This Article Abstract Submit a response to this article Services E-mail this article to a friend Alert me to new issues of the journal

P E R S P E C T I V E :
H O S P I T A L S
 
25 October 2005  
  

Physician-Owned Specialty Hospitals: 
A Market Signal For Medicare 
Payment Revisions

Policymakers should view the growth in these hospitals as a
signal that the hospital payment system is out of balance.


by Jack Hadley and Stephen Zuckerman


ABSTRACT:

Jean Mitchell’s findings show that physician-entrepreneurs respond to financial incentives and take advantage of variations in profitability within Medicare’s hospital payment system. The growth of physician-owned specialty hospitals can be seen as the reflection of parallel growth in profit opportunities. As Medicare plans to do, payments should be revised to squeeze out excess profits. Prohibiting physicians’ use of hospitals they own might be unnecessary and could make it harder to identify future distortions in Medicare prices. If squeezing out excess profits threatens general hospitals’ social missions, then new and explicit ways of identifying and funding social missions must be found.

Jean mitchell’s analysis of physician-owners and nonowners of cardiac specialty hospitals in Arizona finds that owners treat more cases and that the cases they treat in their own hospital are less severely ill and are much less likely to be either health maintenance organization (HMO) or Medicaid (AHCCCS) patients compared with nonowners. Her findings are consistent with those recently reported by the Medicare Payment Advisory Commission (MedPAC), the U.S. Government Accountability Office (GAO), and the Centers for Medicare and Medicaid Services (CMS).¹

Mitchell’s findings should come as no surprise. Physician-entrepreneurs respond to financial incentives and will take advantage of profit opportunities as they arise. MedPAC has shown that the relative profitability of hospital care can vary greatly both across diagnosis-related groups (DRGs) and by patient severity within a DRG.² Thus, the growth of physician-owned specialty hospitals can be seen as the visible reflection of parallel growth in profit opportunities.

As a result of these studies, the CMS is considering revisions to the DRG payment methodology to better account for differences in severity across patients as well as the underlying cost structures of specialty and community hospitals. Congress is also considering legislation to make permanent the prohibition on physician referral of Medicare patients to specialty hospitals in which they have an ownership interest.

We address three questions in this commentary: (1) What prompted the recent growth of physician-owned specialty hospitals? (2) Why should we care about their existence? (3) What should be done, if anything, as a policy response?

Why the growth now? Although there is no way of knowing definitively, several factors were probably at play in the recent rise in the number of physician-owned specialty hospitals. First, consolidation of hospital administrators’ managerial authority as a result of both the inpatient prospective payment system (IPPS) and the growth of managed care probably eroded physicians’ implicit share of hospital profits through salaries and practice subsidies (for example, free office space). MedPAC site visits indicated that physicians formed specialty hospitals to gain more control of hospital operations.³ Second, the IPPS has probably not kept pace with technical changes that have lowered the costs of providing certain types of surgical services.⁴ Third, the Medicare physician fee schedule as well as possibly some private physician fee arrangements have constrained physicians’ payment rates and increased incentives to seek new money-making opportunities.⁵ It might be coincidence, but concerns over physician-owned specialty hospitals emerged as Medicare policies were beginning to produce negative updates in the fee schedule conversion factor.

Why should we care? What does it matter whether patients are treated in physician-owned specialty hospitals rather than general hospitals? Physicians who have a financial conflict of interest could have an incentive to hospitalize patients unnecessarily or, at least, could be unduly influenced to use the facility in which they have an ownership interest. In addition, if the physician-owners of specialty hospitals capture profits that otherwise would accrue to general hospitals, these hospitals’ ability to cross-subsidize charity care or emergency and trauma services could be jeopardized.

There is little evidence to suggest either overuse of services by Medicare beneficiaries or general hospitals’ financial stress.⁶ This suggests that physician-owners are redistributing “profitable” cases to their hospitals, rather than increasing overall admissions, and that general hospitals are either becoming more efficient or cutting back on unprofitable patients and services.⁷ Unfortunately, there is too little good evidence to confirm these responses.

What should be done? What, if anything, should policymakers do? The CMS’s plan to improve the accuracy of DRG payments is an appropriate first step. However, proponents of this strategy have to recognize that the CMS will have to invest more than it has historically in data-collection resources and staff to monitor and evaluate future developments. Although these actions are needed, it is unlikely that an administered price system will ever be perfect. The best we can hope for is that major imbalances in the profitability of different types of patients will be less likely to occur. In addition to using the IPPS to create market signals, policymakers should be watching the market for signals that the IPPS could have problems. Thus, policymakers should view the growth of physician-owned specialty hospitals as a short-term signal that the IPPS is out of balance.

Critics of administered pricing often suggest that Medicare should rely on competing health plans to negotiate provider rates. At best, this strategy is likely to result in a reallocation of profits from specialty hospital investors to managed care companies, with no net savings for the government.⁸ Moreover, a recently released GAO report indicates that private health plans are less able to negotiate favorable rates in areas with highly concentrated hospitals.⁹ Medicare’s administered prices might have an advantage in this situation.

If adjusting DRG payments squeezes out the excess profit for certain types of patients, then we have to presume that cross-subsidies within community hospitals will also be curtailed. This raises the question of whether relying on inaccuracies in price setting is an effective way of paying for hospitals’ social mission. There seems to be no reason to perpetuate historical cross-subsidies, especially since there is no guarantee that hospital profits are fully applied to achieving socially desired objectives. A system that funds hospitals’ social missions more directly would require hospitals to be explicit about activities that provide community benefit and about their costs and funding sources. Greater transparency will lead to greater accountability, equity, and efficiency.

Policymakers can use the activities of for-profit medical care providers to identify where excess profit opportunities exist. In the absence of better evidence on overuse or poorer quality in physician-owned specialty hospitals, prohibiting physicians’ use of hospitals they own might be unnecessary and could make it harder to identify distortions in Medicare prices. Policymakers must make sure that the CMS has the resources to monitor and evaluate market activities and to develop payment methods that capture excess profits and redirect them to socially beneficial services that the for-profit sector should not be expected to provide.

The views expressed are those of the authors and not the Urban Institute or its trustees or sponsors.

NOTES

1. J.M. Mitchell, “Effects of Physician-Owned Limited-Service Hospitals,” Health Affairs, 25 October 2005, content.healthaffairs.org/cgi/content/abstract/hlthaff.w5.481; Medicare Payment Advisory Commission, Report to the Congress: Physican-owned Specialty Hospitals (Washington: MedPAC, March 2005); U.S. Government Accountability Office, Specialty Hospitals: Geographic Location, Services Provided, and Financial Performance, Pub. no. GAO-04-167 (Washington: GAO, October 2003); and M. Leavitt, Study of Physician-Owned Specialty Hospitals Required in Section 507(c)(2) of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, 2005, www.cms.hhs.gov/media/press/files/052005/RTC-StudyofPhysOwnedSpecHosp.pdf (26 September 2005).
2. MedPAC, Report to the Congress.
3. Ibid.
4. P.B. Ginsburg and J.M. Grossman, “When the Price Isn’t Right: How Inadvertent Payment Incentives Drive Medical Care,” Health Affairs, 9 August 2005, content.healthaffairs.org/cgi/content/abstract/hlthaff.w5.376 (26 September 2005).
5. C. Lesser, P. Ginsburg, and L. Felland, “Initial Findings from HSC’s 2005 Site Visits: Stage Set for Growing Health Care Cost and Access Problems,” Issue Brief no. 97 (Washington: Center for Studying Health System Change, August 2005), 2.
6. MedPAC, Report to the Congress; GAO, Specialty Hospitals; and Leavitt, Study of Physician-Owned Specialty Hospitals.
7. L. Dummit, “Specialty Hospitals: Can General Hospitals Compete?” Issue Brief no. 804 (Washington: National Health Policy Forum, 13 July 2005).
8. M.V. Pauly, “Market Power, Monopsony, and Health Insurance Markets,” Journal of Health Economics 7, no. 2 (1988): 111-128.
9. GAO, Federal Employees Health Benefit Program: Competition and Other Factors Linked to Wide Variations in Health Care Prices, Pub. no. GAO-05-856 (Washington: GAO, August 2005).

Read related papers by Jean Mitchell and Allen Dobson and Randall Haught.

Jack Hadley and Stephen Zuckerman (szuckerman{at}ui.urban.org) are principal research associates at the Urban Institute in Washington, D.C.

DOI: 10.1377/hlthaff.w5.491
©2005 Project HOPE–The People-to-People Health Foundation, Inc.