Special Related Issues Although all licensed hospitals have a single legal definition in each state, they are obviously quite different from one another. It is, therefore, important to understand some of the differ- ent ways hospitals can be categorized for such purposes as peer group comparisons, quality evaluations, and market segmentation activities.

It should be noted, however, that despite these differences, all hospitals are facing the same environmental forces, particularly shrinking number of beds due to expanded outpa- tient treatment capabilities and increasing costs. Two major reasons for the cost increases are increases in acuity of care and the nature of the hospital business: very personal and personnel-intensive care. Contrary to popular opinion that hospital expenses are driven by costs of technology, a significant portion of costs is due to wages and benefits. When hos- pital cost containment is considered, one must account for the effect on quality of reducing people. Exhibit 4.4 displays categories of typical hospital costs.

Some of the common ways hospitals are classified, with brief descriptions of each, are presented next.

Size. The usual metric for hospital size is total number of beds. This number can be con- fusing, however, since bed size can be expressed as number of licensed beds (what the state allows the hospital to operate) or the number of beds actually available for use. For example, the hospital may be licensed for 100 beds, but because of cost overruns or staff shortages, it operates 80 beds. The wide distribution of hospitals by bed size is displayed in Exhibit 4.5.

Levels of Care. Levels of care have been traditionally divided into primary, secondary, ter- tiary, and quaternary. The definition of primary care usually mentions that it is the first point of contact patients have with the healthcare system. (Please see Chapter 6, “Payers,” for a full definition and explanation of this term.) For purposes of hospital classification, “a primary care hospital offers basic services, such as an emergency department and limited intensive care facilities. A secondary care hospital generally offers primary care, general

45See, for example, the exceptions listed in the Illinois statute in Exhibit 4.3. Some facilities are excluded not because they are not hospitals, but they are not subject to the state licensing statute, for example, “facilities maintained by the federal government or agencies thereof.” 46AHA Guide 2012 edition. P. A2 Health Forum LLC. An American Hospital Association Company. 155 N. Wacker Drive, Chicago, IL 60606-1725.

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Hospitals and Healthcare Systems 97

EXHIBIT 4.4. Percentage of U.S. Hospital Costs in 2016, by Type of Expensea

56%

11.9%

6.7%

1.2%1.8% 5.5% 5.7%

11.2%

70%

60%

50%

40%

30%

20%

10%

0% Wages and

benefits Professional

fees Prescription

drugs Utilities Professional

liability insurance

All other: non-labor intensiveb

All other: labor

intensive

Other productsc

P e

rc e

n ta

g e

o f

sp e

n d

in g

o n

h o

sp it

a l

ca re

a Does not include capital. b Includes postage and telephone expenses. c For example food, medical instruments, etc.

internal medicine, and limited surgical and diagnostic capabilities. A tertiary care hospital provides a full range of basic and sophisticated diagnostic and treatment services, including many specialized services.”47

The term “secondary care” is not much used in the United States but is particularly common in European countries. It generally refers to the type of care provided at a com- munity hospital. The “specialized services” of the tertiary care hospital often include such procedures as cardiovascular surgery and transplantation. An additional term used by some people is “quaternary care,” which refers to a tertiary care center that is extensively involved in research and experimental treatments.

Many tertiary and quaternary care centers are also teaching hospitals (some of which are also called academic medical centers). A useful definition for these organizations comes

47Federal Trade Commission, Department of Justice. (2004, July). Improving health care: A dose of competition. A report by the Federal Trade Commission and the Department of Justice. Retrieved May 2, 2018 from http://www.justice.gov/ atr/public/health_care/204694/chapter3.htm#3

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98 The U.S. Healthcare System

EXHIBIT 4.5. Number of Registered Hospitals in the United States in 2016, by Number of Beds

1,500

1,250

1,000

750

N u

m b

e r

o f

h o

sp it

a ls

500

567

6 to

2 4

25 to

4 9

50 to

9 9

10 0

to 1

20 0

to 2

30 0

to 3

40 0

to 4

50 0

or m

or e

1,217

1,091 1,157

627

Number of beds

360

196

319

250

from the membership requirements for the Council on Teaching Hospitals (COTHs) section of the American Hospital Association:

Membership in COTH is limited to organizations having a documented affiliation agreement with a medical school accredited by the Liaison Committee on Medical Education (LCME) [the organization that accredits medical schools in the United States and Canada]. Typically, these organizations must sponsor, or participate significantly in, at least four approved, active residency programs. At least two of the approved residency programs should be in medicine, surgery, obstetrics/gynecology, pediatrics, family practice, or psychiatry.48

Ownership of these facilities varies widely. They can be independent corporations (fre- quently but not exclusively nonprofit) or owned by the affiliated university. According to the American Association of Medical Colleges,49 while the nearly 400 teaching hospitals represent only 6% of all U.S. hospitals, they provide:

■ 40% of neonatal intensive care units,

■ 61% of pediatric intensive care units,

48AAMC. Council of Teaching Hospitals and Health Systems. Retrieved May 2, 2018 from https://www.aamc.org/ download/333616/data/cothmemberservices.pdf 49Ibid.

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https://www.aamc.org/download/333616/data/cothmemberservices.pdf

Hospitals and Healthcare Systems 99

■ 79% of all burn care units,

■ 48% of the surgical transplant services,

■ 44% of Alzheimer centers,

■ 22% of all cardiac surgery services,

■ 41% of all hospital charity care, and

■ Are the sites for approximately 28% of all Medicaid hospitalizations.

In addition to the usual insurance payments described below, teaching hospitals receive supplemental funds from Medicare Part A that are called Medicare Direct Graduate Medical Education (DGME) Payments. These payments started with the beginning of Medicare50 and were initiated for two reasons: recognition of the importance of training medical specialists and an inducement for teaching hospitals to participate in the Medicare program. The amount of Graduate Medical Education (GME) support was capped by the Balanced Budget Act of 1997. According to Iglehart:51

Medicare remains the largest supporter of GME, providing both direct payments to hospitals that cover medical education expenses related to the care of Medicare patients (about $3 billion per year) and an indirect medical education (IME) adjustment to teaching hospitals for the added patient-care costs associated with training (about $6.5 billion).

Annual amounts are modified by an update factor (with slightly more support going to primary care residency programs)52 and cover about 100,000 physician trainees. Federal agencies and state Medicaid agencies spent over $16.3 billion in 2015 to fund GME train- ing for physicians—commonly known as residency training. According to a 2018 study, the Government Accountability Office (GAO) found that in 2015 the “federal government spent $14.5 billion through five programs, and 45 state Medicaid agencies spent $1.8 billion. About half of teaching sites that received funding—such as teaching hospitals—received funds from more than one of the five programs.”53 (Please see Exhibit 4.6.)

Increasing economic pressures have caused many states to cut back on their GME fund- ing.54 In addition, the federal government is considering reduction of the IME portion of its subsidies. Of note is that the Departments of Veterans Affairs and Defense also support GME at their own teaching hospitals.

50House Report, Number 213, 89th Congress 1 Session 32 (1965), and Senate Report, Number 404, Pt. 1 89th Congress 1 Session 36 (1965). 51Iglehart, J. K. (2012). Financing graduate medical education-mounting pressure for reform. New England Journal of Medicine, 366, 1562–1563. 52For more details about DGME payments see: Medicare Direct Graduate Medical Education (DGME) Payments. Retrieved May 2, 2018 from https://www.aamc.org/advocacy/gme/71152/gme_gme0001.html 53GAO. (2018, March 29). Physician workforce. HHS needs better information to comprehensively evaluate graduate medical education funding. Retrieved May 2, 2018 from https://www.gao.gov/assets/700/690580.pdf 54Association of American Medical Colleges. (2016). Medicaid graduate medical education payments—A 50-state sur- vey. Retrieved May 2, 2018 from https://www.documentcloud.org/documents/4392445-Medicaid-Graduate-Medical- Education-Payments-a.html

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https://www.aamc.org/advocacy/gme/71152/gme_gme0001.html

https://www.gao.gov/assets/700/690580.pdf

https://www.documentcloud.org/documents/4392445-Medicaid-Graduate-Medical-Education-Payments-a.html

100 The U.S. Healthcare System

EXHIBIT 4.6. Federal Spending on Graduate Medical Education Training, 2015

Program Total GME Spending ($in millions)

Percentage of Total Spending (%)

HHS programs

Medicare 10,335 71

Medicaid (federal share) 2,351 16

Children’s Hospital GME Payment Program 249 2

Teaching Health Center GME Program 76 1

VA program 1,499 10

Total 14,509 100

Source: GAO: Physician workforce. HHS needs better information to comprehensively evaluate graduate medical education fund- ing. March 2018. Retrieved from https://www.gao.gov/assets/700/690581.pdf

In addition to the common hospital definition, teaching hospitals also share three essen- tial features in their mission statements: patient care, education of healthcare professionals (such as physicians and nurses), and research. (Please see Exhibit 4.7 for examples of these statements.) Despite the clarity of these three elements, members of the organization will prioritize them differently. For example, in a teaching hospital without a nursing school, nurses will put patient care far ahead of teaching and research. On the other hand, a junior faculty member will give top priority to research, since productivity in that area alone will determine promotion, tenure, and salary. The other activities merely take time away from research. Leaders in this setting often have conflicting priorities depending on which role they play in a given situation. For example, the dean of a medical school must prioritize research because it affects rankings in the popular press. However, in order to attract medical students, teaching must get high marks. Further, if the dean is head of the faculty medical group, patient care takes priority because it is the largest source of the group’s income. All these different priorities result in mission conflicts. While they cannot always be resolved, they must be appreciated when these organizations formulate their strategies and allocate resources.

Corporate Status/Sponsorship. One of the most common distinctions among hospitals is whether they are operated as for-profit or nonprofit enterprises. (Please see Exhibit 4.8 for trends and relative numbers of these institutions.)

For-profits can be held either privately or by shareholders who trade ownership on stock exchanges. Many of the largest for-profit systems are headquartered in the Nashville area because of their connections with the largest such system located there, Hospital Corporation of America (HCA). Consider these examples: In 2007, Community Health Systems cemented

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Hospitals and Healthcare Systems 101

EXHIBIT 4.7. Sample Mission Statements of Teaching Hospitals

Mission Statement of St. Michael’s Hospital, Toronto, Ontarioa

At St. Michael’s Hospital, we recognize the value of every person and are guided by our commitment to excellence

and leadership. We demonstrate this by:

■ Providing exemplary physical, emotional, and spiritual care for each of our patients and their families

■ Balancing the continued commitment to the care of the poor and those most in need with the provision

of highly specialized services to a broader community

■ Building a work environment where each person is valued, respected, and has an opportunity for personal

and professional growth

■ Advancing excellence in health services education

■ Fostering a culture of discovery in all of our activities and supporting exemplary health sciences research

■ Strengthening our relationships with universities, colleges, other hospitals, agencies, and our community

■ Demonstrating social responsibility through the just use of our resources

The commitment of our staff, physicians, volunteers, students, community partners, and friends to our mission

permits us to maintain a quality of presence and tradition of caring, which are the hallmarks of St. Michael’s.

Mission Statement of Northwestern Medicine (Academic System) Chicago, ILb

Northwestern Medicine is a premier integrated academic health system where the patient comes first.

■ We are all caregivers or someone who supports a caregiver.

■ We are here to improve the health of our community.

■ We have an essential relationship with Northwestern University’s Feinberg School of Medicine.

■ We integrate education and research to continually improve excellence in clinical practice.

■ We serve a broad community and bring the best in medicine closer to where patients live and work.

a stmichaelshospital.com/about/mission.php. b https://www.nm.org/about-us.

its corporate location by its purchase of Triad, an HCA spin-off; Lifepoint was founded in 1999 as a spin-off of 23 HCA hospitals; and Vanguard Health Systems was formed in July 1997 by group of healthcare executives led by Charles Martin, Jr., a former HCA executive.

One of the hallmarks of a nonprofit hospital is its tax-exempt status. According to Castro:55

The policies that initially conferred tax-exempt status on hospitals can trace their roots to the Elizabethan Statute of Charitable Uses of 1601. This British statute commonly bestowed

55Castro, A. I. (1995). Overview of the tax treatment of nonprofit hospitals and their for-profit subsidiaries: A short-sighted view could be very bad medicine comment. Pace Law Review, 15, 501–505.

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102 The U.S. Healthcare System

EXHIBIT 4.8. Number of Hospitals in the United States from 2009 to 2016, by Ownership Type

1,000

2,000

3,000

4,000

5,000

6,000

State/local government Non-profit For-profit Total

2009 2010 2011 2012 2013 2014 2015 2016

N u

m b

e r

o f

h o

sp it

a ls

Source: American Hospital Association © Statistica 2018. Used with permission.

exemptions upon hospitals and other “charitable” organizations which promoted the common general welfare. The United States initially adopted this interpretation through its early com- mon law. The federal government subsequently recognized income tax exemption with the enactment of the Revenue Act of 1894, and afterward with the ratification of the Sixteenth Amendment.

By 1959, the statutes dealing with the tax-exempt status of charitable organizations were consolidated into IRS code 501(c)(3). Nonprofit hospitals are currently incorporated under this code. (Please see Exhibit 4.9 for a full explanation of this category.) The portions that apply directly to hospitals are the charitable, religious, educational, or scientific missions and the requirement that they not be organized or operated for the benefit of private interests. (Hospitals are also evaluated for nonprofit status by state/local governments. Since the criteria for these evaluations can be very different, they will be considered separately.)

Because the U.S. Tax Code does not contain a definition for the word “charitable,” the IRS has used two standards over the years to evaluate whether a hospital meets the criteria of 501 (c) (3): the “charity care standard” and the “community benefit standard.” From 1956 to 1969, IRS Revenue Ruling 56–185 was the statute that spelled out the requirements a hospital needed to meet in order to qualify for 501(c)(3) status. Under this Ruling, a hospital had to provide, within its financial ability, free or reduced-cost care to patients unable to pay for it. It did not specify a minimum requirement for dollars spent or number treated.

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Hospitals and Healthcare Systems 103

EXHIBIT 4.9. Exemption Requirements—Section 501(c)(3) Organizations

To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and

operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any

private shareholder or individual. In addition, it may not be an action organization, i.e., it may not attempt to

influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or

against political candidates.

Organizations described in section 501(c)(3) are commonly referred to as charitable organizations.

Organizations described in section 501(c)(3), other than testing for public safety organizations, are eligible to

receive tax-deductible contributions in accordance with Code section 170.

The organization must not be organized or operated for the benefit of private interests, and no part of a

section 501(c)(3) organization’s net earnings may inure to the benefit of any private shareholder or individual.

The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary,

testing for public safety, fostering national or international amateur sports competition, and preventing cruelty

to children or animals. The term charitable is used in its generally accepted legal sense and includes relief of

the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science;

erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening

neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law;

and combating community deterioration and juvenile delinquency.

Source: Internal Revenue Service Exemption Requirements, Section 501(c)(3) Organizations. Retrieved May 2, 2018 from https:// www.irs.gov/charities-nonprofits/charitable-organizations/exemption-requirements-section-501c3-organizations

With the advent of Medicare and Medicaid in 1966, and the further availability of pri- vate health insurance, charity care and philanthropy were becoming even less of a factor in hospital finances. So, in 1969, the IRS issued Revenue Ruling 69-545, replacing the “charity standard” with a new “community benefit standard.” Under the newer rule:

A nonprofit organization whose purpose and activity are providing hospital care is promoting health and may, therefore, qualify as organized and operated in furtherance of a charitable purpose . . . The promotion of health, like the relief of poverty and the advancement of educa- tion and religion, is one of the purposes in the general law of charity that is deemed beneficial to the community as a whole even though the class of beneficiaries eligible to receive a direct benefit from its activities does not include all members of the community, such as indigent members of the community, provided that the class is not so small that its relief is not of benefit to the community.56

The specific criteria mentioned in the ruling require that the hospital uses “its surplus funds to improve the quality of patient care, expand its facilities, and advance its medical training, education, and research programs.”57 It must also operate an accessible emergency

56Rev. Rul. 69-545, 1969-2 C.B. 117. 57Rev. Rul. 83-157, 1983-2 C.B. 94 set conditions for hospitals to maintain their 501(c)(3) status without having an emer- gency room, for example, if it would duplicate existing services or the hospital was very specialized (like a rehabilitation facility) and provided its community benefits in other ways.

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104 The U.S. Healthcare System

room, maintain a medical staff open to all qualified physicians, and vest control of the hospital in its board of trustees, composed of independent civic leaders.

In subsequent years, Congress and the public have become more skeptical about the tax-exempt status of these institutions. Particular areas of suspicion include:

the prices charged to low-income uninsured patients for medical care in comparison to those charged patients paying through insurance; the methods used by hospitals to collect payment from patients and the classification of bad debt as a community benefit; an increasing num- ber of partnerships between tax-exempt hospitals and for-profit entities; and the amount of compensation paid to high-level employees.58

Research has shown some justification for these worries. “In 2009, tax-exempt hospitals varied markedly in the level of community benefits provided, with most of their benefit-related expenditures allocated to patient care services. Little was spent on community health improvements.”59

Of further concern, particularly in bad economic times, are lost direct tax revenues from these institutions. Calculating the exact amount of this loss is difficult because of lack of current data, differences in what studies include in the community benefits hospitals provide, and differences in assigning an actual dollar value for those benefits. Given these caveats, what is currently claimed about the trade-off between tax benefits and community benefits can be summarized as follows:

■ “The Congressional Joint Committee on Taxation estimated the value of the nonprofit hospital tax exemption at $12.6 billion in 2002—a number that included forgone taxes, public contributions, and the value of tax-exempt bond financing . . . [W]e estimate that the size of the exemption reached $24.6 billion in 2011.”60

■ Tax exempt giving to nonprofit hospitals and healthcare systems in 2016 was $10.143 billion.61

■ “In 2013, the estimated tax revenue forgone due to the tax-exempt status of nonprofit hospitals is $6.0 billion. In comparison, the benefit tax-exempt hospitals provided to their communities . . . is estimated to be $67.4 billion, 11 times greater than the value of tax revenue forgone.”62

58Lunder, E. K., & Liu, E. C. (2010, May 12). 501(c)(3) Hospitals and the community benefit standard. Con- gressional Research Service. Retrieved May 2, 2018 from https://www.everycrsreport.com/files/20100512_RL34605_ 461b539b090d997945e30d4e85afd42cc90294ff.pdf 59Young, G. J. (2013). Provision of community benefits by tax-exempt U.S. hospitals. The New England Journal of Medicine, 386, 1519–1527. 60Rosenbaum, S., Kinday, D. A., Bao, J., Byrnes, M. K., & O’Laughlin, C. (2015). The value of the nonprofit hospital tax exemption was $24.6 billion in 2011. Health Affairs, 34(7): 1225–1233. 61Association for Healthcare Philanthropy. (2017, October 5). Healthcare organizations raised over $11 billion in FY 2016. [The $11 billion was for U.S. and Canadian institutions combined]. Retrieved May 2, 2018 from https://www .prnewswire.com/news-releases/healthcare-organizations-raised-over-11-billion-in-fy-2016-300531776.html 62American Hospital Association: Estimates of the federal revenue forgone due to the tax exemption of nonprofit hospitals compared to the community benefit they provide, 2013. Prepared for the American Hospital Association October 2017 by

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https://www.everycrsreport.com/files/20100512_RL34605_461b539b090d997945e30d4e85afd42cc90294ff.pdf

https://www.prnewswire.com/news-releases/healthcare-organizations-raised-over-11-billion-in-fy-2016-300531776.html

https://www.everycrsreport.com/files/20100512_RL34605_461b539b090d997945e30d4e85afd42cc90294ff.pdf

Hospitals and Healthcare Systems 105

■ “The incremental community benefit exceeds the tax exemption for only 62% of non- profits. Policymakers should be aware that the tax exemption is a rather blunt instrument, with many nonprofits benefiting greatly from it while providing relatively few commu- nity benefits.”63

In order to address these concerns, the IRS began studying the nonprofit activities of these hospitals in 2006. Further, passage of the Patient Protection and Affordable Care Act (ACA) in 2010 offered the possibility that a much larger number of people would be insured through Medicaid expansion and government-sponsored Health Insurance Exchanges; thus, as was the case after Medicare and Medicaid became operational, the definitions of charitable care and its potential reduced impact needed reexamination and redefinition. Anticipating these changes, the ACA included the recommendations for the IRS to formalize community health needs assessment (CHNA) requirements described in Sections 501(r) and 4959 of the IRC. In brief, hospitals64 must now perform the activities detailed in Exhibit 4.10 in order to preserve their 501(c)(3) status and provide documentation on IRS Form 990 Schedule H.65

EXHIBIT 4.10. Hospital Activities to Preserve 501(c)(3) Status

■ A hospital organization must conduct a CHNA at least once every three taxable years, starting with its first

taxable year beginning after March 23, 2012.

■ The CHNA must include:

(1) A description of the community served by the hospital facility and how it was determined.

(2) A description of the process and methods used to conduct the assessment, including a description of

the sources and dates of the data and other information used in the assessment and the analytical

methods applied to identify community health needs. The report should also describe information gaps

that impact the hospital organization’s ability to assess the health needs of the community served by the

hospital facility.

(3) A description of how the hospital organization took into account input from persons who represent

the broad interests of the community served by the hospital facility. It must, at a minimum, take into

account input from—

(a) Persons with special knowledge of or expertise in public health;

Ernst and Young. Retrieved May 2, 2018 from https://www.aha.org/system/files/2018-02/tax-exempt-hospitals-benefits .pdf The reader should look at the study in more detail because it makes certain assumptions, such as that charitable contributions would be made to other organizations if not donated to nonprofit hospitals—so this item is not included in lost governmental benefit. 63Herring, B, Gaskin, D., Zare, H., & Anderson, G. (2018). Comparing the value of nonprofit hospitals’ tax exemption to their community benefits. Inquiry, 55, 1–11. Retrieved May 2, 2018 from https://www.ncbi.nlm.nih.gov/pmc/articles/ PMC5813653 64If a hospital organization operates more than one hospital facility, each facility must meet these requirements (IRS Section 501(r)(2)(B)(i)). 65IRS. 2017 Instructions for Schedule H (Form 990). Hospitals. Retrieved May 2, 2018 from https://www.irs.gov/pub/ irs-pdf/i990sh.pdf

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https://www.aha.org/system/files/2018-02/tax-exempt-hospitals-benefits.pdf

https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5813653/

https://www.irs.gov/pub/irs-pdf/i990sh.pdf

106 The U.S. Healthcare System

(b) Federal, tribal, regional, State, or local health or other departments or agencies with current data or

other information relevant to the health needs of the community served by the hospital facility; and

ulations, and populations with chronic disease needs in the community served by the hospital

facility.

(4) A prioritized description of all of the community health needs identified through the CHNA, as well as

a description of the process and criteria used in prioritizing such health needs.

(5) A description of the existing healthcare facilities and other resources within the community available to

meet the community health needs identified through the CHNA.

■ A CHNA must be made widely available to the public, for example by posting the written report on the

hospital facility’s website.

■ A hospital must adopt a written “implementation strategy” to meet the community health needs identified

through the CHNA. An implementation strategy will:

(1) describe how the hospital facility plans to meet the health need; or

(2) identify the health need as one the hospital facility does not intend to meet and explain why the hospital

facility does not intend to meet the health need.

The implementation strategy must tailor the description to the particular hospital facility, taking

into account its specific programs, resources, and priorities. The date the implementation strategy is

considered approved by the IRS is when it is accepted by an authorized governing body of the hospital

organization.

■ Hospitals that fail to satisfy the CHNA requirements in any consecutive 3-year period will incur a $50,000

excise tax.a

■ A hospital organization must establish a written financial assistance policy (FAP) and a written policy relating

to emergency medical care.b The FAP must include:

(1) eligibility criteria for financial assistance, and whether such assistance includes free or discounted care;

(2) the basis for calculating amounts charged to patients (It is important to note that for those patients who

qualify for its FAP, the hospital cannot use gross charges. Instead, it must limit the amounts to not more

than the amounts generally billed to individuals who have insurance covering such care.);

(3) the method for applying for financial assistance;

(4) the actions the hospital organization may take in the event of nonpayment, including the reasonable

efforts to determine whether an individual is FAP-eligible before engaging in extraordinary collection

actions (ECAs); and

(5) measures to widely publicize the FAP within the community to be served by the hospital organization.

a IRS: Part III—Administrative, Procedural, and Miscellaneous Notice and Request for Comments Regarding the Community Health Needs Assessment Requirements for Tax-Exempt Hospitals Notice 2011-52. Retrieved May 2, 2018 from www.irs.gov/pub/irs- drop/n-11-52.pdf

b Internal Revenue Service 26 CFR Part 1 RIN 1545-BK57, Additional Requirements for Charitable Hospitals. Notice of proposed rulemaking. June 22, 2012. Retrieved May 2, 2018 from https://www.irs.gov/pub/irs-drop/reg-130266-11.pdf

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http://www.irs.gov/pub/irs-drop/n-11-52.pdf

https://www.irs.gov/pub/irs-drop/reg-130266-11.pdf

Hospitals and Healthcare Systems 107

Given these extensive and often vague criteria, why would a hospital organization want to maintain its 501(c)(3) status? The benefits of federal nonprofit status are fourfold. The first two were mentioned above: These hospitals do not have to pay federal taxes on their earnings, and donors can deduct their contributions from taxable income (perhaps encour- aging donations). The third reason is that borrowing costs are reduced because lenders (e.g., bondholders) to these institutions do not have to pay federal taxes on the interest payments they receive from borrowers; therefore, they can charge a lower rate for the loans.66 Finally, these institutions are exempt from paying federal unemployment tax.

Since nonprofit hospitals often engage in for-profit activities, the organizational structure of these institutions must separate those latter businesses to preserve the tax exempt status of the nonprofit activities. For example, if the hospital owns and manages non-healthcare properties, that activity should be isolated from the hospital itself in a distinct corporation (with a separate tax number) that pays taxes.

As mentioned above, since states and localities have their own levies (such as state income taxes and local property taxes), they can set their own criteria for nonprofit status without regard to federal guidelines. The wide variance of criteria is exemplified by two decisions in the 1980s. In the first, the Supreme Court of Utah67 found that just because a hospital takes charitable donations and provides free care to some of its patients, it is not entitled to full property tax exemption. Instead, the extent of free care must be determined annually; if it exceeds the value of the property tax, the hospital does not owe any state taxes. This decision emphasized that a hospital can lose its tax-exempt status not only by engag- ing in for-profit activities but also by not providing sufficient charitable services (both solely defined by the state). In Vermont, by contrast, its Supreme Court68 decided that the property tax exemption could stand if the hospital is “open to all who need it regardless of ability to pay.” Exhibit 4.11 compares the two states’ criteria.

More recently, financially stressed states and localities have been reevaluating their tax-exempt policies. For example, on June 14, 2012, then–Illinois Governor Pat Quinn signed Senate Bill 2194 that changed the tax exemption status of hospitals, requiring them to furnish charity care in amounts at least equal to the value of their property taxes. As the economy and the roles of insurance subsidies change, further state reevaluations of their policies will undoubtedly occur.

Public/Private Status. Most hospitals in the United States are both private and nonprofit. Public hospitals are, by definition, owned by governmental agencies. For example, the federal government owns hospitals for military veterans; many states own psychiatric hospitals; and

66For example, a lender with a tax rate of 33% is indifferent to charging a borrower 6% interest for fully taxable payments and 4% if the interest income is tax exempt. 67Utah County v. Intermountain Health Care Inc., 709 P.2d 265 (Utah 1985). 68Medical Center Hospital of Vermont v. City of Burlington. No. 87–501; October 13, 1989.

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108 The U.S. Healthcare System

EXHIBIT 4.11. Comparison of Criteria between Utah and Vermont Whether an Institution Is Using a Property “Exclusively . . . for Charitable Purposes”*

Comparison of Utah Decision and Vermont Decision

1. whether the stated purpose of the entity is to provide a significant service to others without immediate

expectation of material reward;

Healthcare institution need not dispense any free care in order to be considered charitable for purposes

of tax exemption; relevant inquiry is whether healthcare was made available to all who needed it, regardless

of ability to pay.

2. whether the entity is supported, and to what extent, by donations and gifts;

Healthcare institution need not show that the majority of its income is derived from charitable sources

in order to claim charitable use tax exemption.

3. whether the recipients of the “charity” are required to pay for the assistance received, in whole or in part;

see (1) above.

4. whether the income received from all sources (gifts, donations, and payment from recipients) produces a

“profit” to the entity in the sense that the income exceeds operating and long-term maintenance expenses;

Not-for-profit institutions may generate revenues in excess of their expenses in order to maintain the

organization and still retain charitable use tax exemption, the criteria being only that such revenues not be

passed through to shareholders as profits but put back into operating expenses.

5. whether the beneficiaries of the “charity” are restricted or unrestricted and, if restricted, whether the restric-

tion bears a reasonable relationship to the entity’s charitable objectives; and

6. whether dividends or some other form of financial benefit, or assets upon dissolution, are available to private

interest, and whether the entity is organized and operated so that any commercial activities are subordinate

or incidental to charitable ones.

*Note: Text in regular font is from the Utah decision. Text in italic type is from the Vermont decision. Both states agree on criteria 5 and 6.

many highly populated counties own their own hospitals, such as Kings County (Brooklyn), Cook County (Chicago), and Los Angeles County (in California).

General/Specialty Hospitals. This distinction separates institutions with many different ser- vices from those that tend to specialize according to some market segment, such as age (children’s hospitals), sex (women’s hospitals), or clinical specialty (psychiatry or rehabil- itation). Identifying a specialty hospital is not often obvious, however. For example, some places designated as children’s hospitals are in freestanding facilities while others are in a section of a larger institution.

In addition to those obvious distinctions, specialty hospitals can be segmented by lengths of stay, particularly those of longer duration. Many of these specialty hospitals have their ori- gins as disease-specific facilities, such as tuberculosis sanitaria. The modern movement to

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Hospitals and Healthcare Systems 109

long-term acute care hospitals (LTCHs; pronounced “el tax”) started in the 1980s. At that time, technology began to allow many patients to survive for long times on ventilators, thus crowding hospital intensive care units. Further, after 1982, Medicare started to pay hospi- tals by diagnosis rather than on a fee-for-service (FFS), cost-based system. (See the section in Chapter 6 devoted to Medicare for a full discussion of DRGs.) Therefore, patients with serious and long-term health needs were putting space and financial stresses on hospitals. In order to address these problems, the federal government created the category of LTCHs to qualify for Medicare payment.69 This payment source accounts for about two thirds of the income of these facilities. Currently, three types of organizations can have an LTCH desig- nation: freestanding facilities usually owned by for-profit corporations (such as Kindred70 or Select Medical Holdings,71 which, as the largest two for-profit chains, own more than half of this market’s facilities); satellite facilities usually owned by nonprofit hospitals; and “hos- pitals within hospitals” (HwHs), facilities that are physically part of a hospital (like a floor or wing) but designated for this purpose.

Like acute care hospitals, these facilities are licensed as hospitals according to different state laws; however, to

qualify as an LTCH for Medicare payment, a facility must meet Medicare’s conditions of participation for acute care hospitals and have an average length of stay greater than 25 days for its Medicare patients. (By comparison, the average Medicare length of stay in acute care hospitals is about five days.) There are no other criteria defining LTCHs, the level of care they furnish, or the patients they treat.72

In 2014, 391 LTCHs treated about 134,000 Medicare beneficiaries. Most of these stays are for a few conditions; in 2014, the top 25 LTCH diagnoses made up 65% of all LTCH dis- charges. (Please see Exhibit 4.12 for the top 10 diagnoses.) CMS estimates that total Medicare spending for LTCH services was $5.4 billion in fiscal year 2014. Compared with all Medi- care beneficiaries, those admitted to LTCHs are disproportionately under age 65, over age 85, disabled, and diagnosed with end-stage renal disease. They are also more likely to be African American.

Because of rising costs for these facilities, since 200273 Medicare has paid LTCHs by a prospective payment system74 that is adjusted by relative weights. These weights reflect the

69CMS. Long-term care hospital prospective payment system. Retrieved May 3, 2018 from https://www.cms.gov/ Outreach-and-Education/Medicare-Learning-Network-MLN/MLNProducts/Downloads/Long-Term-Care-Hospital- PPS-Fact-Sheet-ICN006956.pdf 70Retrieved May 3, 2018 from https://www.kindredhealthcare.com 71Retrieved May 3, 2018 from https://www.selectmedical.com 72MedPAC. (2016, October). Long-term care hospitals payment system. Retrieved May 3, 2018 from http://www.medpac .gov/docs/default-source/payment-basics/medpac_payment_basics_16_ltch_final.pdf 73The Medicare, Medicaid, and SCHIP [State Children’s Health Insurance Program] Balanced Budget Refinement Act of 1999 (BBRA) (Pub. L. 106-113) and the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA) (Pub. L. 106-554). 74The payments are, by law, budget neutral (i.e., total expenditures are the same as if the previous method of payment were used). Also, some facilities, such as veterans’ hospitals and others having existing prospective payment, are exempt.

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https://www.cms.gov/Outreach-and-Education/Medicare-Learning-Network-MLN/MLNProducts/Downloads/Long-Term-Care-Hospital-PPS-Fact-Sheet-ICN006956.pdf

https://www.kindredhealthcare.com

https://www.selectmedical.com

http://www.medpac.gov/docs/default-source/payment-basics/medpac_payment_basics_16_ltch_final.pdf

110 The U.S. Healthcare System

EXHIBIT 4.12. Top 10 Diagnoses for LTCHs (2014) MS–LTC–DRG Description Discharges Percentage

189 Pulmonary edema and respiratory failure 16,017 12.0

207 Respiratory system diagnosis with ventilator support 96+ hours 15,224 11.4

871 Septicemia without ventilator support 96+ hours with MCC 8,809 6.6

177 Respiratory infections and inflammations with MCC 3,733 2.8

592 Skin ulcers with MCC 3,663 2.7

208 Respiratory system diagnosis with ventilator support <96 hours 3,105 2.3

949 Aftercare with CC/MCC 2,864 2.1

539 Osteomyelitis with MCC 2,785 2.1

662 Renal failure with MCC 2,437 1.8

919 Complications of treatment with MCC 2,321 1.7

MS–LTC–DRG: Medicare severity, long-term care, diagnosis-related group; LTCH: long-term care hospital; MCC: major complication or comorbidity; CC: complication or comorbidity; OR: operating room. MS–LTC–DRGs are the case-mix system for LTCH facilities.

Source: MedPAC: Chapter 10: Long-term care hospital services. Report to the Congress: Medicare payment policy 2016, p. 284. Retrieved May 3, 2018 from http://www.medpac.gov/docs/default-source/reports/chapter-10-long-term-care-hospital-services- march-2016-report-.pdf?sfvrsn=0.AU

different costs in the LTCH setting as well as outlier payments for especially expensive cases. Unlike other prospective payment schemes, payments to LTCHs are adjusted downwards for cases whose length of stay are shorter than average for a given diagnosis.

After establishment of LTACHs, hospital costs continued to rise, and CMS was con- cerned that hospitals were referring many of their acute cases to their satellites or HwHs in order to be able to bill for the long term as well as acute care parts of the hospital stay. In fiscal year 2005, CMS modified the payment to these affiliated facilities so that if more than 25% of their referrals came from their owner, payments would be the lower of the LTCH prospective payment or the inpatient prospective payment. In 2007, the rule was changed to apply to referrals from any source.75 Further, from 2007 to 2017 (when the law expired), federal legislation mandated (with certain exceptions) a moratorium on the establishment of new LTCHs, LTCH satellites, and increase in the number of LTCH beds. This latter policy change caused consolidation in the sector due to for-profit acquisitions.

75“In special situations (i.e., admissions from rural and urban single or Metropolitan Statistical Area [MSA] dominant hos- pitals), the payment threshold was raised to 50 percent.” Long Term Care Hospital Prospective Payment System: Payment Adjustment Policy (Revised, 4/16/2013). Retrieved May 3, 2018 from http://www.cms.gov/LongTermCareHospitalPPS/ 01_Overview.asp

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http://www.medpac.gov/docs/default-source/reports/chapter-10-long-term-care-hospital-services-march-2016-report-.pdf?sfvrsn=0.AU

http://www.cms.gov/LongTermCareHospitalPPS/01_Overview.asp

Hospitals and Healthcare Systems 111

Despite all these changes, research commissioned by CMS found that “patients trans- ferred to LTCHs had longer stays, higher total payments, and higher provider costs than clinically similar patients who did not use LTCHs, with the smallest proportional differences seen for patients in the ventilator condition group.”76 The payment differences were much less if the LTCH care evaluation focused on the most severely ill patients.

Going forward, the key policy issues regarding these institutions are:

■ Clear and uniform admission criteria need to be set for patients and facilities. Research has not been able to distinguish many complex LTCH patients from those receiving ser- vices in acute care hospitals and some skilled nursing facilities.

■ Uniform payment schedules need to be established for like services. Since the patient populations in LTCHs and other facilities are similar, this uniformity is needed to avoid “selective gaming.” Both major chains, and other owners, have been diversifying into other post-acute care sectors (i.e., intensive rehab facilities, outpatient rehabilitation cen- ters, skilled nursing facilities [SNFs], and home health agencies). These strategies are intended to improve the ability of chains to control costs and limit the impact of payment policy changes.

■ Quality measures need to be implemented on the scale of acute care hospitals. The ACA requires CMS to collect data on quality in LTCHs. The Improving Medicare Post-Acute Care Transformation Act of 2014 (the IMPACT Act)77 mandates that LTCHs submit standardized patient assessment data with regard to quality measures, resource use, and other measures. However, the requirements are just for reporting purposes and are not as rigorous or extensive as those for acute care hospitals.78

Location. This category can have at least four groups. The first group is a region—for example, New England, Upper Midwest, Northwest, and so on. No consistency exists among companies or government agencies with respect to this definition. The second classification is by state. The third location dimension is by Metropolitan Statistical Areas (MSAs) (i.e., aggregations of populations around high-population density centers). These designations are standardized by the U.S. Census Bureau.79

Fourth is the distinction among urban, suburban, and rural hospitals. Because rural areas have fewer beds than do their urban counterparts, federal policies give them special exemp- tion from certain laws or extra compensations. (More about these institutions is included in the section of this chapter titled “Safety Net Providers.”) One special consideration will be

76Kandilov, A., & Dalton, K. (2011). Utilization and payment effects of Medicare referrals to long-term care hospitals (LTCHs). Prepared under contract to the Centers for Medicare & Medicaid Services. Research Triangle Park, NC: RTI International. 77Public Law 113-185. (2014, October 6): Improving Medicare Post-Acute Care Transformation Act of 2014. Retrieved May 3, 2018 from https://www.gpo.gov/fdsys/pkg/PLAW-113publ185/pdf/PLAW-113publ185.pdf 78CMS.gov. (2018, April 10). Long-Term Care Hospital (LTCH) Quality Reporting (QRP). Retrieved May 3, 2018 from https://www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/LTCH-Quality-Reporting/index .html 79Wilson, S. G. (2012, September). United States Census Bureau: Patterns of metropolitan and micropolitan population change: 2000 to 2010: 2010 Census Special Reports. Retrieved May 3, 2018 from https://www.census.gov/content/dam/ Census/library/publications/2012/dec/c2010sr-01.pdf

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https://www.gpo.gov/fdsys/pkg/PLAW-113publ185/pdf/PLAW-113publ185.pdf

https://www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/LTCH-Quality-Reporting/index.html

https://www.census.gov/content/dam/Census/library/publications/2012/dec/c2010sr-01.pdf

112 The U.S. Healthcare System

mentioned here: the swing bed exemption. “Swing beds” are those beds in a hospital that are used for acute care patients but can also be used for post-acute care, like skilled nursing facility services. As mentioned in the LTCH section, hospitals can game their reimbursement by quickly discharging Medicare patients to a long-term care facility they own. Many rural hospitals, however, are not filled to capacity, and the local area often lacks post-acute care institutions. Recognizing that these hospitals are in a special, vulnerable position, Congress included a provision in the Omnibus Budget Reconciliation Act of 1980 allowing Medicare and Medicaid to pay for swing-bed care in rural hospitals that had fewer than 50 beds.

Hospital Systems. According to the American Hospital Association,80 a health [hos- pital] system is defined as “[h]ospitals belonging to a corporate body that owns and/or manages health provider facilities or health-related subsidiaries. The system may also own non-health-related facilities.” “Sixty percent of AHA member hospitals are part of health systems, the majority consisting of three to 10 hospitals . . . Three-quarters are not-for-profit, with another 10% identifying as Catholic church-related and 10% as for-profit investor-owned. The remaining are non-federal government of varying types.”81

The three types of systems that will be discussed here are wholly owned systems, alliances, and group purchasing organizations (GPOs). It is important to note that hospitals can belong to one or more of these arrangements. Since the large majority of hospitals belong to some type of system (please see Exhibit 4.13), the nature of the affiliation will drive institutional strategy and product/service purchasing. It is therefore critical for healthcare managers to understand these organizational arrangements and where the decision-making authority rests.

Wholly owned/singly managed systems. The most obvious type of system exists when a single entity owns or manages two or more hospitals. (Please see Exhibit 4.14 for a list of the 10 largest systems in this category.)

Six reasons exist for formation of these systems:

1. Economies of scale

2. Economies of scope

3. Vertical integration

4. Capture populations

5. Market power over payers

6. Bureaucratization

These reasons are discussed next.

Economies of scale. The benefits of economies of scale result from major savings derived by sharing support functions like payroll, accounting, logistics management, and volume

80American Hospital Association. (2016). Trendwatch chartbook: Glossary. Retrieved May 3, 2018 from https://www .aha.org/system/files/research/reports/tw/chartbook/2016/glossary.pdf 81American Hospital Association. Healthcare systems. Retrieved May 3, 2018 from https://www.aha.org/advocacy/ health-care-systems

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https://www.aha.org/system/files/research/reports/tw/chartbook/2016/glossary.pdf

https://www.aha.org/advocacy/health-care-systems

Hospitals and Healthcare Systems 113

EXHIBIT 4.13. Number of Nonprofit Hospital Systems in the United States from 1995 to 2016 Total Number of Hospitals in Systems: At least 3,200

N u

m b

e r

o f

h o

sp it

a l sy

st e

m s

500

400

300

200

100

0 1995 2000 2005 2008 2013 2016

233 251

299 315

347 371

Source: The Governance Institute © Statistica 2018. Used by permission.

purchasing (although this latter benefit can also be gained from GPO membership, described below). Some shared equipment, such as centralized computers and vehicles, can also achieve this goal. This benefit often accrues with horizontal integration: mergers of like organizations, in this case, hospitals merging with other hospitals. Despite these potential cost savings, research findings are clear and consistent about the results of these mergers: They raise costs without providing other societal benefits. Gaynor recently summarized these findings:

Extensive research evidence shows that consolidation between close competitors leads to substantial price increases for hospitals, insurers, and physicians, without offsetting gains in improved quality or enhanced efficiency. Further, recent evidence shows that mergers between hospitals not in the same geographic area can also lead to increases in price. Just as seriously, if not more, evidence shows that patient quality of care suffers from lack of competition.82

82Gaynor, M. (2018, February 14). Examining the impact of health care consolidation. Statement before the Committee on Energy and Commerce Oversight and Investigations Subcommittee, U.S. House of Representatives. Retrieved May 5, 2018 from https://docs.house.gov/meetings/IF/IF02/20180214/106855/HHRG-115-IF02-Wstate-GaynorM-20180214 .pdf

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114 The U.S. Healthcare System

EXHIBIT 4.14. Ten Largest U.S. Health Systems Based on Number of Hospitals (as of December 2017)

Hospital Corporation of America (Nashville, Tenn.)

U.S. Department of Veterans Affairs (Washington, D.C.)

Community Health Systems (Franklin, Tenn.)

Ascension Health (St. Louis)

O p

e ra

to r

(C it

y, S

ta te

)

Tenet Healthcare Corp. (Dallas, Tex.)

LifePoint Hospitals (Brentwood, Tenn.)

Trinity Health (Livonia, Mich.)

Prime Healthcare Services (Ontario, Calif.)

Providence Health & Services (Renton, Wash.)

Kaiser Permanente (Oakland, Calif.)

0 25 50

119

143

174

75 100

Number of hospitals

125 150 175 200

Source: Becker’s Hospital Review: Top U.S. health systems based on number of hospitals as of 2017 © 2018 Statistica. Retrieved May 2, 2018 from https://www.statista.com/statistics/245010/top-us-for-profit- hospital-operators-based-on-number-of-hospitals Used with permission of Statistica.

Economies of scope. When two or more different services can be produced using common resources at a lower cost than if created individually, then economies of scope exist. For example, a radiology department can produce a variety of diagnostic and therapeutic services using the same staff and equipment. Another way to look at scope is when system members are geographically close (a relative term that will vary case by case), they can diversify the types of services each offers without the expense of duplication. For example, one facility may provide high-level neonatal care, while another might offer invasive cardiac treatments. This advantage is not always possible, however, since expensive diagnostics (such as CT and MRI scanners) often need to be available on-site in the event of an emergency. In addition, many system hospitals are located across a large geographic area so that each serves a different community; each facility must, therefore, be relatively self-sufficient with a diverse portfolio of services. Because systems can draw from and service a larger area than a single hospital, certain types of system-owned, non-acute care facili- ties/programs can better demonstrate economies of scope. (Please see Exhibits 4.15 and 4.16 for examples.)

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Hospitals and Healthcare Systems 115

EXHIBIT 4.15. Types of Facilities Owned by Systems

Acute care hospitals

Assisted living facilities

Continuing-care retirement communities

Freestanding psychiatric hospitals

Home care facilities

Long-term acute care facilities

Physician organizations

Rehabilitation

Skilled nursing facilities

EXHIBIT 4.16. Types of Programs Run by Systems

Adult day care

Behavioral clinics

Cancer treatment

Chest pain clinics

Diagnostic imaging

Dialysis

Emergency service facility

Hospice

Laboratories

Mobile imaging

Occupational health

Pain management

Pediatrics

Pharmacy

Physical therapy/sports medicine

Physician offices/clinics

Rehabilitation centers

Sleep centers

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116 The U.S. Healthcare System

EXHIBIT 4.16. (Continued)

Surgery centers

Urgent care

Wellness centers

Women’s health centers

Wound care

Vertical integration. Because vertical integration is a bit more complex than the other rea- sons for system formation, it will be explained in more detail. Vertical integration occurs when one organization acquires (or creates) another that is elsewhere along the value chain from production of the product (or service) to its delivery to (or consumption by) the end user. Vertical integration primarily occurs when it is not economically advantageous or feasible to create bilateral agreements, such as purchasing/sales contracts or alliances/joint ventures. Backward integration arises when the other entity supplies inputs to the organization, while forward integration occurs when the other entity receives the outputs from the organization. The simplest general examples of vertical integration are when an auto manufacturer buys a parts supplier (backward integration) or a dealership (forward integration). Hospitals have vertically integrated by such activities as buying physician practices (backward integration) and creating home health agencies (forward integration). In addition to these patient care services, vertical integration is also occurring when hospital systems set up their own health insurance capability. Exhibits 4.14 and 4.15. also provide examples of vertical integration.

Given the theme of this chapter, the relevant questions are: Should hospitals vertically integrate and, if so, when? Stuckey and White83 posit that there are four reasons for vertical integration. These reasons are discussed below in the context of hospital systems.

1. A vertical market “fails” when transactions within it are too risky and the contracts designed to overcome these risks are too costly (or impossible) to write and administer.

2. Companies in adjacent stages of the industry chain have more market power than com- panies in your stage.

The transactions necessary for a hospital to assume financial and clinical risk are characterized by high frequency and the potential of certain participants to slow care or make it costlier to deliver. The best-studied vertical integration strategy is hospital purchase of physician practices. Consider the following two examples of reasons for vertical integration: If a hospital is taking global financial risk for a population but its physicians demand high fees, the system will not be viable. If a hospital wishes to contract with a payer for global fees for cardiovascular services but the surgeons do not want to participate, the enterprise will fail. In these cases, the power of suppliers (or more correctly, business partners) is disproportionately large.

83Stuckey, J., & White, D. (1993, April 15). When and when not to vertically integrate. MIT Sloan Management Review, 34I(3) (Spring), reprint #3435. Retrieved May 3, 2018 from http://sloanreview.MIT.edu/article/when-and-when-not-to- vertically-integrate

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Hospitals and Healthcare Systems 117

3. Integration would create or exploit market power by raising barriers to entry or allowing price discrimination across customer segments.

4. The market is young and the company must forward integrate to develop a market, or the market is declining and independents are pulling out of adjacent stages.

Organized delivery systems (ODSs) can successfully differentiate themselves and access risk contracts only if they are clinically integrated. (See the Organized (Integrated) Delivery Systems/Accountable Care Organizations section later in this chapter.) If the delivery systems can achieve this clinical integration, they can raise barriers to entry for others who cannot accomplish it. The price discrimination occurs when the system develops market power over payers and can command higher fees.

Of note is that, with respect to hospitals, vertical integration has historically not been challenged on antitrust grounds as much as has horizontal integration, though that laissez-faire attitude is changing.84 The reason was succinctly stated by Spengler in a classic and oft-quoted article: “Horizontal integration may, and frequently does, make for higher prices and a less satisfactory allocation of resources than does pure or workable competition. Vertical integration, on the contrary, does not, as such, serve to reduce competition and may, if the economy is already ridden by deviations from competition, operate to intensify competition.”85 Given this statement, one must ask what the research shows about benefits or harms of vertical integration. Three relationships have been studied: hospital–physician, hospital–post-acute care, and hospital–insurance.

Studies on the effects of hospital–physician integration come mainly from the 1990s. Using data from Arizona, Florida, and Wisconsin for 1994 to 1998, Cuellar and Gertler86

found that “integration has little effect on efficiency, but is associated with an increase in prices, especially when the integrated organization is exclusive and occurs in less compet- itive markets.” On the other hand, using data from California for 1994 to 2001, Ciliberto and Dranove87 found “no evidence of higher prices. If anything, integration is associated with lower prices, though the estimated price reductions are neither precise nor statistically significant.”

Hospitals bought many physician practices in the 1990s, but the strategy mostly failed and systems lost a great deal of money. More recently, attempts to replicate this integration have not fared much better. “Hospitals lose $150,000 to $250,000 per year over the first 3 years of employing a physician—owing in part to a slow ramp-up period as physicians establish themselves or transition their practices and adapt to management changes. The losses decrease by approximately 50% after 3 years but do persist thereafter.”88

84One of the earliest challenges in antitrust litigation for vertical integration was reported in: FTC and Idaho Attorney General Challenge St. Luke’s Health System’s Acquisition of Saltzer Medical Group as Anticompetitive. Retrieved May 3, 2018 from http://www.ftc.gov/opa/2013/03/stluke.shtm 85Spengler, J. J. (1950). Vertical integration and antitrust. Journal of Political Economy, 58(4), 347–352. 86Cuellar, A. & Gertler, P. J. (2006). Strategic integration of hospitals and physicians. Journal of Health Economics, 25, 1–28. 87Ciliberto, F., & Dranove, D. (2006). The effect of physician–hospital affiliations on hospital prices in California. Journal of Health Economics, 25, 29–38. 88Kocher, R. & Sahni, N. R. (2011). Hospitals’ race to employ physicians—The logic behind a money-losing proposition. New England Journal of Medicine, 364, 1790–1793.Co

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118 The U.S. Healthcare System

Research studies have also consistently shown that after hospitals purchase physician practices, insurance and patient costs increase. For example: “For certain cardiology, ortho- pedic, and gastroenterology services, hospital employment of physicians results in up to 27% higher costs for Medicare and 21% higher costs for patients.”89

With respect to post-acute care, David et al.90 found that:

hospitals that are vertically integrated tend to discharge patients to their own HHA [home health agency] and skilled nursing facilities sooner and in poorer health compared with non-integrated hospitals; yet, health outcomes are actually better for patients who transi- tion to hospitals’ own skilled nursing facilities and no worse for patients who transition to hospital’s own HHA.

In other words, the shift to the lower-cost settings does not result in reduced quality of care.

The last type of vertical integration discussed here is a payer (insurance)–hospital combi- nation, called provider-sponsored health plans.91 Payer-provider combinations, such as group or staff model HMOs (discussed in the Managed Care section of Chapter 6), are well known and have been shown to lower costs compared to indemnity coverage. Kaiser-Permanente is a prominent example. However, these older organizations were designed from their start to integrate functions and harmonize incentives. In the past, when hospitals purchased insur- ers or set up their own companies, the efforts largely failed. (Please see Exhibit 4.17 for an example.) More recent efforts have not been much more successful. In an oft-quoted study, Baumgarten concluded:

Dozens of provider systems have established their own health plans since 2010 . . . Based on the analysis reported here, it is hard to identify any of the new cohort of provider-sponsored health plans that show strong promise . . . A few new plans have enjoyed some success, reaching enrollments of 100,000 in just a few years. However, almost all these plans continue to operate at a loss, in some cases reporting very large losses . . . The key to success for provider-sponsored health plans is the ability to enunciate and then deliver on a value proposition: a provider system and its affiliated physicians and hospitals providing high-quality medical care at a lower cost . . . But, so far, the plans reviewed in this research are only able to price competitively by paying their own providers below market rates. That is not a strategy that can be sustained for long.92

89Avalere Health, LLC. (2017, November). Implications of hospital employment of physicians on Medicare beneficiaries. Retrieved May 6, 2018 from http://www.physiciansadvocacyinstitute.org/Portals/0/assets/docs/PAI_Medicare%20Cost %20Analysis%20--%20FINAL%2011_9_17.pdf 90David, G., Rawley, E., & Polsky, D. (2011). Integration and task allocation: Evidence from patient care. Journal of Economics & Management Strategy, 22(3), 617–639. 91For a list of some of the largest plans, see: Morse, S. (2016, September 16). 25 biggest provider-sponsored health plans include some of the nation’s biggest systems. Healthcare Finance. Retrieved May 5, 2018 from http://www .healthcarefinancenews.com/news/25-biggest-provider-sponsored-health-plans-include-some-nations-biggest-systems 92Baumgarten, A. (2017, June). Analysis of Integrated Delivery Systems and New Provider Sponsored Health Plans. Study for the Robert Wood Johnson Foundation. Retrieved May 5, 2018 from https://www.rwjf.org/content/dam/farm/ reports/reports/2017/rwjf437615

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http://www.physiciansadvocacyinstitute.org/Portals/0/assets/docs/PAI_Medicare%20Cost%20Analysis%20--%20FINAL%2011_9_17.pdf

http://www.healthcarefinancenews.com/news/25-biggest-provider-sponsored-health-plans-include-some-nations-biggest-systems

https://www.rwjf.org/content/dam/farm/reports/reports/2017/rwjf437615

Hospitals and Healthcare Systems 119

EXHIBIT 4.17. Example of Early Failure of Provider-Sponsored Health Insurance Plan

HealthChicago was a commercial HMO incorporated on January 2, 1984, by four suburban Chicago-area hospitals:

Central Du Page Hospital in Winfield, Elmhurst Memorial Hospital in Elmhurst, Ingalls Memorial Hospital in Harvey,

and Northwest Community Hospital in Arlington Heights. The plan grew rapidly, so that at its peak in 1988 it had

85,000 members. Despite success in enrollment, the hospital-owned plan ran into early financial troubles. Financial

statements ending December 31, 1986, showed a negative net worth of $2.21 million because of $6.3 million in

losses. The following year was worse, when the plan had a $23 million loss. In order to maintain state-mandated

reserve requirements, owners needed to come up with $14 million in early 1988, bringing their total investment

to $41 million. By the end of September 1988, Northwest Community Hospital announced it was pulling out of

the venture. According to one news reporta: “The hospital said its directors concluded that ownership of an HMO

isn’t consistent with its role as a care provider.” In 1992, membership declined to 65,000 and losses persisted. On

January 22, 1992, Humana announced its acquisition of the plan for an undisclosed amount. The lack of insurance

expertise as the principal cause of the failure is demonstrated by a postscript to this story. In August 1993, an Illinois

Appellate Court dismissed a lawsuit HealthChicago had originally brought against its former auditors Touche, Ross

and Company (a predecessor organization to Deloitte). “In its original complaint, plaintiff alleged that defendant

failed to inform it of the need for changes in its pricing structure and levels of claims reserves and that such failure

cost plaintiff approximately $25 million.”b These activities are routine practices for any insurance company.

a Moore, P. (September 28 1988). One of Health Chicago’s part owners calls it quits. Chicago Sun Times. b HealthChicago, Inc. v. Touche, Ross and Co., 625 N.E.2d 706 (1993) 252 Ill. App.3d 608,192 Ill. Dec. 551.

In summary, what can now be said is that the outcome of vertical integration may depend on highly specific market characteristics, including method of physician compensation. Stuckey and White caution: “Do not vertically integrate unless absolutely necessary. This strategy is too expensive, risky, and difficult to reverse.”93 Other models with aligned financial incentives, such as joint ventures or strategic alliances, could be employed instead of vertical integration, but the power among participants would be more equal, a situation not always to the liking of hospital administrators.

Capture populations. It is important for individual hospitals to develop patient loyalty so that no matter what services are needed, the institution stays top of mind. One way systems can accomplish this goal is by developing strong brand recognition. Another way is by providing geographic coverage. For example, patients often wonder if they should choose a physician or hospital close to work or home. Systems with a strong brand identity and geographic coverage can offer themselves to patients across a variety of settings.

Market power over payers. This advantage is a separate outgrowth of the previous one but can be an independent motivator for system formation. With geographic coverage and a large, loyal patient base, insurance companies will need to include these systems in their networks. The one caveat systems face in this strategy is the possibility of antitrust.

93Stuckey, J., & White, D. (1993, April 15). When and when not to vertically integrate. MIT Sloan Management Review, 34I(3) (Spring), reprint #3435. Retrieved from http://sloanreview.MIT.edu/article/when-and-when-not-to-vertically- integrate

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120 The U.S. Healthcare System

Bureaucratization. The advantage of bureaucratization is mainly seen in public institu- tions and in countries that have regionalized their hospitals into de facto systems. Examples include the Veterans Administration, hospital clusters of the Hong Kong Hospital Author- ity, Local Health Integrated Networks in Ontario, and the Agences Régionales de Santé in France.

Alliances. Alliances form for the same reasons as do single-owned/operated systems (except for bureaucratization). In pooling alliances, entities bring together similar resources to achieve economies of scale. Trading alliances are formed when participants bring different resources to the enterprise to achieve economies of scope. Proponents of alliances see these arrangements as a way to address the increasingly complex healthcare environments while maintaining individual participant autonomy. However, this autonomy is also the source of the greatest weakness of this type of arrangement, and it has been estimated that 50% to 80% of all alliances fail.94

Three major reasons exist for failure. First, participants may enter the alliance with diver- gent goals that can cause conflict over strategic direction of the overall organization. These disagreements can be over such matters as different types of capital investments, location of deployed resources, or incorporation of additional partners (e.g., those with additional exper- tise or in a different location). Second, the governing structure may be unstable. Governing boards are usually comprised of member organizations with equal or near-equal votes. This problem has caused the failure of systems that need to make decisions but are paralyzed by democracy. A third potential problem is clash of organizational cultures. In this case, culture can dictate which issues are major problems, how problems are addressed, and how conflicts are handled.

An example of an alliance that failed for these reasons was the teaching hospitals of Northwestern University, called Northwestern Healthcare Network, which operated in the 1990s before dissolving. One of the reasons it failed was predicted in an interview with Gary Mecklenburg, then CEO of Northwestern Memorial Hospital: “Voluntary organizations continue to have a very important place in health care. But they don’t have the ability to make the hard decisions when health care is changing, and we must make hard decisions in terms of organization, structure, cost, etc. I start off with a premise that says regional networks or systems must have some degree of substantial authority to make them work.”95

Successful, large national alliances include Premier96 and Vizient-owned hospitals.97

Reasons for their success include large national presences, provision of services highly

94Zajac, E. J., D’Aunno, T. A., & Burns, L. R. (2011). Managing strategic alliances. In L. R. Burns, E. H. Bradley, & B. J. Wiener (Eds.), Shortell and Kaluzny’s healthcare management: Organization design and behavior (pp. 321–346). Clifton Park, NY: Delmar. This reference provides an excellent discussion of healthcare alliances. 95Johnson, D. E. (1992). CEO interview: Gary A. Mecklenburg—Networks help assure survival. Health Care Strategic Management, 10, 12–17. 96Retrieved May 6, 2018, from www.premierinc.com 97“Vizient was founded in 2015 as the combination of VHA Inc., a national health care network of not-for-profit hospitals; University HealthSystem Consortium, an alliance of the nation’s leading academic medical centers; and Novation, the health care contracting company they jointly owned.” Retrieved May 6, 2018, from https://www.vizientinc.com/About-us

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Hospitals and Healthcare Systems 121

valued by their stakeholders (such as supply chain management, revenue cycle man- agement, and quality benchmarking information), and health policy involvement. From empirical observation, it appears that alliances succeed when they focus on cost savings (such as economies of scale) and quality improvement. Failure occurs more often when conflicts arise over ways to increase revenues (such as resource allocations among member institutions).

Group purchasing organizations. According to the group purchasing organization (GPO) trade group, the Healthcare Supply Chain Association (HSCA), “GPOs date back to 1909, when the Hospital Superintendents of New York first considered establishing a purchasing agent for laundry services. In 1910, the first GPO was created, the Hospital Bureau of New York.”98 These organizations provide members not only with buying power but also such services as supply chain management (i.e., assistance with acquisition, inventory manage- ment, clinical evaluation, standardization of products, and evaluations of new technology). A GAO study of the services provided by the six largest GPOs is displayed in Exhibit 4.18. Many firms are owned by members; others are patronized by those who only pay member- ship fees. Some specialize in certain merchandise types while others offer a broad range of products. Most of these arrangements are voluntary; members are able but not required to make purchases from the GPO to which they belong. Hospitals and systems typically belong to two to four organizations and make 96% to 98% of their purchases through them.99 On average, GPO contracts account for about 73% of nonlabor purchases that hospitals make.100

The business model for these companies derives principally from “administrative fees” vendors pay based on the purchase price that the healthcare provider pays; Exhibit 4.19 provides a typical scheme for payment flows. Membership charges also contribute to revenue.

The largest organizations by annual spending volume are:101

1. Vizient (Irving, TX)—$100 billion

2. Premier (Charlotte, NC)—>$50 billion

3. HealthTrust (Nashville, TN.)—$30 billion

4. Intalere (St. Louis, MO)—$9 billion

The benefit of these organizations to their members has been highlighted in a number of studies. For example, Burns and Lee102 found that GPOs lower product prices, particularly

98Retrieved May 6, 2018, from http://www.supplychainassociation.org/?page=FAQ 99Healthcare Supply Chain Association (HSCA). A primer on group purchasing organizations: Questions and answers. Retrieved May 6, 2018, from http://c.ymcdn.com/sites/www.supplychainassociation.org/resource/resmgr/research/gpo_ primer.pdf 100Schneller, E. S. (2009, April). The value of group purchasing–—2009: Meeting the need for strategic savings. Scotts- dale, AZ: Health Care Sector Advances. 101Gooch, K. (2017, February 6). Four of the largest GPOs, 2017. Becker’s hospital CFO report. Retrieved May 6, 2018, from https://www.beckershospitalreview.com/finance/4-of-the-largest-gpos-2017.html 102Burns, L. R., & Lee, J. A. (2008). Hospital purchasing alliances: Utilization, services, and performance. Health Care Management Review, 33, 201–215.

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122 The U.S. Healthcare System

EXHIBIT 4.18. Services the Six Largest Group Purchasing Organizations (GPO) Reported Providing in 2008

Servicea GPO

A B C D E F

Custom contracting ✓ ✓ ✓ ✓ ✓ ✓

Clinical evaluation and standardization ✓ ✓ ✓ ✓ ✓ ✓

Technology assessments ✓ ✓ ✓ ✓ ✓ ✓

Supply-chain analysis ✓ ✓ ✓ ✓ ✓

Electronic commerce ✓ ✓ ✓ ✓ ✓

Materials management consulting ✓ ✓ ✓ ✓ ✓

Benchmarking data ✓ ✓ ✓ ✓ ✓

Continuing medical education ✓ ✓ ✓ ✓ ✓

Market research ✓ ✓ ✓ ✓

Materials management outsourcing ✓ ✓ ✓

Patient safety services ✓ ✓ ✓

Marketing products or services ✓ ✓ ✓

Insurance services ✓ ✓

Revenue management ✓ ✓

Warehousing ✓

Equipment repair ✓

Otherb ✓ ✓ ✓

Note: The six largest GPOs were selected based on their reported 2007 purchasing volume in Health Industry Distributors Associ- ation, Group Purchasing Organization & Integrated Delivery Network: Market Brief, Alexandria, Va., July 2009.

a This list includes services that may be offered through affiliates of the GPO. b Other reported services included, for example, contracting for environmentally friendly products, energy-related services and education, and public policy services.

Source: GAO structured data collection protocol. GAO (2010, August). Group purchasing organizations. Services provided to customers and initiatives regarding their business practices. Retrieved May 6, 2018 from www.gao.gov/new.items/d10738.pdf.

for commodity and pharmaceutical products, and reduce transaction costs. GPOs are less successful in lowering prices of other valued services, do not reduce costs for expensive physician preference items, and do not impede contracting with innovative firms or restrict desired products. These benefits as well as ownership in GPOs and payment of rebates to pur- chasers make entry into this sector very difficult. For example, in 2017, Amazon announced

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Hospitals and Healthcare Systems 123

EXHIBIT 4.19. Hypothetical Flow of Contract Administrative Fees

Purchases product from...

Pays contract administrative fees to...

Uses a portion of the contract administrative fees to cover operating expenses and to finance other ventures

Distributes a portion of the contract administrative fees to...

Vendor GPOCustomer

Source: GAO (2010, August). Group purchasing organizations. Services provided to customers and ini- tiatives regarding their business practices. August 2010. Retrieved May 6, 2018 from www.gao.gov/new .items/d10738.pdf

it would enter the hospital supply business; by April 2018, the company pulled back this initiative.103

The message here for healthcare product and service firms is that in addition to direct customer sales, they must also develop a marketing strategy that involves multiple GPOs in their channels.

Physician-Owned Hospitals. Although this category could be included in either the owner- ship or specialty sections, some distinct issues warrant its separation. Like many healthcare issues, physician-owned hospitals are not new. Many prominent organizations that own or control hospitals are named for their physician-founders, including the Mayo, Menninger, and Ochsner clinics.104 After decades of stagnation, starting in the 1990s there was rapid growth in these organizations. In 2017, there were about 250 such hospitals, with a heavy concentration in Texas. According to the Physician Hospitals of America105 (the trade organi- zation for these institutions), the top five categories of these hospitals (in declining frequency) are: Surgical, General Care, Orthopedic, Cardiac, and Long-Term Acute Care.

Proponents of these hospitals cite the following benefits compared to non-physician- owned establishments:

■ Better clinical outcomes due to specialization ■ Lower costs ■ Higher patient satisfaction ■ More procedural efficiency

103See, for example: Aungst, T. (2018). Amazon withdraws plans for medication distribution. Pharmacy Times (April 19). Retrieved May 7, 2018, from http://www.pharmacytimes.com/contributor/timothy-aungst-pharmd/2018/04/amazon- withdrawals-plans-for-medication-distribution 104These institutions are nonprofit, as distinguished from current for-profit physician-owned hospitals. 105Retrieved May 7, 2018, from http://www.physicianhospitals.org

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http://www.pharmacytimes.com/contributor/timothy-aungst-pharmd/2018/04/amazon-withdrawals-plans-for-medication-distribution

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124 The U.S. Healthcare System

Critics (especially the American Hospital Association and Federation of American Hos- pitals) claim:

■ Physicians choose the highest-margin services to care for patients and do not care for Medicaid or indigent patients.

■ By taking healthier, better-insured patients, these hospitals leave general, nonprofit insti- tutions to care for sicker patients without the cross-subsidy of the profitable services.

■ Physicians who have an interest in these facilities do more unnecessary/low-value procedures.

The research to support any of these claims, while extensive, is somewhat contradictory. Further, studies fall into two general time frames: before and after 2011 (i.e., during and after a period of rapid expansion and competitive pressures, respectively). The reason to divide the research into these time periods is that, starting in 2011, the ACA restricted new construction or expansion of existing physician-owned hospitals:

■ The number of operating rooms, procedure rooms, and beds is frozen except for certain counties with high population growth and/or low bed capacity. Medicare and Medi- caid stopped payment for services at such facilities if they were built or expanded after December 31, 2010.

■ Referring and treating physicians must disclose to patients their ownership interests (if any) in the hospital, giving patients enough time to make a “meaningful decision” about the place of care.

■ “Ownership or investment returns [cannot be] . . . distributed to each owner or investor in the hospital in an amount that is directly proportional to the ownership or investment interest of such owner or investor in the hospital.” In other words, profits cannot be distributed based on the number or profitability of the patients referred or treated by physician-owners.106

Currently, the federal government is considering lifting this freeze; however, some of the important recommendations still rely on older studies.107 Before policy makers enact changes, a thorough statistical and methodologic review of more current studies should be conducted. However, since the debate continues using studies over the past two decades, it is worthwhile to selectively analyze some of them.

106PPACA (Consolidated) (2010, June 9). Title VI—Transparency and Program Integrity. Subtitle A—Physician Own- ership and Other Transparency. Sec. 6001. Limitation on Medicare Exception to the Prohibition on Certain Physician Referrals for Hospitals, pp. 619–624. Retrieved May 7, 2018, from https://www.cms.gov/Medicare/Fraud-and-Abuse/ PhysicianSelfReferral/Downloads/Section_6001_of_the_ACA.pdf 107See, for example: Letter from MedPAC to Seema Verma [CMS Director], May 23, 2017, which largely relies on its 2005 report. Retrieved May 8, 2018, from http://medpac.gov/docs/default-source/comment-letters/05232017_ medpac2018ippscommentletterfinal.pdf?sfvrsn=0 This memo’s recommendation with respect to these hospitals largely relies on a 2005 MedPAC study: MedPAC: Physician-owned Specialty Hospitals. March 2005. Retrieved from http:// www.medpac.gov/documents/Mar05_SpecHospitals.pdf

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https://www.cms.gov/Medicare/Fraud-and-Abuse/PhysicianSelfReferral/Downloads/Section_6001_of_the_ACA.pdf

http://medpac.gov/docs/default-source/comment-letters/05232017_medpac2018ippscommentletterfinal.pdf?sfvrsn=0

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In a widely cited paper, Mitchell108 found: “The consistent finding of higher use rates by physician owners across time clearly suggests that financial incentives linked to ownership of either specialty hospitals or ambulatory surgery centers influence physicians’ practice patterns.” Although the results make some intuitive sense, the study was done in one state (Idaho), with data from one insurer, and analyzed one specialty. Further, causality cannot be determined: Did the physicians use their facilities solely to make money, or did these facilities provide a more efficient way to treat patients in an area where shortages prevented timely service provisions? Three additional criticisms of these types of studies exist. First, they focus on ownership but not whether referring physicians (as distinguished from those performing the procedures) have an interest in the facilities. Second, in most studies, utilization and other measured parameters are not correlated with degree of ownership interest. This question is especially important since the vast majority of physicians have ownership shares in these facilities of less than 5%.109 Further, according to Greenwald et al.:

[A]lthough we found that physician-owners do tend to favor their own specialty hospitals, they also refer patients to competitor hospitals; the size of the ownership share appears to be an important factor, not the fact of ownership per se. We also found that most physician-owners have very small shares in their specialty hospital and, possibly as a consequence, make few referrals to the facility.110

Third, almost all the studies contributing to this debate were conducted prior to imple- mentation of the Medicare Severity-Diagnosis Related Groups (MS-DRGs) in 2007. (Please see Chapter 6 for an explanation of this method.) Briefly, prior to this time, facilities could profit by doing the same procedures on healthier patients. After this time, payments have been adjusted depending on the severity of each case, thus limiting (though not eliminating) the ability to “cream skim” the patients with the lowest resource use.

The research in this area has focused not just on the term “physician-owned hospitals” but also on “single-specialty hospitals” (SSHs). Specific definitions have varied, but Medicare has used the term “SSH” to designate facilities that are largely physician-owned and that primarily treat patients with cardiac, orthopedic, or general surgical services; physician ownership varies by type of hospital and ranges from about 33% to 100%.

108Mitchell, J. (2010). Effect of physician ownership of specialty hospitals and ambulatory surgery centers on frequency of use of outpatient orthopedic surgery. Archives of Surgery, 145, 732–738. In another article (Mitchell, J. [2008]. Do financial incentives linked to ownership of specialty hospitals affect physicians’ practice patterns? Medical Care, 46, 732–737), the author comes to the same conclusions based on a sample of Oklahoma workers’ compensation cases for back/spine disorders. 109Schneider, J. E., Ohsfeldt, R. L., & Li, P. (2010). The effects of endogenous market entry of physician-owned hospitals on medicare expenditures: An instrumental variables approach. Contemporary Economic Policy, 29, 151–162. 110Greenwald, L., Cromwell, J., Adamache, W., Bernard, S., Drozd, E., Root, E., & Devers, K. (2006). Specialty versus community hospitals: Referrals, quality, and community benefits. Health Affairs, 25(1), 106–118.

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An example of a study using this terminology provides further insights. Carey et al.111

found that:

SSHs are entering less regulated markets; virtually all SSH growth nationally since 1990 has been in states without certificate of need (CON) laws.

[R]esults did not show an overall statistical effect of either growing or declining safety-net services among general hospitals. [In other words, if SSHs take the most profitable patients, the provision of necessary community services were not reduced due to loss of profitable cross subsidies.]

SSH entry is associated not only with more cardiac services being performed, but with more hospitals performing cardiac services since some that did not offer these services prior to the SSH entry added them. Competition from orthopedic and surgical SSHs also is associated with the growth of freestanding outpatient centers that are affiliated with general hospitals.

[H]igh-technology diagnostic services showed a very strong pattern of growth in markets with increasing SSH competition compared to markets without SSH competition.

Further, numerous studies have concluded that after adjustments for lower severity and higher procedure volume, “specialty hospitals appear to offer levels of [technical] quality at least comparable and in some cases better than their general hospital counterparts.”112

Proponents of these hospitals claim the results are from the specialization in a particular service and process, so-called focused factories.113 Critics point out that even after clin- ical risk adjustment, differences in such factors as race and insurance status skew these results in favor of the SSH. Some even criticize the comparability of populations after risk adjustment.114

Using another type of measure, patient satisfaction, SSHs have enjoyed high scores com- pared to general hospitals in the same market.115

111Carey, K., Burgess, J. F., & Young, G. J. (2009, Summer). Single specialty hospitals and service competition. Inquiry, 46, 162–171. 112Several of these studies are summarized in: Schneider, J. E., Miller, T. R., Ohsfeldt, R. L., Morrisey, M. A., Zeiner, B. A., & Li, P. (2008). The economics of specialty hospitals. Medical Care Research and Review, 65, 531–553. 113Herzlinger, R. (1997). Market-driven healthcare: Who wins, who loses in the transformation of America’s largest service industry. Reading, MA: Addison-Wesley. 114O’Neill, L., & Hartz, A. J. (2012). Lower mortality rates at cardiac specialty hospitals traceable to healthier patients and to doctors’ performing more procedures. Health Affairs, 31(4), 806–815. 115See, for example: Dunn, L. (2012, January 27). Press Ganey honors 20 physician-owned hospitals with sum- mit award. Becker’s Hospital Review. Retrieved from http://www.beckershospitalreview.com/news-analysis/ press-ganey-honors-20-physician-owned-hospitals-with-summit-award.html; and, more recently, Dyrda, L. (2017, February 13). 38 physician-owned hospitals receive top patient ratings. Beckers Hospital Review. Retrieved from https://www.beckershospitalreview.com/rankings-and-ratings/38-physician-owned-hospitals-receive-top-patient-ratings .html

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https://www.beckershospitalreview.com/rankings-and-ratings/38-physician-owned-hospitals-receive-top-patient-ratings.html

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As far as cost, while higher profitability of SSHs has been linked to choice of higher reimbursed services, there is evidence that they are more efficient than general hospitals.116

Further, Schneider et al.117 concluded:

Much of the policy concerns over physician ownership, particularly those arguing that the “demand inducement” aspects of physician ownership drive up costs, are likely overstated. Conversely, taking the quality and expenditure savings estimates together, POHs [physician-owned hospitals] would generate about $10 billion in savings over a 10-year period.

Other, more recent, studies reached these conclusions:

■ “Although POHs may treat slightly healthier patients, they do not seem to systematically select more profitable or less disadvantaged patients or to provide lower value care.”118

■ “Certain models consistently outperformed others based on the VBPP [Medicare Value Based Purchasing Program] methodology. In general, smaller physician-owned hospitals outscored larger tertiary centers, teaching hospitals, and safety-net providers.”119

■ “[P]hysician-owned hospitals are associated with lower mean Medicare costs, fewer complications, and higher patient satisfaction following THA [total hip arthroplasty] and TKA [total knee arthroplasty] than non-physician-owned hospitals.”120

In summary, the two objections to physician-owned hospitals that have led to government regulation, namely that taking the most profitable patients causes a decrement in the ability of general hospitals to care for poorer patients and increases overall expenses, have not been conclusively proved.121 More current analyses need to be performed to enlighten healthcare policy. However, in the absence of such data, the future of such facilities will depend as much on which political party controls Congress and the lobbying power of their critics as it does on their cost and quality performances.

116Kumar, K. (2010). Specialty hospitals emulating focused factories. International Journal of Health Quality Assurance, 23, 94–109. 117The effects of physician-owned hospitals on medical care quality and expenditures: A review and update (“Avalon Health Economics Study”) (July 2015). Retrieved May 8, 2018, from http://waysandmeans.house.gov/wp-content/ uploads/2016/08/20150519HL-SFR-Johnson-PHA-Summary-Value-Manuscript-.pdf N.B.: “This research received par- tial support from an unrestricted research grant from Physician Hospitals of America.” 118Blumenthal, D., Orav, E. J., Jena, A. B., Dudzinski, D. M., Le, S. T., & Jha, A. K. (2015). Access, quality, and costs of care at physician-owned hospitals in the United States: Observational study. BMJ, 351, h4466. doi:10.1136/bmj.h4466. 119Ramirez, A., Tracci, M. C., Stukenborg, G. J., Turrentine, F. E., Kozower, B. D., & Jones, R. S. (2016). Physician-owned surgical hospitals outperform other hospitals in the medicare value-based purchasing program. Journal of the American College of Surgeons, 223(4), 559–567. 120Courtney, P. M., Darrith, B., Bohl, D. D., Frisch, N. B., Della Valle, C. J. (2017). Reconsidering the affordable care act’s restrictions on physician-owned hospitals: Analysis of CMS data on total hip and knee arthroplasty. Journal of Bone and Joint Surgery, 99(22), 1888–1894. 121For a detailed economic analysis of this issue, see: Schneider, J. E., Miller, T. R., Ohsfeldt, R. L., Morrisey, M. A., Zeiner, B. A., & Li, P. (2008). The economics of specialty hospitals. Medical Care Research and Review, 65, 531–553.

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Safety Net Providers. Many public and private facilities are included in a group called safety net providers. The Institute of Medicine122 described these institutions as those that:

deliver a significant level of health care to uninsured, Medicaid, and other vulnerable patients . . . These providers have two distinguishing characteristics:

1. Either by legal mandate or explicitly adopted mission, they offer care to patients regardless of their ability to pay for those services; and

2. A substantial share of their patient mix are uninsured, Medicaid, and other vulnerable patients. Core safety net providers typically include public hospitals, community health centers, and local health departments, as well as special service providers such as AIDS and school-based clinics.123

Additionally, the hospital’s financial condition and the provision of selected services (e.g., trauma, burn, and neonatal intensive care) may be considered.124

Within this group are a number of classifications distinguished by payer mix, geography, and the method of federal payment for their services. These types of institutions are subject to their own Medicare Conditions of Participation in addition to the eligibility requirements that distinguish each one.

Disproportionate share hospitals. Medicare and Medicaid have separate programs to help hospitals who care for a disproportionate number of poorer Medicare patients (those on Supplemental Security Income [SSI]) and Medicaid (non-dual eligible) patients, respec- tively. Prior to 1981, the payment method for Medicaid services was a vaguely worded “reasonable costs” standard, and the federal government gave states leeway to set eligibility and payments standards. To establish a more solid footing for payments and address increasing costs, the Disproportionate Share Hospital (DSH) program was started by the Omnibus Budget Reconciliation Act of 1981. It was strengthened by the Omnibus Budget Reconciliation Act of 1987 (P.L. 100-203), which required state Medicaid agencies to make additional payments to hospitals that serve disproportionate numbers of low-income patients with special needs. (Its permanence was codified in Section 1923 of the Social Security Act.) However, because the payments were not capped, program costs began to rise rapidly, caus- ing the federal government to gradually institute three measures to control spending. First, national and state-specific ceilings were placed on special payments to DSH hospitals.125

122Institute of Medicine. (2000). America’s health care safety net: Intact but endangered. Washington, DC: The National Academies Press. doi:10.17226/9612 123Two important organizations that represent these facilities are the National Association of Community Health Centers (http://www.nachc.org) and the National Association of Public Hospitals and Health Systems (http://www.naph.org). Both retrieved May 8, 2018. 124Bachrach, B., Braslow, L., & Karl, A. (2012). Toward a high performance health care system for vulnerable popula- tions: Funding for safety-net hospitals. The Commonwealth Fund (March 8). Retrieved April 29, 2018, from http://www .commonwealthfund.org/Publications/Fund-Reports/2012/Mar/Vulnerable-Populations.aspx?view=print&page=all 125Medicaid Voluntary Contribution and Provider-Specific Tax Amendments of 1991 (P.L. 102–234).

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Second, hospital-specific ceilings were set on payments.126 Finally, limits to DSH allot- ments were set at 12 % of states’ total annual Medicaid expenditures.127 Except for some adjustments in 2003, the structure remained the same until passage of the Affordable Care Act (ACA) in 2010. Since the government anticipated that many more people would be insured under the ACA, the law contains provisions to scale back DSH payments through 2020. In addition to the change in amounts, Section 3133 of the ACA also revises the method for computing the Medicare DSH adjustment for discharges occurring on or after October 1, 2013:

1. Instead of the amount that would otherwise be paid as the DSH adjustment, hospitals receive 25 percent of the amount determined under the current Medicare DSH payment method begin- ning in fiscal year (FY) 2014 (for discharges occurring on or after October 1, 2013).

2. The remainder, equal to 75 percent of what otherwise would have been paid as Medicare DSH, becomes available for an uncompensated care payment after the amount is reduced for changes in the percentage of individuals who are uninsured. The Centers for Medicare & Medicaid Services (CMS) is currently using uncompensated care costs reported on Worksheet S-10 in combination with insured low-income days (the sum of Medicaid days and Medicare SSI days) to develop hospital uncompensated care payments. Each hospital eligible for Medicare DSH payments receives an uncompensated care payment based on its relative share of total uncompensated care costs and low-income days reported by Medicare DSHs.128

Subsequent laws provide examples of legislative delay, indecision, and bowing to political pressures. First, the payment reductions were extended to 2021129 and 2022.130

In 2013, the lowered payments were put on hold until 2016, but the reductions were extended to 2023.131 The following year, the reductions were delayed until 2017 and extended to 2024.132 In 2015, the reductions were revised further to cover 2018 to 2025, with increasing reductions in payments reaching $8 billion for the final 2 years. Finally, in 2018, the 2018–2019 reductions were eliminated and the cutbacks for 2020 to 2025 were adjusted.133 Under current law, federal DSH allotments are scheduled to be reduced in fiscal year (FY) 2020 by $4 billion, which is 31% of states’ unreduced DSH allotment amounts. DSH allotment reductions are scheduled to increase to $8 billion a year in FYs 2021 to 2025.

126The Omnibus Budget Reconciliation Act of 1993 (P.L. 103–66). 127Balanced Budget Act of 1997 (BBA 97, P.L. 105–33). 128Medicare Learning Network Fact Sheet. (2018, May) Medicare disproportionate share hospital. Updated May 2018. Retrieved from https://www.cms.gov/Outreach-and-Education/Medicare-Learning-Network-MLN/MLNProducts/ Downloads/Disproportionate_Share_Hospital.pdf 129Middle Class Tax Relief and Job Creation Act of 2012 (P.L. 112–96). 130American Taxpayer Relief Act of 2012 (P.L. 112–240). 131Bipartisan Budget Act of 2013 (P.L. 113–67). 132Protecting Access to Medicare Act of 2014 (P.L. 113–93). 133Bipartisan Budget Act of 2018 (P.L. 115–123).

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Future payments will take into account the Medicaid and Children’s Health Insurance Program (CHIP) Payment and Access Commission (MACPAC) assessments of the program. Most recently, MACPAC reported that it:

continues to find little meaningful relationship between DSH allotments and the number of uninsured individuals; the amounts and sources of hospitals’ uncompensated care costs; and the number of hospitals with high levels of uncompensated care that also provide essential community services for low-income, uninsured, and vulnerable populations. Total hospi- tal charity care and bad debt continue to fall, especially in states that expanded Medicaid coverage.134

Specifically, the study found that in the years since implementation of the ACA, total hospital charity care and bad debt fell by $8.6 billion (23%) between 2013 and 2015, with the largest declines occurring in states that expanded Medicaid.

Currently, eligibility is determined according to the formula below. “If a hospital’s DPP [Disproportionate Patient Percentage] equals or exceeds a specified threshold amount, the hospital qualifies for the Medicare DSH adjustment. The Medicare DSH adjustment is deter- mined by using a complex formula (the applicable formula is also based on a hospital’s particular DPP).”135

Alternatively, a hospital can qualify if it is located in an urban area, has 100 or more beds, and can demonstrate that more than 30% of total net inpatient care revenues come from state and local government sources for indigent care (other than Medicare or Medicaid).

Medicare DPP

Total Medicare Days Total Patient Days

Medicare/Supplemental Security Income Days Medicaid, Non-Medicare Days

According to MACPAC, in fiscal year 2017, “a total of $12 billion in federal funds was allotted for DSH payments. Similar to other types of Medicaid payments, federal DSH funds must be matched by state funds; in total, $21 billion in state and federal DSH funds were allotted in FY 2017.”136

Despite these delays and particularly in the face of subsequent adjustments, six issues must still be considered with regard to reduced DSH’s financial impact. First, in order to keep their volumes up and provide a source of funding that currently comes from DSH payments, these facilities will need to obtain contracts with the companies participating in

134MACPAC (Medicaid and CHIP Payment and Access Commission). (2018, March). Report to Congress on Medicaid and CHIP. Retrieved May 9, 2018, from https://www.macpac.gov/wp-content/uploads/2018/03/Report-to-Congress-on- Medicaid-and-CHIP-March-2018.pdf 135Medicare Learning Network Fact Sheet, op. cit. 136MACPAC. (2017, June). Issue Brief https://www.macpac.gov/wp-content/uploads/2017/06/Medicaid-DSH- Allotments-How-Could-Funding-for-Safety-Net-Hospitals-Change-in-2018.pdf

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https://www.macpac.gov/wp-content/uploads/2017/06/Medicaid-DSH-Allotments-How-Could-Funding-for-Safety-Net-Hospitals-Change-in-2018.pdf

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the Health Insurance Exchanges that the ACA created. Second, when DSH payments are reduced or eliminated, the Medicaid payments may remain inadequate, since each state has wide discretion in its own program’s design, including scope of benefits and payment amounts. Third, about 15.5% of adults aged 19 to 64 remain uninsured, higher than in 2016.137 Current DSH payments may no longer be available to subsidize their care. Fourth, many of these hospitals provide specialty care to currently insured patients. For example, Cook County Hospital has one of the area’s few burn care units. With subsidy removals for services that are undercompensated (like burns), hospitals may be hard-pressed to continue offering them. Fifth, reduction in DSH payments was based on anticipated full enrollment in Medicaid expansion. However, with states being able to opt out, these uninsured persons will still seek uncompensated care, but now without DSH payments. The uninsured rate in states that did not expand their Medicaid programs is 21.9%.138 Finally, a significant number of these hospitals’ patients are Medicare beneficiaries. Medicare’s payment structure is increasingly incorporating a “value-based” purchasing scheme that reduces payment if patient evaluations of the process of care fall below target values.139 Because safety-net hospitals (SNHs) have lower scores than non-SNHs on measures of patient-reported experience,140 their Medicare payments will suffer, thus reducing yet another source of funds.

Medicare-dependent hospitals. Medicare-dependent hospitals (MDHs) have 100 or fewer beds, are not also classified as a sole community hospital (SCH) (see below), and at least 60% of their inpatient days or discharges are attributable to individuals receiving Medicare Part A benefits.141 Because hospitals have claimed that Medicare payments do not adequately compensate them for their expenses, MDHs can receive inpatient payments based on the greater of the Medicare Prospective Payment Rate (PPR) or a blend of the PPR (25%) and their historical costs (75%).142

Although most of these facilities are rural, a subset are designated Urban Medicare Dependent Hospitals (UMDHs). Section 3142 of the ACA defines an UMDH as a hospi- tal that

does not receive any additional Medicare payments or adjustments under section 1886(d) of the Social Security Act, such as indirect graduate medical education payments

137Collins, S. R., Gunja, M. Z., Doty, M. M., & Bhupal, H. (2018, May 1). First look at health insurance coverage in 2018 finds ACA gains beginning to reverse. Retrieved May 9, 2018, from http://www.commonwealthfund.org/publications/ blog/2018/apr/health-coverage-erosion 138Ibid. 139HCAHPS (Hospital Consumer Assessment of Healthcare Providers and Systems). Retrieved May 9, 2018, from https:// www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/HospitalQualityInits/HospitalHCAHPS .html 140Chatterjee, P., Joynt, K. E., Orav, E. J., & Jha, A. K. (2012). Patient experience in safety-net hospitals: Implications for improving care and value-based purchasing. Archives of Internal Medicine, 172(16), 1204–1210. 14142 C.F.R. § 412.108 Special treatment: Medicare-dependent, small rural hospitals. Title 42—Public Health. 142MedPAC. (2017, October). Critical access hospitals’ payment system. Retrieved May 10, 2018, from http://www .medpac.gov/docs/default-source/payment-basics/medpac_payment_basics_17_cah_final09a311adfa9c665e80adff00009 edf9c.pdf?sfvrsn=

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https://www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/HospitalQualityInits/HospitalHCAHPS.html

http://www.medpac.gov/docs/default-source/payment-basics/medpac_payment_basics_17_cah_final09a311adfa9c665e80adff00009edf9c.pdf?sfvrsn

http://www<?xmltex \pgtag{\break}?>.medpac.gov/docs/default-source/payment-basics/medpac_payment_basics_17_cah_final09a311adfa9c665e80adff00009edf9c.pdf?sfvrsn

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under subsection (d)(5)(B), disproportionate share payments, payments to a rural referral center (RRC), payments to a sole community hospital (SCH), or payments to a Medicare-dependent small rural hospital. In addition, the hospital must not be a critical access hospital (CAH).143

This program was extended by the Bipartisan Budget Act of 2018 through September 30, 2022, and the terms are discussed in the 2019 Medicare Inpatient Prospective Payment System (IPPS) rule.144 CMS projected that the MDH program extension should have paid hospitals about $119 million in 2018.

Sole community hospitals. Congress created the Sole Community Hospital (SCH) program in 1983 to support small rural hospitals that, “by reason of factors such as isolated location, weather conditions, travel conditions, or absence of other hospitals, [are] the sole source of inpatient hospital services reasonably available in a geographic area to Medicare beneficia- ries.”145 CMS defines an SCH as a hospital paid under the Medicare IPPS that meets one of the following criteria:

1. The hospital is located at least 35 miles from other like hospitals, i.e., those that furnish short-term, acute care; are paid under the Medicare Acute Care Hospital PPS; and are not Critical Access Hospitals or

2. The hospital is rural, located between 25 and 35 miles from other like hospitals, and meets one of these criteria:

a) No more than 25 percent of residents who become hospital inpatients or no more than 25 percent of the Medicare beneficiaries who become hospital inpatients in the hospital’s ser- vice area are admitted to other like hospitals located within a 35-mile radius of the hospital or, if larger, within its service area or

b) The hospital has fewer than 50 beds and would meet the 25 percent criterion above if not for the fact that some beneficiaries or residents were forced to seek specialized care outside of the service area due to the unavailability of necessary specialty services at the hospital or

c) The hospital is rural and located between 15 and 25 miles from other like hospitals but because of local topography or periods of prolonged severe weather conditions, the other like hospitals are inaccessible for at least 30 days in each of 2 out of 3 years or

d) The hospital is rural and because of distance, posted speed limits, and predictable weather conditions, the travel time between the hospital and the nearest like hospital is at least 45 minutes.146

143Sibelius, K. (2010). Report to Congress. Department of Health and Human Services Study of Urban Medicare- Dependent Hospitals. Retrieved May 10, 2018, from http://www.cms.gov/Research-Statistics-Data-and-Systems/ Statistics-Trends-and-Reports/Reports/downloads/Riley_UMDH_RTC_2010.pdf 144Department of Health and Human Services (2018, May 7). Centers for Medicare & Medicaid Services 42 CFR Parts 412, 413, 424, and 495. Federal Register,83, 88. Proposed Rules, pp. 20172–20175. Retrieved from https://www.gpo.gov/ fdsys/pkg/FR-2018-05-07/pdf/2018-08705.pdf. 145Section 405.476, Title 42 of the 1983 Code of Federal Regulations. 146Medicare Learning Network: Acute Care Hospital Inpatient Prospective Payment System. March 2018. https://www.cms.gov/Outreach-and-Education/Medicare-Learning-Network-MLN/MLNProducts/Downloads/ AcutePaymtSysfctsht.pdf Retrieved May 10, 2018.

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https://www.gpo.gov/fdsys/pkg/FR-2018-05-07/pdf/2018-08705.pdf

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3. The hospital is rural and located between 15 and 25 miles from other like hospitals but because of local topography or periods of prolonged severe weather conditions, the other like hospitals are inaccessible for at least 30 days in each of 2 out of 3 years or

4. The hospital is rural and because of distance, posted speed limits, and predictable weather con- ditions, the travel time between the hospital and the nearest like hospital is at least 45 minutes . . .

A hospital’s service area is the area from which it draws at least 75% of its inpatients dur- ing the most recent 12-month cost reporting period ending before it applies for classification as an SCH.

Rural SCHs are paid for inpatient care on a cost basis rather than by DRG and are allowed to choose from several years on which to base these payments.147 Starting in 2016, rural SCHs received an additional 7.1% above standard payment rates for outpatient prospective payment services excluding drugs, biologics, brachytherapy sources, and devices paid under the pass-through payment policy (devices that receive temporary extra payment because of their newness and uniqueness).

Critical access hospital. The Balanced Budget Act of 1997 (P.L. 105-33) created the category of critical access hospitals (CAHs), expanding and replacing the Essential Access Commu- nity Hospital/Rural Primary Care Hospital Program and the Medical Assistance Facilities demonstration in Montana.148

A Medicare-participating hospital must meet the following criteria for CMS to designate it a CAH:149

■ Be located in a state that has established a State Medicare Rural Hospital Flexibility Program.

■ Be designated by the state as a CAH.

■ Be located in a rural area or an area that is treated as rural.

■ Be located either more than 35 miles from the nearest hospital or CAH or more than 15 miles in areas with mountainous terrain or only secondary roads; OR prior to January 1, 2006, was certified as a CAH based on state designation as a “necessary provider” of healthcare services to residents in the area.

■ Maintain no more than 25 inpatient beds that can be used for either inpatient or swing-bed services. In addition to the 25 inpatient CAH beds, a CAH may also operate a psychiatric and/or a rehabilitation distinct part unit of up to 10 beds each. These units must comply with the Hospital Conditions of Participation.

147Code of Federal Regulations. Title 42—Public Health. Vol. 2, Date: 2017-10-01 Title: Section Â§ 412.92—Special treatment: Sole community hospitals. Retrieved May 10, 2018, from https://www.gpo.gov/fdsys/pkg/CFR-2017-title42- vol2/xml/CFR-2017-title42-vol2-sec412-92.xml 148Since a number of legislative changes shaped this program over the years since its establishment, see CAH Legislative History. Retrieved May 10, 2018, from http://www.aha.org/advocacy-issues/cah/history.shtml 149Critical Access Hospitals. Retrieved May 3, 2018, from http://www.cms.gov/Medicare/Provider-Enrollment-and- Certification/CertificationandComplianc/CAHs.html

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■ Maintain an annual average length of stay of 96 hours or less per patient for acute inpa- tient care (excluding swing-bed services and beds that are within distinct part units).

■ Demonstrate compliance with the critical access hospitals conditions of participation found at 42 Code of Federal Regulations (CFR), Part 485 subpart F.

■ Furnish 24-hour emergency care services 7 days a week.

These facilities may also be health clinics or centers (as defined by the state) that previ- ously operated as a hospital before being downsized to a health clinic or center.

Like MDHs and SCHs, the CAHs are not subject to the fixed Inpatient Prospective Pay- ment System (IPPS) or Outpatient Prospective Payment System. Instead, a CAH may bill Medicare under one of two methods. The Standard Payment Method allows the hospital to bill for facility services (inpatient and outpatient) based on 101% of reasonable costs.150

Under the Optional Payment Method, the hospital can bill for both facility and physician services, the latter at 115% of local Medicare rates. In order to be eligible for the optional method, a physician must assign Part B billing rights to the CAH. Additionally, since 2007, physicians and other practitioners electing the optional method can bill Medicare for tele- health services.151

These higher payment levels (compared to Medicare inpatient and outpatient prospec- tive payment methods) are supposed to enable these facilities to furnish services in scarcity areas while maintaining quality care. Research on this topic shows that for most services, CAHs furnish comparable care; however, this finding does not necessarily hold as complexity increases. For example:

■ With respect to Medicare beneficiaries, prior to 2002, CAHs and non-CAHs had similar mortality rates. However, for “beneficiaries with acute myocardial infarction, congestive heart failure, or pneumonia, 30-day mortality rates for those admitted to CAHs, compared with those admitted to other acute care hospitals, increased from 2002 to 2010.”152

■ “Among Medicare beneficiaries undergoing common surgical procedures, patients admitted to critical access hospitals compared with non–critical access hospitals had no significant difference in 30-day mortality rates, decreased risk-adjusted serious complication rates, and lower-adjusted Medicare expenditures, but were less medically complex.”153

150The Medicare Prescription Drug, Improvement, and Modernization Act (MMA) of 2003 (P.L. 108–173, Section 405). This Act increased payment to 101% of costs and created the Optional Payments method. 151Medicare Learning Network. (2017, August). Critical Access Hospital. Retrieved May 10, 2018, from https://www.cms .gov/Outreach-and-Education/Medicare-Learning-Network-MLN/MLNProducts/downloads/CritAccessHospfctsht.pdf 152Joynt, K. E., Orav, E. J., & Jha, K. A. (2013). Mortality rates for Medicare beneficiaries admitted to critical access and non–critical access hospitals, 2002–2010. JAMA, 309, 1379–1387. 153Ibrahim, A. M., Hughes, T. G., Thumma, J. R., Dimick, J. B. (2016). Association of hospital critical access status with surgical outcomes and expenditures among Medicare beneficiaries. JAMA, 315(19), 2095–2103.

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■ “Compared with PPS hospitals, CAHs are significantly less likely to have any observed (unadjusted) adverse event on 4 of the 6 indicators. After adjusting for patient mix and hospital characteristics, CAHs perform better on 3 of the 6 indicators. Accounting for the number of discharges eliminated the differences between CAHs and PPS hospitals in the likelihood of adverse events across all indicators except one . . . The study suggests there are no differences in surgical patient safety outcomes between CAHs and PPS hospitals of comparable size.”154

■ “For emergency colectomy procedures, Medicare beneficiaries in critical access hospi- tals experienced lower mortality rates but more frequent re-operation and readmission. These findings suggest that critical access hospitals provide safe, essential emergency surgical care, but may need more resources for postoperative care coordination in these high-risk operations.”155

The relative numbers of the three types of hospitals described above are displayed in Exhibit 4.20.

EXHIBIT 4.20. Share of Hospitals and Medicare Payments by Rural Hospital Type, 2015

Standard PPS 15%

Share of rural hospitals Share of rural Medicare payments

MDH 8%

SCH 17%

CAH 61%

Standard PPS 27%

MDH 8%

SCH 31%

CAH 34%

Religious-sponsored (faith-based) hospitals. The origins of these hospitals are discussed in the history section above, and they share many of the same issues as other hospitals. What

154Natafgi, N., Baloh, J., Weigel, P., Ullrich, F., & Ward, M. M. (2017). Surgical patient safety outcomes in critical access hospitals: How do they compare? The Journal of Rural Health, 33(2), 117–126. 155Ibrahim, A. M., Regenbogen, S. E., Thumma, J. R., Dimick, J. B. (2018). Emergency surgery for medicare beneficiaries admitted to critical access hospitals. Annals of Surgery, 267(3), 473–477, 2018.

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136 The U.S. Healthcare System

distinguishes them from the other types of hospitals is that religious beliefs guide not only what care they provide but how they provide the care (e.g., with compassion and attention to the individual’s spiritual, as well as physical, needs). The number of these organizations has continued to grow, as shown in Exhibit 4.21.

The predominant affiliation of these hospitals is Catholic. The more than 600 Catholic hospitals make up over 14% of the all acute care hospitals and 1 in 6 acute care beds. CMS has identified 46 of them as being “sole community” providers. Further, Catholic systems own more than 1,400 long-term care facilities across 50 states.156

These hospitals control what is provided to patients in such areas as reproductive services and end-of-life care. The principles that guide their actions are dictated by the United States Conference of Catholic Bishops.157

EXHIBIT 4.21. Number of Faith-Based Hospitals in the United States from 1995 to 2016

P e rc

e n

ta g

e o

f h

o sp

it a ls

800

600

400

200

0 1995 2000 2005 2008 2013 2016

585

662 663 658 667

726

Note: In 2016, 17% of all U.S. hospitals were faith-based.

Source: The Governance Institute. © Statistica. Used with permission.

156Johnson, S. R. (2017, September 14). As Catholic systems grow by acquiring other hospitals, abortions plummet. Mod- ern Healthcare. Retrieved May 10, 2018, from http://www.modernhealthcare.com/article/20170914/NEWS/170919931 157United States Conference of Catholic Bishops. (2009). Ethical and Religious Directives for Catholic Health Care Ser- vices (5th ed.). Retrieved May 10, 2018, from http://www.modernhealthcare.com/article/20170914/NEWS/170919931

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HOSPITAL INPATIENT PAYMENT METHODS

Hospitals include in their descriptions of financial conditions and projections a metric called payer mix, or what percentage of their services are paid by private payers, Medicare, Medi- caid, self-pay (direct patient payments), and charity (free) care. Of equal importance, though often lacking, is a description of the mix of the methods of payment. The frequency of these methods on a geographic or hospital-specific level can vary dramatically, depending on such population factors as economics (Medicaid eligibility) and age (Medicare) and on such insur- ance market factors as penetration of types of managed care and degree of competition among payers and providers.

The following eight methods (which are not mutually exclusive for a given institution) are used to pay hospitals for inpatient services; they may also be used in other countries as well as in the United States.

1. Fee for service. This arrangement is the traditional retail model where the payer pays charges. This method is best for hospitals since markups are significant and can cover uncompensated/undercompensated care. It is obviously the worst method for payers.

2. Discount fee for service. This scheme is not quite a “wholesale” model since the charges on which the discounts are based can be raised significantly to make payments substan- tial. It is very favorable for hospitals and only slightly better for payers.

3. DRGs. Please see the Medicare section in Chapter 6 for a discussion of DRGs. Briefly, this method is a single payment for inpatient services based on the reason (diagnosis) the patient was in the hospital. DRGs cover only the hospital portion while bundled/global payments (see below) cover physician services and possibly some post-discharge care as well. This method is better for payers since it can help predict hospital costs given the mix of expected illnesses in a population. It also limits payment for particularly costly patients.158

4. Per diems. Before discussing this topic, it should be noted that hospital expense for pro- viding inpatient care is typically greatest in the first day or two of the stay, when costly procedures and/or tests are usually performed. As patients recuperate or receive ongo- ing treatment (such as intravenous medication), costs are lower than at the beginning of the stay. When payment is by DRG or global rate, shorter times are more profitable for the hospital, since revenue does not increase with longer stays but expenses do accumulate. With FFS-like payments, however, longer stays are much more lucrative for hospitals since (barring complications) their margins are higher nearest the time of discharge.

When managed care plans such as health maintenance organizations (discussed in more detail in the Managed Care section in Chapter 6) started to become more prevalent in the 1980s, they were looking for clearer, easier, and presumably cheaper alterna- tives to FFS hospital payments. While some companies negotiated payments based

158If patients are very ill and require prolonged services, Medicare will pay extra amounts called “outlier payments.”

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on discount charges or DRG-like schemes, others crafted a method based on a flat, all-inclusive, daily (per diem) fee. Each level of service (such as intensive care, regular medical/surgical care, maternity care, and psychiatric care) has its own daily charge. Total payment is, therefore, the sum of all the daily charges. The method for calculating these fees was simple: With adjustments for days spent at different levels of care, the per diem was the quotient of total costs divided by total days.

While this method is simple, for three reasons it led to inadequate compensation for hospitals. First, the patients who were being admitted were sicker than the average case used to calculate the average payments. This situation was due to an increased capability to treat many illnesses in the outpatient setting and increased scrutiny of the appropriateness of hospitalization (utilization review). Second, the lengths of stay were shortened and patients were being transferred to less expensive sites of care, such as skilled nursing facilities. The “profitable” part of the hospital stay was, therefore being truncated. Finally, when most of the payers compensated hospitals on an FFS basis, no shortfall existed (or it was insignificant); all fixed costs were essentially being cov- ered by these traditional plans, and these per diem contracts were more than covering marginal costs. However, when many private payers switched to per diem payments after the late 1980s, hospitals began to feel the economic strains.

5. Budgets. Many government hospitals, such as those of the Veterans Administration (VA) and counties, are given annual budgets with which they must deliver all their services. These hospitals are not prohibited from collecting from private payers when such coverage is available; however, frequently they are not equipped or are unwilling to do so because of the relatively low volume of these patients. For example, a 2009 GAO study found that for patient services at 18 VA medical centers: “Although some medical services are not billable, such as service-connected treatment, management had not validated reasons for related unbilled amounts of about $1.4 billion to assure that all billable costs are charged to third-party insurers.”159

The advantage to the payer of this method is the ability to budget expenses. The disadvantage is that the hospitals have a disincentive to be more efficient; if they do not spend their budgeted money in the designated year, their next allocation is reduced at least by the amount of the savings.

6. Risk. This arrangement is more fully explained in the next section on organized deliv- ery systems/accountable care organizations. Briefly, this scheme requires hospitals to accept financial risk for caring for patients (akin to insurance risk) as well as clinical risk (i.e., responsibility for the quality of care). In the latter case, the payer financially rewards the organization with additional payments if certain targets are met. Monies may also be deducted from payments if hospitals do not achieve certain thresholds.

159Government Accountability Office Document GAO-10-152T: VA Health Care: Ineffective Medical Center Controls Resulted in Inappropriate Billing and Collection Practices. October 15, 2009. Retrieved May 8, 2018, from https://www .gao.gov/assets/130/123540.pdf

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7. Bundled/global/packaged payments.160 Instead of receiving a bill for multiple ser- vices from multiple providers, the payer negotiates one fee for an episode of care. As mentioned above, while DRGs refer only to in-patient services, bundled payments can refer to outpatient care as well as combined inpatient and outpatient care for the same episode of illness. Bundled payments often include professional charges (such as physician fees) and ancillaries (laboratory and radiology). While private payers have been paying in this fashion for a number of years (e.g., for such services as transplantation and coronary artery bypass surgery), as a result of provisions in the ACA, Medicare has been at the forefront of initiating a bundled payments program based on the success of previous pilot studies. For example, in the Medicare Acute Care Episode (ACE) Demonstration project, which bundled certain in-hospital cardiac and orthopedic procedures in selected states, Medicare achieved a per- episode savings of $319 and total net savings of approximately $4 million.161 The Medicare bundled payment programs have undergone many politically motivated changes in the past several years. Most recently, CMS announced voluntary Bundled Payments for Care Improvement Advanced (BPCI Advanced) for 32 clinical episodes in order “to align incentives among participating health care providers for reducing expenditures and improving quality of care for Medicare beneficiaries.”162 The program began October 1, 2018, and will run through December 31, 2023. Exhibit 4.22 provides a list of these episodes. Note the diversity of conditions, which provides the opportunity for businesses to partner with provider organizations to deliver cost-effective care.

8. Quality payments. In addition to the above methods, hospitals are also paid or penal- ized for their performance of clinical care. Please see Chapter 9 for details of this process.

ORGANIZED (INTEGRATED) DELIVERY SYSTEMS/ACCOUNTABLE CARE ORGANIZATIONS

Origins and Definition In the 1990s, a number of researchers conducted studies on what were then called integrated or organized delivery systems (IDSs or ODSs). These systems were formed for the same reasons listed above for hospital systems. An ODS was defined as “[a] network of orga- nizations which provides or arranges to provide a coordinated continuum of services to a

160These three terms are often used interchangeably or idiosyncratically. Since Medicare has a program that it calls Bundled Payment, this term will be used for this concept. 161Centers for Medicare & Medicaid Services Final Evaluation Report Evaluation of the Medicare Acute Care Episode (ACE) Demonstration. May 31, 2013. Retrieved May 10, 2018, from https://downloads.cms.gov/files/cmmi/ACE- EvaluationReport-Final-5-2-14.pdf Of note is that the savings from the acute care episode (physician and hospital charges) were more substantial; post-acute care costs reduced savings by 45%. 162CMS.gov. (2018, April 30). BPCI Advanced. Retrieved May 10, 2018, from https://innovation.cms.gov/initiatives/ bpci-advanced

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140 The U.S. Healthcare System

EXHIBIT 4.22. Clinical Episodes for the Bundled Payments for Care Improvement Advanced Program—29 Inpatient Clinical Episodes

1. Disorders of the liver excluding malignancy, cirrhosis, alcoholic hepatitis

2. Acute myocardial infarction

3. Back and neck except spinal fusion

4. Cardiac arrhythmia

5. Cardiac defibrillator

6. Cardiac valve

7. Cellulitis

8. Cervical spinal fusion

9. COPD, bronchitis, asthma

10. Combined anterior posterior spinal fusion

11. Congestive heart failure

12. Coronary artery bypass graft

13. Double joint replacement of the lower extremity

14. Fractures of the femur and hip or pelvis

15. Gastrointestinal hemorrhage

16. Gastrointestinal obstruction

17. Hip and femur procedures except major joint

18. Lower-extremity/humerus procedure except hip, foot, femur

19. Major bowel procedure

20. Major joint replacement of the lower extremity

21. Major joint replacement of the upper extremity

22. Pacemaker

23. Percutaneous coronary intervention

24. Renal failure

25. Sepsis

26. Simple pneumonia and respiratory infections

27. Spinal fusion (noncervical)

28. Stroke

29. Urinary tract infection

Three outpatient clinical episodes:

1. Percutaneous coronary intervention (PCI)

2. Cardiac defibrillator

3. Back and neck except spinal fusion

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Hospitals and Healthcare Systems 141

defined population and is willing to be held clinically and fiscally accountable for the out- comes and health status of the population served. An ODS will own or be closely aligned with an insurance product.”163

The ideal structure of these systems is outlined in Exhibit 4.23. Noteworthy about this scheme are the following observations:

1. The stakeholders are the same ones discussed in Chapter 1, “Understanding and Man- aging Complex Healthcare Systems.”

2. The end states are cost, quality, and access.

EXHIBIT 4.23. The Value Chain of Healthcare Delivery

Stakeholders

End States

Competencies

Communities Patients Employees Employers Purchasers Government Investors

Ease of access

Interpersonal satisfaction

Accurate diagnosis

Competent treatment

Positive outcomes

Affordable cost

More knowledgeable consumer

Disease Prevention

Health promotion

Primary care

Acute care management

Rehabilitative care management

Chronic care management

Supportive care management

Underlying Capabilities

Functional Integration

Physician-system Integration

Clinical Integration

Source: Shortell, S., Gillies, R. R., Anderson, D. A., Erickson, K. M., & Mitchell, J. B. (2000). Remaking healthcare in America: The evolution of organized delivery systems (2nd ed.). San Francisco: Jossey-Bass.

Functional Integration. The extent to which the supported functions and activities (e.g., financial man-

agement, human resources management, information technology management, strategic planning, qual-

ity improvement) are coordinated across operating units so as to add greatest overall value to the

system.

Physician Integration. The extent to which physicians and the ODSs with which they are associated agree on

the aims in purposes of the system and work together to achieve mutually shared objectives.

Clinical Integration. The extent to which patient care services are coordinated across people, functions, activ-

ities, and sites over time so as to maximize the value of services delivered to patients.

163Shortell, S., Gillies, R. R., Anderson, D. A., Erickson, K. M., & Mitchell, J. B. (2000). Remaking healthcare in America: The evolution of organized delivery systems (2nd ed.). San Francisco: Jossey-Bass.

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142 The U.S. Healthcare System

3. The competencies represent care across the spectrum of services (from prevention to end-of-life support).

4. Functional integration is the low-hanging fruit of integration—easy to achieve and rec- ognize its financial benefits. It mainly derives from economies of scale.

5. Physician integration requires not just shared culture and goals between those profes- sionals and the system but also a compensation scheme that aligns them.

6. Clinical integration is the hardest alignment to achieve. It requires that the organiza- tions not only have a process in place to learn and develop best practices, but also has a mechanism to spread those best practices and make them part of how the firm works.

7. In order to ensure that these systems accept not only clinical risk for care but also financial risk, they must assume an insurance-like function, either directly by owning an insurance plan or by contracting on some type of risk basis with one.

Despite the success of long-standing, mostly private systems (such as Geisinger, Inter- mountain Healthcare, Cleveland Clinic, Mayo Clinic, and others), for reasons explained below, this concept did not fulfill the promise of transforming the way care was delivered. More recently, Section 3022 of the ACA164 added Section 1899 to the Social Security Act that requires the Secretary to establish a Medicare Shared Savings Program, which is the origin of federal ACO initiatives. This change spurred a more recent attempt at using these ODSs (now often called ACOs) to address large regional variations in costs and quality of care. While Medicare funding is the underpinning of this program, the topic is discussed here since it has created a large, renewed impetus for systems to form and integrate. The struc- tures of these newer arrangements are also shaped by the different payment mechanisms described below.

The goal of the ACO initiative is to reward quality performance and operational effi- ciency rather than sheer volume of services. Also, federal budget deficits made shifting financial risk for the provision of care to providers more attractive to CMS.

According to CMS: “ACOs are groups of doctors, hospitals, and other health care providers, who come together voluntarily to give coordinated high-quality care to the Medicare patients they serve.”165

In addition to addressing Medicare issues, other provisions in the ACA create a num- ber of constraints on the profitability of private payers (e.g., regulated premiums, reduced ability to charge different rates to older and higher risk members, mandated benefits, limits on members’ out-of-pocket payments and bounds on profit margins). Consequently, these commercial plans are also very interested in shifting more risk to providers. The result is

164Section 3022 of the Affordable Care Act added a new section 1899 to the Social Security Act that requires the Secretary to establish a Medicare Shared Savings Program, which is the origin of federal ACO initiatives. 165Like many other facts in this book, these provisions are subject to change. The provisions were taken from the CMS publication of the Shared Savings Program: Accountable Care Organizations, October 11, 2011. Retrieved May 13, 2018, from http://www.cms.gov/sharedsavingsprogram

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private ACO arrangements whereby the health delivery system takes substantial clinical and financial risk for patient care. Since private payer contracts can vary considerably, the next section focuses on operational requirements of Medicare ACOs.166

Eligibility ACO participants or combinations of ACO participants must qualify as one, or more, of the following providers or suppliers or participate through an ACO formed by one or more of these groups:167

■ Professionals in group practice arrangements

■ Networks of individual professional practices

■ Partnerships or joint venture arrangements between hospitals and ACO professionals

■ Hospitals employing ACO professionals

■ CAHs that bill for both Medicare Part A and B (such as inpatient and physician compo- nents)

■ Rural health clinics (RHCs)

■ Federally Qualified Health Centers (FQHCs)

In 2018, there were 561 ACOs that enrolled 10.5 million beneficiaries; the distribution of types of these organizations in the Shared Savings Program (see below) were:168

■ Physicians only: 171 (30%)

■ Physicians, hospitals, and other facilities: 324 (58%)

■ FQHCs/RHCs: 66 (12%)

CMS identifies providers using their National Provider Identifier (NPI) and Taxpayer Identification Number (TIN)—either an Employer Identification Number or a Social Security number. While specialists can contract with multiple organizations, primary care doctors can join only one ACO. Members of a group with one TIN must join the same ACO regardless of their office locations. The only way to avoid this situation is if each group member has a different TIN.

Financial Arrangements In order to achieve its goals, Medicare withholds parts of its usual payments to ACOs and pays them back as bonuses if those organizations meet certain financial and quality

166See, also, the website for the National Association of ACOs, the trade group of these organizations. Retrieved May 15, 2018, from https://www.naacos.com 167For more details on eligibility, see: CMS Eligibility Requirements Checklist for MSSP ACO Participation. Retrieved May 13, 2018, from https://www.hcca-info.org/Portals/0/PDFs/Resources/Conference_Handouts/Compliance_Institute/ 2014/mon/101handout1.pdf 168CMS. (2018, January). Medicare Shared Savings Program Fast Facts. Retrieved May 13, 2018, from https://www.cms .gov/Medicare/Medicare-Fee-for-Service-Payment/sharedsavingsprogram/Downloads/SSP-2018-Fast-Facts.pdf

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https://www.naacos.com

https://www.hcca-info.org/Portals/0/PDFs/Resources/Conference_Handouts/Compliance_Institute/2014/mon/101handout1.pdf

https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/sharedsavingsprogram/Downloads/SSP-2018-Fast-Facts.pdf

144 The U.S. Healthcare System

benchmarks. Patients are assigned to an ACO based on whom they recently saw for primary care services (as determined by certain procedure codes). Except for the Pioneer and Next Generation ACOs (see below), these organizations often do not know which patients are assigned to them until the end of the assessment period, when CMS calculates the bonuses (or deficits). The benchmarks are adjusted using a severity-of-illness measure for the local county population (as opposed to individual patients). One important characteristic of these plans is that, like traditional Medicare, patients are free to seek care from any provider; if they do so, the financial and quality performance of the non-ACO providers are attributed to the ACO to which the patient is assigned.

Eligible providers are able to enroll in one of three types of ACOs, described next. The first, and most common, type of ACO is the Medicare Shared Savings Program

(MSSP), which offers participants several options that allow for varied amounts of downside risk. These options are explained in Exhibit 4.24.

EXHIBIT 4.24. Shared Savings Program ACO Participation Options Track

(% of ACOs)

Financial Risk

Arrangement

Description

(82%)

One-sided Track 1 ACOs do not assume downside risk (shared losses) if

they do not lower growth in Medicare expenditures.

Medicare ACO Track 1+ Modela

(10%)a

Two-sided Medicare ACO Track 1+ Model (Track 1+ Model) ACOs assume limited downside risk (less than Track 2 or Track 3).

(1%)

Two-sided Track 2 ACOs may share in savings or repay Medicare losses

depending on performance. Track 2 ACOs may share in a

greater portion of savings than Track 1 ACOs.

(7%)

Two-sided Track 3 ACOs may share in savings or repay Medicare losses

depending on performance. Track 3 ACOs take on the greatest

amount of risk but may share in the greatest portion of savings

if successful.

a The Track 1+ Model is a time-limited CMS Innovation Center model. An ACO must concurrently participate in Track 1 of the Shared Savings Program in order to be eligible to participate in the Track 1+ Model. See: CMS: FACT SHEET: New Accountable Care Organization Model Opportunity: Medicare ACO Track 1+ Model. July 2017. Retrieved May 14, 2018 from https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/sharedsavingsprogram/Downloads/New- Accountable-Care-Organization-Model-Opportunity-Fact-Sheet.pdf See also CMS: Medicare Program; Revisions to Payment Poli- cies Under the Physician Fee Schedule and Other Revisions to Part B for CY 2018; Medicare Shared Savings Program Requirements; and Medicare Diabetes Prevention Program November 15, 2017 Section H. Medicare Shared Savings Program. Regulations effective January 1, 2018. Retrieved May 14, 2018 from https://www.federalregister.gov/documents/2017/11/15/2017-23953/medicare- program-revisions-to-payment-policies-under-the-physician-fee-schedule-and-other-revisions

Source: CMS.gov (2018, March 27). Shared savings program: About the program. Retrieved May 14, 2018 from https://www.cms .gov/Medicare/Medicare-Fee-for-Service-Payment/sharedsavingsprogram/about.html

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https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/sharedsavingsprogram/Downloads/New-Accountable-Care-Organization-Model-Opportunity-Fact-Sheet.pdf

https://www.federalregister.gov/documents/2017/11/15/2017-23953/medicare-program-revisions-to-payment-policies-under-the-physician-fee-schedule-and-other-revisions

https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/sharedsavingsprogram/about.html

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The second type of plan is the Advanced Payment ACO. Recognizing that smaller and/or rural hospitals may have financial constraints in developing the systems and infras- tructure needed for an ACO, starting in 2012, CMS offered the Advanced Payment ACO model option. This subset of the MSSP provided advanced payments to these organizations as well as monthly, population-based payments. Hospitals were to repay these advances out of future savings. This program was terminated in 2015 and replaced with the ACO Investment Model with the same aims and general financial structure.169 CMS is accepting applications for the latter model in 2019, with future operations dependent on further evaluations.

The third model is the Pioneer ACO. This program was designed for experienced, inte- grated systems that wanted to accept more risk and share more in the upside of savings. It was launched in 2012 with 32 organizations and closed at the end of 2016 with 8 (by some accounts, 9). It is useful to understand how Pioneer ACOs differed from MSSPs for two reasons: CMS is now moving to have MSSPs accept more risk, and some of the new fea- tures may reprise the terms of Pioneer participation; and the Next Generation ACO model described below is the successor to these plans.

The Pioneer ACO Model differed from the Medicare Shared Savings Program in some of the following ways:

The first 2 years of the Pioneer ACO Model were a shared savings payment arrangement with higher levels of savings and risk than in the Shared Savings Program.

In year three of the program, those Pioneer ACOs that elected to and showed savings over the first 2 years were eligible to move to a population-based payment model. Population-based payment is a per-beneficiary per month payment amount intended to replace some or all of the ACO’s fee-for-service (FFS) payments with a prospective monthly payment.

Pioneer ACOs were encouraged to negotiate similar outcomes-based payment arrangements with other payers by the end of the second year, and fully commit their business and care models to offering seamless, high quality care.

Pioneer ACOs were generally responsible for the care of at least 15,000 aligned beneficiaries (5,000 for rural ACOs) . . .

Population-based payments were per-beneficiary per-month payments intended to replace a por- tion of the ACO’s fee-for-service (FFS) payments with prospective payments.170

169CMC.gov. (2017, March 27). ACO investment model. Retrieved May 15, 2018, from https://innovation.cms.gov/ initiatives/ACO-Investment-Model 170CMS.gov. (2017, February 17). What was the Pioneer ACO Model?). Retrieved May 15, 2018, from https://innovation .cms.gov/initiatives/Pioneer-ACO-Model/Pioneer-ACO-FAQs.html

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https://innovation.cms.gov/initiatives/Pioneer-ACO-Model/Pioneer-ACO-FAQs.html

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At the end of the program, eight Pioneer ACOs produced gross savings of $68 million and six earned enough to participate in shared savings. CMS published a final report in December 2016 with cumulative evaluation and performance data.171

The Next Generation ACO172 was introduced in 2016 as a replacement for Pioneer ACOs; these plans are authorized to run until 2020. In 2018, 51 organizations covering about 1.4 million beneficiaries were participating under multiple risk arrangements (up to 100%) for achieving spending and quality173 performance benchmarks.174 In 2016 (the only data currently available), the original 18 Next Generation ACOs generated net savings of $63 million.175 All participants scored 100% across 33 quality measures, and 11 of the original 18 ACOs in this program received $58 million in shared savings bonuses. However, the other 7 sites had to pay back $20 million.176 By participating in this model, organizations gain four advantages177 over the MSSP offerings:

1. Telehealth expansion waiver. The enhanced ability to bill for these services normally reserved for rural and underserved areas.

2. Post discharge home visit waiver. Relaxes supervision requirements for billing for home visits by ancillary personnel.

3. Three-day skilled nursing facility waiver. Normally Medicare only pays for skilled nursing home visits after a 3-day inpatient stay. This provision waives the requirement to receive this benefit.

4. Voluntary alignment assistance. In the MSSP, patients are most often unaware they are part of an ACO (see below for problem discussion). Under the voluntary alignment assistance, Next Generation ACOs are able to offer their assigned patients the option to confirm (or deny) their relationships with specific providers.

Beginning in 2017, under an arrangement called the All-Inclusive Population-Based Pay- ments (AIPBPs), the Next Generation ACOs were offered the option of receiving capitation for Medicare beneficiaries enrolled with those plans. In other words, the ACO receives a

171L&M Policy Research, LLC. (2016). Evaluation of CMMI Accountable Care Organization Initiatives Pioneer ACO, Final Report (December 2). Retrieved May 15, 2018, from https://innovation.cms.gov/Files/reports/pioneeraco- finalevalrpt.pdf 172For more details, see: CMS. Next Generation Accountable Care Organization (ACO) Model: Frequently Asked Ques- tions. Retrieved May 16, 2018, from https://innovation.cms.gov/Files/x/nextgenacofaq.pdf 173CMS. (2018). 33 ACO quality measures. Retrieved May 16, 2018, from https://www.cms.gov/Medicare/Medicare- Fee-for-Service-Payment/sharedsavingsprogram/Downloads/ACO-Shared-Savings-Program-Quality-Measures.pdf 174Participation in this option counts as an Advanced Payment Mechanism (APM) under the Medicare and CHIP Reau- thorization Act (MACRA) and is thus eligible for additional payments not based on the ACO formula. More details on this program are explained in the Quality Chapter. 175Kaiser Family Foundation. 8 FAQs: Medicare accountable care organizations (ACOs). Retrieved May 16, 2018, from http://files.kff.org/attachment/Evidence-Link-FAQs-Accountable-Care-Organizations 176Leventhal, R. (2017, October 16). CMS releases 2016 next generation ACO data with positive financial, quality results. Healthcare Informatics. Retrieved May 18, 2018, from https://www.healthcare-informatics.com/article/value- based-care/cms-releases-2016-next-generation-aco-data-positive-financial-quality 177For more details about these benefits, see: CMS.gov. Next generation ACO model. Retrieved May 18, 2018, from https://innovation.cms.gov/initiatives/Next-Generation-ACO-Model

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https://innovation.cms.gov/Files/reports/pioneeraco-finalevalrpt.pdf

https://innovation.cms.gov/Files/x/nextgenacofaq.pdf

https://www.cms.gov/Medicare/Medicare-Fee-for-Service-Payment/sharedsavingsprogram/Downloads/ACO-Shared-Savings-Program-Quality-Measures.pdf

http://files.kff.org/attachment/Evidence-Link-FAQs-Accountable-Care-Organizations

https://www.healthcare-informatics.com/article/value-based-care/cms-releases-2016-next-generation-aco-data-positive-financial-quality

https://innovation.cms.gov/initiatives/Next-Generation-ACO-Model

Hospitals and Healthcare Systems 147

per-person, per-month payment for those assigned to that organization. Under this scheme, the ACO is responsible for paying all bills for its assigned patient members.

Future Issues. A number of problems exist for this program now and in the future:

1. Readiness for a risk-based model. Eighty-two percent of ACOs are in the MSSP Track 1, which does not have any downside payment risk. These plans are allowed to remain in this track for two periods of 3 years each before they are required to convert to a risk-based model. The 82 ACO that started operations in 2012 or 2013 are, therefore, confronting this transition. The problem is that all the losses in this program occurred in this track. In other words, only ACOs that assumed financial risk saved money for Medicare. (Please see Exhibit 4.25.) The Association of ACOs has appealed to CMS, saying that 71% of respondents to a poll said they are slightly to very likely to drop out of the program if forced to go at risk.178 Many will not be able to demonstrate they

EXHIBIT 4.25. Savings and Losses of Risk-Based and No-Risk ACOs

Net Medicare spending on ACO models, in millions:

ALL ACOs No-risk ACOs

MSSP Track 1

$72m

–$47m

–$18m –$14m –$24m

–$63m

MSSP Track 2

MSSP Track 3

At-risk ACOs

Next Generation

Pioneer

No. of ACOs:

N e t

Sa vi

n g

s $0

458 410 6 16 8 18

N e t

C o

st s

Net Medicare spending on ACO models, in millions:

ALL ACOs No-risk ACOs

MSSP Track 1

$72m

–$47m

–$18m –$14m –$24m

–$63m

MSSP Track 2

MSSP Track 3

At-risk ACOs

Next Generation

Pioneer

No. of ACOs:

N e t

Sa vi

n g

s $0

458 410 6 16 8 18

N e t

C o

st s

Analysis excludes Comprehensive ESRD (End-Stage Renal Disease) Care Model. Advance Payment (AP) and Accountable Care Organization Investment Model (AIM) ACOs are included in their respective MSSP tracks.

Source: The Henry J. Kaiser Family Foundation. (2018, January). 8 FAQs: Medicare accountable care organizations (ACOs). Retrieved May 18, 2018 from http://files.kff.org/attachment/Evidence-Link-FAQs-Accountable-Care-Organizations

178National Association of ACOs. (2018, May 2). Press Release. Retrieved May 20, 2018, from https://www.naacos.com/ assets/docs/pdf/PressReleaseonT1ExtensionSurvey050218.pdf

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have the financial resources to pay back CMS if required to do so. CMS administrator Seema Varma responded with the government’s position on these organizations: “The presence of these upside-only tracks may be encouraging consolidation in the market- place, reducing competition and choice for our beneficiaries. While we understand that systems need time to adjust, our system cannot afford to continue with models that are not producing results.”179

2. Unclear responsibility. Medicare beneficiaries do not choose to belong to an ACO. CMS identifies primary care providers (general practitioner, family practitioner, internist, or geriatrician as well as a nurse practitioner or physician assistant) who belong to an ACO and then assigns their patients to that ACO. This assignment is based on claims that use primary care billing codes180 linked to the provider’s NPI. If beneficiaries do not see a primary care provider, then they are assigned to an ACO based on whomever is providing primary care services, such as a cardiologist, pulmonologist, rheumatologist, oncologist, and so on. However, it is not always clear which patients fall under ACO responsibility. For example, a healthy patient who sees her personal physician every few years may have visited an urgent care center for a minor problem. She may, therefore, be enrolled with the ACO that employs the urgent care physician rather than with her personal physician. Except for the Next Generation model, other ACOs and their patients may know the affiliation status only when CMS calculates bonuses or deficits at the end of the year. Thus, if an ACO wants to inform its members about its services in order to try to keep them in its network, it is unable to do so.

Despite this uncertainty, CMS requires that:

Providers participating in an ACO must notify beneficiaries that they are participat- ing in an ACO, and that the provider is eligible for additional Medicare payments for improving the quality and coordination of care the beneficiary receives while reduc- ing overall costs or may be financially responsible to Medicare for failing to provide efficient, cost-effective care. The beneficiary may then choose to receive services from the provider or seek care from another provider that is not part of the ACO. A provider may not require a beneficiary to obtain services from another provider or supplier in the same ACO, as beneficiaries maintain the freedom to choose which providers they see.181

179Dickson, V. (2018, May 12). Heading for the exit: Rather than face risk, many ACOs could leave. Modern Healthcare. Retrieved May 20, 2018, from http://www.modernhealthcare.com/article/20180512/NEWS/180519966 180The primary care codes are 99201 to 99215 (new visit and follow-up office visits), 99304 to 99340 (new, follow-up or discharge services for skilled nursing facility or domiciliary care), 99341 to 99350 (home visits) and G0402 (Welcome to Medicare Visit). 181CMS. (2012, December 11). Accountable care organization 2012 program analysis: Quality performance standards narrative measure specifications, final report. Retrieved May 20, 2018, from http://www.cms.gov/Medicare/Medicare- Fee-for-Service-Payment/sharedsavingsprogram/Quality_Measures_Standards.html

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Hospitals and Healthcare Systems 149

3. Lack of control. The Medicare program is based on complete freedom for beneficiaries to seek care from any Medicare-affiliated physician. This freedom is preserved with all ACO models. It means that ACOs are responsible for care over which they have no control. The potential magnitude of this problem was highlighted by McWilliams et al.:182 “Among ACO-assigned beneficiaries, 8.7% of office visits with primary care physicians were provided outside of the assigned ACO, and 66.7% of office visits with specialists were provided outside of the assigned ACO. Leakage of outpatient specialty care was greater for higher-cost beneficiaries.”

4. Inadequate risk adjustment. Many of potentially at-risk organizations believe they take care of sicker populations. Since the financial risk is calculated on a county-wide basis (as opposed to a per-individual basis), these ACOs are worried that their costs of care have a high probability to register losses without a concomitant upside potential.

5. Need to coordinate care across the continuum of services. Proponents of integration believe ACOs are well positioned to improve quality and lower costs for populations with specific chronic conditions and expensive, acute diseases. While this notion is attractive, there is little systematic evidence to support the effectiveness of disease man- agement programs. For example, in a large study of such efforts, RAND Corporation researchers found that “although disease management seems to improve quality of care, its effect on cost is uncertain.”183 Further, since ACO formation often involves hospital mergers, such consolidation must also be assessed. One study of cardiac patients that considered 40 mergers in California from 1990 to 2006 found that “merger completion is associated with a 3.7 per cent increase in utilization of bypass surgery and angio- plasty and a 1.7 per cent increase in inpatient mortality.”184 Further, programs such as those geared to lower readmissions have not consistently proven successful.185 In short, these benefits are not self-evident.

6. Shortage of primary care physicians. In order to succeed, ACOs need a core of primary care physicians who will coordinate care. In the case of Medicare patients, internists or family physicians with a geriatric specialty are necessary; they are already in short supply, and the situation is getting worse. This problem is discussed further in the Physi- cians section of Chapter 5, “Healthcare Professions.”

182McWilliams, J. M., Chernew, M. E., Dalton, J. B., & Landon, B. E. (2014). Outpatient care patterns and organizational accountability in Medicare. JAMA Internal Medicine, 174(6), 938–945. 183Mattke, S., Seid, M., & Ma, S. (2007). Evidence for the effect of disease management: Is $1 billion a year a good investment? American Journal of Managed Care, 13, 670–676. See also Weintraub, A., & Terhune, C. (2010). Take your meds, exercise—and spend billions. Businessweek (February 4). Retrieved May 20, 2018, from http://www.businessweek .com/magazine/content/10_07/b4166046292556.htm 184Hayford, T. (2012). The impact of hospital mergers on treatment intensity and health outcomes. Health Services Research, 47(1): 1008–1027. 185Center for Health Research and Transformation. (2013, May). Acute care readmission reduction initiatives: Major program highlights. Retrieved May 20, 2018, from https://www.chrt.org/publication/acute-care-readmission-reduction- initiatives-major-program-highlights

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http://www.businessweek.com/magazine/content/10_07/b4166046292556.htm

https://www.chrt.org/publication/acute-care-readmission-reduction-initiatives-major-program-highlights/

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7. Alignment of incentives. Successful ACOs must reward physicians for prac- ticing cost-effective, high-quality medicine—a shift from so-called volume to value. However, according to physician placement firm Merritt Hawkins (which recruits mainly for hospitals): “Despite the rise in value/quality-based incentives, volume-based incentives . . . continue to be the most frequently utilized physician productivity metric . . . value-based incentives only account for about four percent of overall physician compensation.”186 Further, hospital administrators are also still largely paid for volume performance.187 Clearly, hospitals have not made the appropriate shift in incentive payments necessary for ACO success.

8. Startup costs. According to CMS, startup costs for ACO formation average $1.7 million per organization. While many established systems can start a shared savings ACOs with minimum additional costs, smaller organizations that want to enter the program may find it too costly to participate; recall that startup funding is limited to the ACO Investment Model. A further problem is that ACOs wishing to move to a risk basis may need to incur further significant expenses, such as information systems and additional administrative personnel.

9. Dealing with different insurance models. While MSSP ACO models are now largely paid on a cost-saving basis using fee-for-service (FFS) data, the government’s intention is that eventually all will move toward global payments based on capitation (AIPBPs). ODSs employed these payment models without much success; ACOs have generally not yet adapted to make them work. One of the important questions ACOs must address is how they will distribute capitated or bundled payments among both independent and institutionally-based providers. Another unresolved problem is the system’s ability to collect and analyze the data needed to handle these payment models.

In transitioning to a new payment model, ACOs must recognize that in addition to inpatient care, they bear risk for other potentially costly services, such as home health and skilled nursing facility care.

Past experience has shown that four elements can challenge these systems’ ability to profit by taking insurance risk: low enrollment, inadequate funding, adverse selection (enrollment of sicker patients), and lack of expertise managing insurance products. With respect to low enrollment, Medicare has put a lower membership limit on ACOs; the 5,000 members that Medicare requires should be sufficient to mitigate size-related risk. The initial shared-savings mode of payment provides FFS compensation at Medicare rates, diminishing the payment adequacy problem (at least until capitation is phased-in). However, the latter two risks remain as significant barriers to ACO success.

186Merritt, H. (2017). 2017 review of physician and advanced practitioner recruiting incentives. Retrieved May 20, 2018, from https://www.merritthawkins.com/uploadedFiles/MerrittHawkins/Pdf/2017_Physician_Incentive_Review_Merritt_ Hawkins.pdf 187Hancock, J. (2013, June 13). Hospital CEO bonuses reward volume and growth. Kaiser Health News. Retrieved May 20, 2018, from http://www.kaiserhealthnews.org/Stories/2013/June/06/hospital-ceo-compensation-mainbar.aspx?utm_ source=khn&utm_medium=internal&utm_campaign=skybox2

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https://www.merritthawkins.com/uploadedFiles/MerrittHawkins/Pdf/2017_Physician_Incentive_Review_Merritt_Hawkins.pdf

http://www.kaiserhealthnews.org/Stories/2013/June/06/hospital-ceo-compensation-mainbar.aspx?utm_source=khn&utm_medium=internal&utm_campaign=skybox2

Hospitals and Healthcare Systems 151

The issue of adverse selection was discussed above. What could go wrong is highlighted by the experience of The Greater Marshfield Community Healthplan, a Medicare HMO prototype in the early 1980s.188 The plan was based around the tertiary care center, Marshfield Clinic, in rural central Wisconsin. Because patients were sicker than at other demonstration sites in that state and around the country, and because capitation was based on rural Wisconsin rates, the plan folded after experiencing significant losses.

The last problem is that insurance risk and management are not core competencies of these hospital-based organizations. (See the HealthChicago example in Exhibit 4.16 above.) Outsourcing will not completely help since the ACO needs to understand and oversee companies that perform these services on their behalf.

10. Information system needs. While current information systems are a vast improvement over those of the past two decades, at least two major problems remain. First, for ACOs to operate efficiently and effectively, systems across the enterprise must be able to talk to one another, an issue called interoperability. Despite the promises of health infor- mation exchanges, this requirement has not yet been realized to the extent necessary. Second, before information systems can enhance efficiency, the underlying processes which they automate must be evaluated and often reengineered. Too often, this latter process has not been accomplished.189 More will be said about this topic in Chapter 8, “Information Technology.”

11. Culture. Hofstede defined culture “as the collective programming of the mind that dis- tinguishes members of one group or category of people from another . . . . Culture is to a human collectivity what personality is to an individual.”190 While mergers are con- sidered and then executed after financial issues are extensively vetted, few merging institutions assess cultural compatibility. This oversight is puzzling because it can lead to failure of the merged organization. Perhaps the most famous example was the merger of University of California at San Francisco (UCSF) and Stanford University Medical Centers in 1997. The reason for its dissolution in 2000 was succinctly stated by Nathan Nayman of the Hospital Council, a trade organization representing Northern Califor- nia hospitals: “Comparing Stanford and UCSF is like comparing apples and oranges. The two hospitals had radically different institutional cultures, which made the merger impossible in the end.”191

188Iglehart, J. K. (1982). The greater Marshfield community health plan: The future of HMOs. The New England Journal of Medicine, 307, 451–456. 189Carayon P., Karesh, B.-T., & Cartmill, R. S. (2010, October). Incorporating health information technology into workflow redesign—summary report. (Prepared by the Center for Quality and Productivity Improvement, University of Wisconsin–Madison, under Contract No. HHSA 290-2008-10036C). AHRQ Publication No. 10-0098-EF. Rockville, MD: Agency for Healthcare Research and Quality. 190Hofstede, G. (2001). Culture’s consequences: Comparing values, behaviors, institutions, and organizations across nations (2nd ed.). Thousand Oaks, CA: Sage Publications. 191Pyati, A. (2000). UCSF/Stanford: Marriage was rough; divorce is expensive. San Francisco Business Times (April 23). Retrieved May 20, 2018, from http://www.bizjournals.com/sanfrancisco/stories/2000/04/24/focus4.html?page=all

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152 The U.S. Healthcare System

12. Antitrust. Antitrust concerns have always threatened integration efforts; however, from 1994 to 2007, the Department of Justice (DOJ) failed to prevent any nonprofit hospital mergers. Richman192 noted that “confidence that nonprofit hospitals’ market concentration does not lead to higher prices largely drives judicial sympathy for nonprofits in merger cases, and in turn a tolerance of nonprofits’ market power.” Governmental successes in challenging these combinations began on August 7, 2007 when the Federal Trade Commission (FTC) commissioners unanimously ruled that the 2000 acquisition by Evanston Northwestern Healthcare (ENH) of Highland Park Hospital violated Section 7 of the Clayton Act by creating a highly concentrated market, thereby increasing hospital prices and harming consumers. (The system is now known as NorthShore University HealthSystem.) The philosophical change in attitude about nonprofits is summarized by the FTC’s conclusion: “ENH’s nonprofit status did not affect its efforts to raise prices after the merger, and . . . does not suffice to rebut complaint counsel’s evidence of anticompetitive effects.”193 Even though ENH claimed it spent more than $120 million on integration improvements with the extra charges, the FTC said quality improvements must result from cost-saving efficiencies, not higher prices. Since then, the FTC has been successful in a number of challenges to horizontal and vertical integration of hospitals and medical groups.194 As Carlson195

pointed out: “The collision of old-world antitrust enforcement and new ideas like accountable care, bundled payments, value-based purchasing and patient-centered medical homes has ratcheted up the uncertainty over healthcare needs.” Although the DOJ and FTC have developed joint antitrust guidelines for the ACO shared savings program, the interpretation and application of these rules is still unclear. A further wrinkle on this issue came in 2013 when the U.S. Supreme Court ruled that even a government-owned hospital is not exempt from antitrust when it seeks to purchase a local for-profit hospital.196

13. Achieving physician alignment. This issue is discussed above but is worth another mention because it is critical to organizational success. Of particular relevance here is realizing that when the ACO assumes full risk and is receiving only global payments, the problem of dividing the money will emerge as an important issue. Further, since

192Richman, B. D. (2007). Antitrust and nonprofit hospital mergers: A return to basics. University of Penn- sylvania Law Review, 156, 121–150. Retrieved May 20, 2018, from https://pdfs.semanticscholar.org/804b/ 26c7ece7119ec5bc10c8ec99b96d284efaaa.pdf 193Federal Trade Commission. Commission Rules that Evanston Northwestern Healthcare Corp.’s Acquisition of High- land Park Hospital Was Anticompetitive. Retrieved May 20, 2018, from http://www.ftc.gov/opa/2007/08/evanston.shtm 194Meier, M. H., Albert, B. S., & Monahan, K. (2018, September). Overview of FTC actions in health care services and products. Health Care Division, Bureau of Competition, Federal Trade Commission. Washington DC. Retrieved May 20, 2018, from https://www.ftc.gov/system/files/attachments/competition-policy-guidance/overview_health_care_ september_2017.pdf 195Carlson, J. (2012) Pulled in two directions. Providers pursuing coordinated care confused by antitrust actions. Modern Healthcare, 42, 6–7, 16. 196Federal Trade Commission v. Phoebe Putney Health System, Inc., et al. Supreme Court Docket No. 11-1160 [Internet]. Retrieved from http://www.supremecourt.gov/opinions/12pdf/11-1160_1824.pdf

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https://pdfs.semanticscholar.org/804b/26c7ece7119ec5bc10c8ec99b96d284efaaa.pdf

http://www.ftc.gov/opa/2007/08/evanston.shtm

https://www.ftc.gov/system/files/attachments/competition-policy-guidance/overview_health_care_september_2017.pdf

http://www.supremecourt.gov/opinions/12pdf/11-1160_1824.pdf

Hospitals and Healthcare Systems 153

the enterprise is at increased risk for losses, it must deal with the problem of which part of the system will bear the burden if those shortfalls occur. Like many of these issues, achieving physician alignment is not new. This latter issue was one of the core difficulties in the above-mentioned UCSF-Stanford breakup. According to Stanford University president Gerhard Casper, “one of the largest problems was administrators’ failure to achieve physician buy-in. Faculty members at both institutions resisted the merger from the beginning, refusing to combine their practices and share financial risk.”197

Because of some of these problems (particularly items 2, 3, and 4), many well-respected, mature organizations decided from the program’s beginning not to participate.198 How many more will drop out or be reluctant to participate will be seen in the near future as they must decide whether to continue with the program on a risk basis.

HOSPITAL GOVERNANCE

This section will address hospital governance by focusing on its board of trustees or directors. Since the literature on corporate governance is extensive, the focus here is primarily on the essentials as they relate to nonprofit hospitals.

Definition and Purpose The relevant origin of the word “board” is the table where a communal meal is served. Hence, according to the Oxford English Dictionary, a board is “[t]he company of persons who meet at a council-table; the recognized word for a body of persons officially constituted for the transaction or superintendence of some particular business.” The importance of the definition is that the board decides and acts communally, in distinction from management members whose day-to-day function is frequently as individuals, though as part of a larger team. Early hospital boards were made up of philanthropist trustees who raised and donated money for the institution. As the first board of Massachusetts General Hospital stated in 1814 when trying to raise $100,000: “We shall instance, in both classes of objects, to which this Institution relates, the sick poor and the insane [emphasis in the original] . . . It purposes to afford the best medical aid; the best nurses; the most suitable apartments; all the assistance which sickness requires; and all the comforts, which are subsidiary to convalescence.”199

Once the money was secured, trustees were responsible for proper stewardship of the charitable funds according to the institutional mission. More recently, as nonprofits have become more complex organizations, their success has depended on performance of a larger

197“We Took on Too Much”: Stanford-UCSF System Breaks Up. California Healthline. Friday, October 29, 1999. Retrieved February 10, 2018, from http://www.californiahealthline.org/articles/1999/10/29/we-took-on-too-much-- stanforducsf-system-breaks-up.aspx 198Alonso-Zaldivar, R. (2011, May 11). Obama plan for health care quality dealt a setback: Mayo Clinic, other top health providers say “accountable care” is too complex. Retrieved May 20, 2018, from http://www.nbcnews.com/id/42997540/ ns/health-health_care/t/obama-plan-health-care-quality-dealt-setback 199Quincy, J., Perkins, T. H., Sargent, D., May, J., Barnard, T., Higginson, S., . . . Sullivan, R. (1814, January 8). Address of the board of trustees of the Massachusetts General Hospital to the public Boston: J. Belcher.

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and more complex portfolio of tasks. Green and Griesinger200 succinctly stated that the prac- titioner literature:

reveals significant consensus that the activities of effective nonprofit boards should at least include (1) determining or setting the organization’s mission, purpose, and policies; (2) strategic planning; (3) determining or evaluating the organization’s programs and services; (4) board development; (5) selecting, evaluating, and terminating the CEO; (6) ensuring adequate resources, including fund development; (7) financial management (operating budget); (8) interaction with the community; and (9) serving as a court of appeal for the resolution of disputes involving staff, clients, or both.

Legal Requirements Most of the legal requirements covering boards derive from state hospital licensure laws that mandate a governing board for each institution. Further, corporate laws describe standards for stewardship, setting three interrelated fiduciary requirements for board members:201

1. Duty of Care Requires action in good faith (primarily without self-interest) that any ordinarily

prudent person would take in the best interests of the organization. In taking this action, the board member must make sure that sufficient information is available. It is rea- sonable to rely on management and other experts’ reports for this information except when there is reason to believe problems exist with its truthfulness. Although the courts require that a corporate information and reporting system is in place, they do not spec- ify the exact content and methods. Each institution must, therefore, develop its own compliance plan that satisfies its unique needs.

2. Duty of Loyalty Prohibits action in self-interest, particularly that which would result in economic

gain to a board member doing business with the institution.

3. Duty of Obedience to Purpose Requires action to further the purposes of the institution in accordance with its

mission statement, articles of incorporation, and bylaws. Legal adherence to these duties is not always straightforward.

The difficulty in articulating a standard for nonprofit board business accountability is that the legal concept of duty is ambiguous and the judicial tests are muddled, forging a rather odd hybrid standard mixing charitable and nonprofit law. Such ambiguity in

200Green, J. C., & Griesinger, D. W. (1996). Board performance and organizational effectiveness in nonprofit social services organizations. Nonprofit Management and Leadership, 6(4), 381–402. 201American Health Lawyers Association (2011, August 29). The health care director’s compliance duties: A continued focus of attention and enforcement. A joint publication from the Office of the Inspector General, U.S. Department of Health and Human Services, and the American Health Lawyers Association. © 2010. Updated.

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nonprofit board decision making hampers good faith business judgment, particularly for multi-state hospital systems.202

Further, sometimes these duties clash. One of the major sources of such conflict arises when board members seek to fulfill the institution’s charitable mission while maintaining its financial sustainability. On this theme, the late Sister Irene Kraus (who was president of the Daughters of Charity National Health System and AHA board chair) is said to have exhorted her staff: “No margin, no mission.”203 The seriousness of this dilemma was highlighted when the Minnesota attorney general sued Accretive Health for “compromising patient privacy and using strong-arm tactics to collect payments from patients at a health system [Fairview Health Services] in Minneapolis.”204

In response to prominent violations of these corporate duties, Congress passed the American Competitiveness and Corporate Accountability Act of 2002, commonly known as the Sarbanes-Oxley Act. Except for provisions prohibiting retaliation against whistleblowers and the destruction, alteration, or concealment of certain documents or the impediment of investigations, Sarbanes-Oxley does not generally apply to nonprofit organizations. Its influence, however, has caused many nonprofit hospital boards to reconsider the level and mechanism of oversight. In this respect, the American Bar Association suggestions are listed in Exhibit 4.26.

EXHIBIT 4.26. Nonprofits and Sarbanes-Oxley

Ten general principles of corporate governance emerging from the Sarbanes-Oxley reforms may be worthy of

consideration for the governance of nonprofit organizations:

Principle 1. Role of Board. The organization’s governing board should oversee the operations of the organi-

zation in such manner as will assure effective and ethical management.

Principle 2. Importance of Independent Directors. The independent and non-management board members

are an organizational resource that should be used to assure the exercise of independent judgment in key

committees and general board decision-making.

Principle 3. Audit Committee. An organization with significant financial resources should have an audit com-

mittee composed solely of independent directors, which should assure the independence of the organization’s

financial auditors, review the organization’s critical accounting policies and decisions and the adequacy of its

internal control systems, and oversee the accuracy of its financial statements and reports.

202Blum, J. (2010). The quagmire of hospital governance, finding mission in a revised licensure model. Journal of Legal Medicine, 31, 35–57. 203Bryant-Friedland, B. (1998, August 25). Sister Irene Kraus remembered for vision, leadership. The Florida Times-Union. 204Schorsch, C. (2018, April 4). Investors cool to Accretive’s management shakeup. Crain’s Chicago Business. Retrieved May 20, 2018, from http://www.chicagobusiness.com/article/20130404/NEWS03/130409891/investors-cool- to-accretives-management-shakeup

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Principle 4. Governance and Nominating Committees. An organization should have one or more committees,

composed solely of independent directors, that focus on core governance and board composition issues,

including: the governing documents of the organization and the board; the criteria, evaluation, and nomina-

tion of directors; the appropriateness of board size, leadership, composition, and committee structure; and

codes of ethical conduct.

Principle 5. Compensation Committee. An organization should have a committee composed solely of inde-

pendent directors that determines the compensation of the chief executive officer and determines or reviews

the compensation of other executive officers, and assures that compensation decisions are tied to the exec-

utives’ actual performance in meeting predetermined goals and objectives.

Principle 6. Disclosure and Integrity of Institutional Information. Disclosures made by an organization regard-

ing its assets, activities, liabilities, and results of operations should be accurate and complete, and include all

material information. Financial and other information should fairly reflect the condition of the organization,

and be presented in a manner that promotes rather than obscures understanding. CEOs and CFOs should

be able to certify the accuracy of financial and other disclosures, and the adequacy of their organizations’

internal controls.

Principle 7. Ethics and Business Conduct Codes. An organization should adopt and implement ethics and

business conduct codes applicable to directors, senior management, agents, and employees that reflect a

commitment to operating in the best interests of the organization and in compliance with applicable law,

ethical business standards, and the organization’s governing documents.

Principle 8. Executive and Director Compensation. Executives (and directors if appropriate) should be compen-

sated fairly and in a manner that reflects their contribution to the organization. Such compensation should

not include loans, but may include incentives that correspond to success or failure in meeting performance

goals.

Principle 9. Monitoring Compliance and Investigating Complaints. An organization should have procedures

for receiving, investigating, and taking appropriate action regarding fraud or noncompliance with law or

organization policy, and should protect “whistleblowers” against retaliation.

Principle 10. Document Destruction and Retention. An organization should have document retention policies

that comply with applicable laws and be implemented in a manner that does not result in the destruction of

documents that may be relevant to an actual or anticipated legal proceeding or governmental investigation.

Source: American Bar Association Coordinating Committee on Nonprofit Governance (2005), Guide to Nonprofit Corporate Gov- ernance in the Wake of Sarbanes-Oxley. Chicago: American Bar Association, pp. 17–18.

Responsibilities In addition to legal requirements, boards are responsible for ensuring institutional payment and accreditation, the latter being closely linked to evaluations of quality. Perhaps the most important obligation of the board with respect to payment is its responsibilities delineated by the Medicare Conditions of Participation and Conditions for Coverage.205

205CMS.gov. Conditions for coverage (CfCs) & conditions of participations (CoPs). Retrieved May 21, 2018, from http:// www.cms.gov/Regulations-and-Guidance/Legislation/CFCsAndCoPs/index.html?redirect=/cfcsandcopsCo

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Hospitals and Healthcare Systems 157

Medicare standards require six areas in which boards must act: (1) overseeing the medical staff, including credentialing and approval of bylaws; (2) appointing the hospital chief executive officer; (3) ensuring appropriate patient care; (4) developing an institutional budget; (5) providing oversight of contracted services; and, (6) if emergency services are offered, conducting them in a high-quality fashion. The relevant parts of these requirements for the governing body are excerpted in Exhibit 4.27.

EXHIBIT 4.27. Medicare Conditions of Participation and Conditions for Coverage

§ 482.12 Condition of Participation: Governing Body

The hospital must have an effective governing body legally responsible for the conduct of the hospital as an

institution . . .

(a) Standard: Medical staff. The governing body must:

(1) Determine, in accordance with State law, which categories of practitioners are eligible candidates for

appointment to the medical staff;

(2) Appoint members of the medical staff after considering the recommendations of the existing members

of the medical staff;

(3) Assure that the medical staff has bylaws;

(4) Approve medical staff bylaws and other medical staff rules and regulations;

(5) Ensure that the medical staff is accountable to the governing body for the quality of care provided to

patients;

(6) Ensure the criteria for selection are individual character, competence, training, experience, and

judgment . . .

(b) Standard: Chief executive officer. The governing body must appoint a chief executive officer who is respon-

sible for managing the hospital.

following requirements are met:

(1) Every Medicare patient is under the care of [a licensed practitioner in accordance with state laws]:

(2) Patients are admitted to the hospital only on the recommendation of a licensed practitioner permitted

by the State to admit patients to a hospital . . .

(3) A doctor of medicine or osteopathy is on duty or on call at all times.

(4) A doctor of medicine or osteopathy is responsible for the care of each Medicare patient with respect

to any medical or psychiatric problem . . .

(d) Standard: Institutional plan and budget. The institution must have an overall institutional plan that meets

the following conditions:

(1) The plan must include an annual operating budget that is prepared according to generally accepted

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158 The U.S. Healthcare System

(2) The budget must include all anticipated income and expenses. This provision does not require that the

budget identify item by item the components of each anticipated income or expense.

(3) The plan must provide for capital expenditures for at least a 3-year period . . .

(6) The plan must be reviewed and updated annually.

(7) The plan must be prepared—

(i) Under the direction of the governing body; and

(ii) By a committee consisting of representatives of the governing body, the administrative staff, and

the medical staff of the institution.

(e) Standard: Contracted services. The governing body must be responsible for services furnished in the hospital

whether or not they are furnished under contracts . . .

(f) Standard: Emergency services. (1) If emergency services are provided at the hospital, the hospital

must . . . meet the emergency needs of patients in accordance with acceptable standards of practice . . .

organized under the direction of a qualified member of the medical staff [and] . . . integrated with other

departments of the hospital.

Source: 42 C.F.R. Part 482—Conditions of Participation for Hospitals. Retrieved May 21, 2018 from https://law.justia.com/cfr/ title42/42-3.0.1.5.21.html#42:3.0.1.5.21.2.199.2.

In most hospitals (for-profit as well as nonprofit), the board’s oversight of quality originated from the governance criteria of the Joint Commission, a principal organization responsible for accrediting hospitals. (See Chapter 9, “Quality,” for more information about accreditation and the Joint Commission.) More recently, however, the board has needed to take a more active interest in quality performance due to Medicare-imposed financial penalties for certain clinical events, such as catheter-related sepsis, pressure sores, and hospital readmissions within 30 days of discharge, to name a few. Further, with increased transparency of hospital quality data,206 the board is more engaged with the issue of quality as a competitive strategy. Unfortunately, hospital boards are not always as involved as they should be in this latter regard. For example, Jha and Epstein207

found that:

Among our nationally representative sample of chairs of boards from [1,000] nonprofit U.S. hospitals, a little over half identified clinical quality as one of the two top priorities for board oversight. Although 69 percent of board chairs thought that the CEO had great influence on quality of care, just 44 percent identified quality performance as one of the two most important criteria for evaluating the CEO’s performance. Programmatic emphasis on quality was not uniformly high. Also, although only a few board chairs had work experience in the health care sector, fewer than one-third of nonprofit boards sampled had formal training programs that include clinical quality.

206See, for example, http://www.medicare.gov/hospitalcompare (accessed May 21, 2018). 207Jha, A., & Epstein, A. (2010). Hospital governance and the quality of care. Health Affairs, 29(1), 182–187.

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Hospitals and Healthcare Systems 159

Since that study was published in 2010, little progress has been made in this area. As Pronovost et al.208 note: “In most organizations outside health care, the Board of Trustees (or Directors) assumes ultimate accountability for performance. This is rarely the case in health care, where boards have traditionally fixated on financial performance and delegated quality of patient care to the medical staff, often with limited board oversight.”

Board Structure and Activities Given the importance of the board in institutional oversight, and the many possibilities for its structure and operational features, one might ask what model(s) works best. Board prac- tices found to be associated with better performance in both process of care and mortality include (1) having a board quality committee; (2) establishing strategic goals for quality improvement; (3) being involved in setting the quality agenda for the hospital; (4) including a specific item on quality in board meetings; (5) using a dashboard with national bench- marks that includes indicators for clinical quality, patient safety, and patient satisfaction; and (6) linking senior executives’ performance evaluation to quality and patient safety indica- tors. Involvement of physician leadership in the board quality committee also enhances the hospital’s quality performance.209

Further insight into this question involves examination of the corporate mission and structures of hospitals. For example, as hospitals moved way from strictly philanthropic organizations, the purpose and expertise of their boards needed to change. Alexander et al.210

draw a distinction between philanthropic and corporate models for hospital boards. “The phil- anthropic model stresses community participation, due process, and stewardship, whereas the corporate model stresses strategy development, risk taking, and competitive positioning.”211

While their research showed that corporate model institutions were associated with enhanced operational efficiency, higher volume of adjusted admissions, larger market share, better strategic adaptivity, and quicker responses to changing environmental conditions, hospital occupancy and cash flow were generally unrelated to the governing board’s configuration. Despite these advantages, institutions should not necessarily move to the corporate model. One reason for this caution is the relationship of the institution to its stakeholders. Hospitals (even nonprofits) that are part of a system will be subject to a corporate model board at the parent’s organizational level; thus, local institutions that have their own boards may want to

208Pronovost, P., Armstrong, M., Demski, R., Peterson, M. H. A., & Rothman, M. D. (2018). Taking health care gover- nance to the next level. NEJM Catalyst. Retrieved May 21, 2018, from https://catalyst.nejm.org/healthcare-governance- next-level-quality-committee 209Jiang, H. G., Lockee, C., Bass, K., & Fraser, I. (1988). Board oversight of quality: Any differences in process of care and mortality? Journal of Healthcare Management, 54(1), 15–29; discussion 29–30. 210Alexander, J., Morlock, L. L., & Gifford, B. D. (1988). The effects of corporate restructuring on hospital policymaking. Health Services Research, 23(2), 311–337. 211Alexander, J., & Lee, S. D. (2006). Does governance matter? Board configuration and performance in not-for-profit hospitals. The Milbank Quarterly, 84(4), 733–758. The authors add this cautionary note to their findings and recommen- dations: “ . . . the hospital governance data for this study were based on surveys conducted in the mid to late 1980s, and the dependent variables reflected hospital performance in the period between 1986 and 1994. Accordingly, our findings should be generalized with caution to NFP hospitals in recent years.”

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160 The U.S. Healthcare System

retain a philanthropic focus that is more community oriented. A similar reason applies to public hospitals, which have other layers of governmental oversight.

In addition to the nature of stakeholders and corporate status, the overall environment (including location and resources) also plays an important part in the board’s structure and direction. In a comprehensive description of hospital boards, Shoou-Yih et al.212 identified three overarching board responsibilities: mission and strategy setting, performance evalua- tion and oversight, and external relations.

Mission and strategy setting includes definition and maintenance of hospital mission, and the board’s role in the approval of strategic plans for fulfilling mission. Performance evaluation and oversight role comprises the assessment of hospital and CEO performance in areas such as financials, care quality, patient safety, community health outcomes, and physician and staff relationships. External relations role includes such activities as community and government relations, public accountability, and fundraising.

While all three activities would seem important, the authors give the following caveat: “[H]igh levels of activity in multiple governance roles may not be synonymous with effectiveness . . . the effectiveness of the board and its impact on hospital performance may . . . be determined by the match between governing board roles and the organizational and environmental conditions of the hospitals.” In implementing any governance model, it is important to note the interdependency of its characteristics (viz., the components are complex and symbiotic). Changing features piecemeal may therefore destroy the effectiveness of the whole. Even so, other studies have identified independent features and practices of higher performing boards; for example, they tend to have more physician members. 213

Research214 into a number of other characteristics of higher performing boards yields some useful, and occasionally counterintuitive, findings:

■ Size. Size of the boards and marginal profit were unrelated.

■ Terms of service. Limiting term length for board members but not board officers was associated with higher profit margin. Limiting the number of terms had no effect for either officers or board members.

■ Compensation. Compensating board members of a nonprofit has been controversial. Study results do not indicate that payment (even travel or conference reimbursement) has any effect on profitability.

212Shoou-Yih, D. L., Alexander, J. A., Wang, V., Margolin, F. S., & Combes, J. R. (2008). An empirical taxonomy of hospital governing board roles. Health Services Research, 43(4), 1223–1243. The authors also provide a taxonomy of five types of boards and their characteristics. 213Prybil, L. D. (2006). Size, composition, and culture of high-performing hospital boards. American Journal of Medical Quality, 21, 224–229. 214Culica, D., & Prezio, E. (2009). Hospital board infrastructure and functions: The role of governance in financial per- formance. International Journal of Environmental Research and Public Health, 6, 862–873. Note: Performance was measured using the average profit margins over the three years of the study.

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Hospitals and Healthcare Systems 161

■ Standing committees. Paradoxically, the presence of audit and finance/budget commit- tees is highly negatively correlated with higher profit margins, as is the regular review of financial statements. Likewise, the presence of the CFO as a board member is slightly negatively correlated with higher profit margins. The presence of a governance com- mittee is also slightly negatively correlated with profitability. Routine review of capital planning, however, was associated with greater profitability.

■ Benchmarks. Consistent with the above findings, market share is a more useful bench- mark than strict financial performance.

■ Individual board member expertise. Knowledge of finance, insurance, or managed care was not correlated with higher profit margins.

■ Frequency of meetings. Greater frequency of meetings is negatively correlated with prof- itability, with fewer than six meetings a year being optimal.

“One limitation of the study was the potential issue of reverse causality (i.e., the gover- nance variables may themselves be affected by the hospital performance).”215 For example, hospitals in better financial shape may require only a few meetings per year, while poorer organizations may need to meet more often to correct problems.

In summary, while the general legal and regulatory requirements of a hospital board are similar across institutions, the most effective ways to meet obligations are not straightfor- ward. Hospitals must consider the issues mentioned above and create a board that meets its current, unique needs but is flexible enough to change as the organization’s internal and external environments evolve.

SUMMARY

Prior to the 20th century, hospitals played a peripheral part in the provision of most health- care. In the last 100 years, a confluence of advances in technology, new organizational models, and emergence of insurance payments placed these institutions at the centers of care. These same forces, however, are refocusing where care is and should be delivered. Technology is increasingly enabling outpatient services; organizational models are incor- porating nonhospital sites of care; and payers are promoting noninstitutional care to drive down costs. The questions that remain are: How far can these trends proceed? Can hospitals adapt and still be able to provide high-quality care?

215Ibid.

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