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Legally Speaking


Issue: February, 2005
Author: Paul Bachman

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Financial Impact of Physician Ownership in Specialized Healthcare Centers

The recent rapid growth of specialty hospitals has given rise to issues regarding physician ownership and self-referral to such facilities, as well as concerns regarding the financial viability of general hospitals when forced to compete directly with this new genre. Most of the growth of specialty hospitals has been in large metropolitan areas. Rural settings like Wyoming may only be indirectly affected by these new hospitals in that the neighboring states of Idaho, Montana, South Dakota and Utah either already have specialty hospitals or have them under development. It remains to be seen how Wyoming will be impacted.

The United States Code defines a specialty hospital as a facility that is primarily or exclusively engaged in patient care and treatment of one of the following areas: cardiology, orthopedics, surgery, or any other designated specialized category of services. Such hospitals are nothing new; in fact, children’s and other types of specialty hospitals have existed for decades.

Underlying the ever increasing growth of specialty hospitals is the trend among physicians to invest in this genre of hospitals. The most commonly stated reasons for this trend are that ownership allows doctors to gain more control over their work environment and obtain more revenue in a time of ever decreasing reimbursements.
Physicians are becoming increasingly dissatisfied with hospitals’ working environments. “Inefficiency, operating room block time, and waiting time for diagnostic services are common complaints.” Physicians are more comfortable in a working environment that is centered on the procedures they most commonly perform. To use orthopedists as an example: “Orthopedists go to a hospital setting and work in the same operating room where general surgery and obstetrics are done…orthopedics is nuts-and-bolts equipment intensive. It drives them crazy to have a staff that’s not familiar with a tray of multisize screws and nuts and bolts.” Ownership as well as work opportunities in specialty hospitals can give these dissatisfied physicians the ability to gain some control over their work environment.

The second factor contributing to the rapid growth of these facilities are cuts in reimbursements from private and public payers in response to ever increasing medical costs. Typically, health care payers provide hospitals a fixed payment for specific medical diagnosis, regardless of the actual costs of serving particular patients. This system was “designed to promote hospital efficiency by discouraging hospitals from providing unnecessary services as a way to boost revenues. The initial response of physicians to cuts in reimbursements was simply to work harder, in order to see more patients, and thereby sustain their anticipated level of income. A more recent reaction has been the increased investment in specialty hospitals. Declining reimbursements have driven physicians to at least inquire if there are other markets for their services.

Proponents of specialty hospitals argue that this genre will improve efficiency, reduce costs, and lead to better outcomes. One of the best ways to assure good outcomes is to do many processes repetitiously, involving the same teams of physicians, nurses, and technicians. Also, specialist physicians no longer receive stagnant incomes, but increasingly will be better compensated, enticing the best up and coming physicians to specialize in order to assure themselves better compensation for their added years of training.

Critics have generally attacked the growth of specialty hospitals in two ways. The first issue is that physician investment in specialty hospitals is in conflict with the Stark Anti-Referral laws. The second issue is a financial concern that specialty hospitals “skim the most profitable of procedures.”

Conflict with Stark Law
Federal law prohibits physicians from referring Medicare and Medicaid patients for specific health care services to hospitals in which the referring physician has a financial interest. “Interest” here is very broadly construed to include any ownership or investment interest in a hospital. This referral prohibition (the “Stark” law) “was enacted after studies found that physicians with ownership interests in separate clinical laboratories, diagnostic imaging centers, or physical therapy providers tended to make more referrals to them and order substantially more services at higher costs.”

There is an exemption under the Stark law that permits physicians who have an ownership interest in an entire hospital and who also are authorized to perform services there to refer patients to that hospital. The reason for this exemption is that Congress was not concerned about referrals by physicians who have an ownership interest in an entire hospital because the end financial gain for the physicians would be minimal. However, the Stark law specifically prohibits physician referral when that physician has an ownership interest in a hospital subdivision and a referral is made to that subdivision. Another concern with physician ownership is the referral power of the physician owner. This referral power gives the physician owner the ability to steer profitable patients to the specialty hospital in which she has an ownership interest, leaving more complex and expensive patients to the general hospitals.

In response to the issue of physician investment and physician referral to specialty hospitals, Congress enacted an 18-month moratorium (enacted on November 18, 2003 and in effect until June 2005) on physician self-referrals to specialty hospitals in order to gather information on these issues before making an ultimate decision. Excepted under this general ban are specialty hospitals that were in existence or under development prior to enactment of the Act.

Congress requested the General Accounting Office (GAO) investigate whether specialty hospitals’ arrangements with doctors are consistent with the Stark laws. One finding by the GAO found that “at approximately half of all specialty hospitals with physician ownership, the average share owned by an individual physician was less than two percent.” Such data would indicate that specialty hospitals should still fall under the general hospital ownership exemption of the Stark law because an individual physician would not realize much economically from referrals.

While the purpose of the Stark law is well founded, physician ownership in specialty hospitals is not likely to have enough of an economic impact on the referring physician as to require that specialty hospitals be specifically excluded from the investment exemption of the Stark law. Another consideration is that the attempt to shut down specialty hospitals because of their questionable applicability under the exemption of the Stark law misses the mark in that absent physician investment, specialty hospitals will obtain financing from other sources.

Financial Impact of Specialty Hospitals
General hospitals are concerned that specialty hospitals typically focus on cardiology, orthopedics, and surgery, which, not coincidentally, are three of the medical services that create a surplus in most hospital settings. Representative Bill Thomas (R, Calif.), chair of the House Ways and Means Committee, has been quoted as saying, “You should call them cash-cow hospitals, because what they’ve done is taken a look at a typical all-service hospital, figured out where the real money-making centers are, and pulled those out.” The obvious concern with this trend is that general community hospitals lose the ability to offset losses that may be sustained from other non-profit oriented departments of the hospital with the surplus’s produced by the lucrative revenue producers lost to the specialty hospitals.

Specialty hospitals have generally denied such financial effects. The American Surgical Hospital Association’s (ASHA) president Michael Lipomi argues that “opponents of specialty hospitals have yet to identify any hospital that has closed because of competition from one of these new, innovative providers.” Lipomi further argues that “all that’s happened is competition has been introduced into the marketplace, which is good for the consumer.”

Community hospitals should respond by engaging in competition with the specialty hospitals. One example of such a response was from a teaching hospital in Milwaukee, which “dedicated several operating rooms strictly to orthopedic care and provided specially trained nurses.” The example suggests that this concession will keep physicians happy and allow the hospital to “continue to provide revenue-generating procedures that fund more-costly programs, such as the trauma center and the burn unit.” An alternate solution to direct competition would be to encourage community hospitals to finance and take equity shares in specialty hospital projects, rather than develop their own cardiac, orthopedic, or surgical programs.

General hospitals are also concerned that specialty hospitals generally treat a less acute mix of patients than general hospitals, enabling them to recognize more of an economic gain on each reimbursement. Critics of specialty hospitals contend “that this practice of drawing away a more favorable selection of patients makes it more financially difficult for general hospitals to fulfill their broad mission to serve all of a community’s needs, including charity care, emergency services, and stand-by capacity to respond to community wide disasters.”

The primary reason for this concern is that health care payers typically make fixed-rate, lump sum payments to hospitals for inpatient care for patients with a given diagnosis, regardless of the costs of serving particular patients. This payment system is designed to discourage hospitals from providing unnecessary services as a way to boost revenues and promote efficiency. The problem with these lump-sum payments however, is that they may foster undesirable incentives for hospitals to gain financially by serving a disproportionate share of low-cost patients. The mechanics of how this system works is illustrated as follows:

Under its system of prospective payments, Medicare pays a predetermined rate for each hospital discharge, based on the patient’s diagnosis and whether the patient received surgery…the payments reflect an average bundle of services that the beneficiary is expected to receive as an inpatient for a particular diagnosis. Discharges are classified according to DRG’s. DRG payment rates are based on the expected cost of the diagnosis group’s typical case compared with the cost for all Medicare inpatient cases. The DRG payment is not adjusted for within-DRG differences in severity of illness. Therefore, hospitals have a financial incentive to treat as many patients as possible whose costs are low relative to the average in each DRG.

This is the reason that allegations have arisen that specialty hospitals treat a less acute mix of patients, thereby gaining financially from a built-in profit reimbursement, while “leaving the general hospitals and particularly but not exclusively the non-profit hospitals with the less lucrative patients.”

To determine whether there were actual differences in illness severity between patients treated at specialty hospitals and patients treated at general hospitals, the GAO analyzed patient discharge data at 25 specialty hospitals in the year 2000. The GAO study found that “21 out of 25 specialty hospitals treated a lower percentage of patients who were severely ill compared with patients in the same diagnosis categories treated at general hospitals in the same urban areas.”

While officials representing ASHA, MedCath Corporation, and NSH (three major specialty hospital chains) generally agreed with the information in the GAO report, these organizations disputed the patient severity analysis. They mainly argued that the reported differences in illness severity were misleading because it did not analyze the economic or clinical implications of the differences. The GAO accepted that the report may be misleading because they in fact did not attempt to determine the economic implications of the analysis. Other disputations of the GAO’s findings come from the Lewin Group, which did its own analysis of Medicare data and found that “the company’s average case mix index is 20% to 25% higher than that of other hospitals in the communities where it operates.”

One argument that specialty hospitals’ case mixes are not as upside down as claimed by critics is that if they were, then specialty hospitals would completely outperform general hospitals on a financial level. The findings show that specialty hospitals in 2001, when limited to Medicare inpatient business, appeared to perform about as well as general hospitals. During the same fiscal year, for-profit general hospitals had average Medicare inpatient profit margins of 14.6%, which actually exceeded Medicare inpatient margins for specialty hospitals of 12.4%. Such would indicate that when Medicare reimbursement is at issue, specialty hospitals are actually outperformed by general hospitals. However, “when revenues and costs are considered from all lines of business and all payers are included, the average financial performance of specialty hospitals exceeded that of general hospitals.”

The actual financial performance figures indicate that there is not a great disparity between specialty hospitals and general hospitals when all revenues and costs are included. If specialty hospitals were in fact treating a substantially healthier case load, while receiving the same reimbursements under a DRG system, then they should substantially outperform general hospitals financially. Because this is apparently not the case, it appears that the concern that specialty hospitals treat a less acute case mix is not substantial and should not lead to further restrictions on the growth of specialty hospitals.

The concern of violating the Stark law is a legitimate one. Congress should conduct more studies in order to determine whether specialty hospitals are in violation of the Stark law. They should focus on the percentage ownership that physicians hold in these facilities in order to determine whether specialty hospitals should fit within the exemption or whether they should be specifically excluded from the exemption because of their likeness to subdivisions within general hospitals. However, until such findings are made, physicians should be allowed to invest in these hospitals as they have not as of yet been found to be in violation of the Stark law.

The issue of financial viability of general hospitals when forced to compete with specialty hospitals is also a legitimate concern. It is not heavily disputed that specialty hospitals focus on revenue intensive specialties. However, this should not stop hospitals from attempting to keep these specialties within their hospitals.

The possibility of specialty hospitals treating a less acute mix of patients is an important issue for Congress to consider when determining reimbursement amounts for Medicare and Medicaid. If there is such a problem occurring, it should be addressed by Congress by fixing the reimbursement plan as to provide no financial gain to those that “work the system” so to speak.

In a perfect situation, one would hope that specialty hospitals would treat the more acute patients because of their better ability to treat such patients more effectively at a lower cost than their counterpart general hospitals. The less acute patients could then be sent to general hospitals in cases when a highly specialized setting is not as necessary.

Paul Bachman graduated from Weber State University with a B.S. in accounting. He is currently a student at the University of Wyoming College of Law. He plans to further his education by attaining an LLM degree in taxation.