Below, a guest-post by HealthBeat reader Pat S.
Medicare is the second largest health care payer in America, trailing only Medicaid. The program is very popular with its enrollees, with polls showing a higher level of satisfaction than with private insurance.
Medicare is less popular with hospitals.
Opponents of health care reform in general and of a strong public option in particular often cite hospital dissatisfaction with Medicare as a reason why the reform programs won’t work. They report that evidence suggests that overall Medicare pays hospitals less than what it costs them to provide care. Private insurers pay more, and by “cost-shifting,” hospitals use these payments to make up the losses on Medicare. Opponents worry that if a public option linked to or modeled on Medicare becomes the dominant payer for people under 65, hospitals will go broke without the “subsidy” from private insurers, and the health system will be destroyed. Data collected by hospital groups and the insurance industry suggests that this is unlikely to happen.
Reports claim that global data–which provides a snapshot of average reimbursements to hospitals for patient care–show that Medicare pays hospitals between 93% and 97% of what it costs them to provide care, while private insurance pays between 115% and 125% of those costs. Even that crude data suggests that private insurers are paying hospitals far more than they need to make up for “underpayment” by Medicare.
However, this is global data. Examine the payments to individual hospitals in more detail, and you discover that many hospitals actually make a profit on most Medicare patients.
First, according to the American Hospital Association itself, 42% of hospitals make a profit on Medicare overall.
In the remaining hospitals, most Medicare patients are profitable. Losses on Medicare patients are related to a minority of patients who need much more care than average because of longer stays, more complications, and underlying health problems. Since the profits on most Medicare patients are small, large losses on this small number of outliers can drive overall payments below costs.In looking at any data on payments, it is very important to distinguish between Medicare and Medicaid. Payments by Medicaid – the government plan for the poor—are significantly lower. On average, Medicaid pays 72% of what Medicare pays for the same service. Those who oppose any government plan often lump Medicaid and Medicare reimbursements together to argue that Medicare grossly underpays providers. There is no question that Medicaid needs significant revision. Medicaid reimbursements should be hiked; payments to states should cover states’ costs. The House health care bill takes a step in that direction by mandating that Medicaid reimbursement for primary care must be raised to equal Medicare payments, and by providing direct funding to cover that raise and to cover new patients enrolled as a result of reform.
However, it is true that while many hospitals actually make an overall profit on Medicare patients, at the other end of the spectrum some hospitals lose more than average.
Regional Variations in Payments
One reason for some disparities is that Medicare payments to hospitals are not uniform throughout the country. In some areas, Medicare pays far more than in other areas. The differences can be quite large, with the highest paid hospitals collecting twice as much as the lowest paid. In some cases, this variation contributes to losses and has led to political controversy. “Blue Dog Democrats,” whose predominantly rural constituencies contain many of the low payment areas, are especially concerned.
As usual, this is more complicated than partisans would like us to think. Many rural hospitals in Blue Dog districts actually enjoy better than average Medicare margins, partly because of special adjustments to payments specifically for rural hospitals. Critics suggest that much of the focus on hospital payments was at least partially orchestrated by the Blue Cross plans to try to kill the public sector insurance option that progressive Democrats say we need to keep private insurers “honest”—and to give Americans choices.
How Medicare Works
When Medicare was started, the government agreed to follow Blue Cross and Blue Shield in the way it paid hospitals and doctors. However, that resulted in larger costs than anticipated, and when Nixon became president, Medicare switched to a new system, paying hospitals based on what it cost them to treat patients. Medicare would make a preliminary payment to hospitals as services were provided, then at the end of the year the hospitals and Medicare went through a “rectification procedure,” figuring out what it had ultimately cost the hospital to provide treatment, and the government would make additional payments to cover the actual expense of delivering care.
Under that program, the government tried to control costs primarily through the “Certificate of Need” (CON) program, which required that hospitals get approval for spending on capital improvements, including building, remodeling, and purchase of equipment above a certain cost, as well as creation of new service programs. The system was designed to inject rational behavior into the process of hospital growth, and to prevent costly duplication of services. The CON system quickly created a cottage industry of experts able to guide CON applications to approval, often by getting politicians to intervene.
The “cost and CON” system had major problems. When hospitals are paid for what it “costs” them to treat patients, hospitals are rewarded for inefficiency and profligate spending. Then as now, in some hospitals patients stayed longer and underwent more aggressive and more intensive care. These hospitals were rewarded with the highest reimbursements. The Dartmouth research, just beginning back then, showed that outcomes were no better for these patients, and often were worse. Meanwhile, under the cost-based payment system and its cousin, the CON, payments spiraled. Between 1967 and 1985, Medicare payments to hospitals soared twenty fold.
In the 1980s, the Reagan administration, with the consent of Congress, abolished the cost-based payment system for Medicare Part A payments to hospitals and replaced it with the Diagnosis Related Group (DRG) payment system, which breaks illnesses down by diagnosis and pays a certain amount for each patient diagnosed with a particular health problem. The DRG system remains in place today.
DRG is a prospective payment system that covers payment for all patient costs for each hospitalization except doctors’ fees, which are covered separately under Part B. For each patient and each admission, the hospital is paid a fixed amount that is meant to cover all hospital costs and charges for services that would be needed to treat a patient with a particular problem. About five hundred DRG categories have been created, each associated with a specific disease or injury. Modification for other co-existing or underlying health problems alters the payments, in effect creating thousands of categories. For example, there is a DRG for acute cholecystitis (gall bladder infection) that can be modified by other DRG’s for complications like co-existing infections, gallbladder rupture, and pancreatitis, or for underlying conditions like diabetes or heart disease, and so on.
The values of DRG’s are set empirically, based on actual data collected about costs of hospital services, and modified on a regular basis to reflect changes in costs and management approaches. There is one baseline DRG for each condition, but that baseline payment for hospitals is adjusted for other factors, including local labor costs, hospital location, teaching and training programs, large Medicaid and non-paying populations, and so on. The dollar value of the modifiers often exceeds the dollar value of the underlying DRG. It is these modifiers that account for the large region to region variation.
For example, a hospital in San Francisco may receive an added labor cost allowance that is 50% of DRG, and receive ad
ditional payments for having a teaching program and for having a large Medicaid population, resulting in a payment of more than twice the DRG baseline. Meanwhile, a hospital in rural Nebraska might actually receive less than the standard payment for a particular DRG because labor costs are lower than average, and there are no additional modifiers, resulting in a payment which is less than the baseline.
However, there are some special modifiers for rural hospitals that are sole providers or regional referral centers that can increase payment for services in rural areas as well.
The value of DRG’s and modifiers are supposed to be derived from evidence, but in reality there is also a large political component, with members of Congress intervening aggressively to force changes in payments for their areas, both rural and urban.
The political factor leads to some strange results, with areas blessed with involved congressmen receiving higher payments than those with more passive representatives. Labor payment indices are set county by county, and Dade County, FL, (Miami) has the highest payments, higher than other areas where the cost of living is clearly higher—such as New York City and San Francisco. Reimbursements in Miami also are substantially higher than in cities with fairly similar costs, like Minneapolis.
This uneven payment pattern is behind the recent statement by the Blue Dog caucus that they would not support health care reform unless the Medicare payment system was changed to reduce the disparities that put hospitals in their regions at a disadvantage. Some of the perception of inequality is no doubt correct, but some of it may be due to complaints by doctors and hospital administrators that are not grounded in reality. One truism in health care is that almost everyone believes they are not receiving fair payments.
Anger about these regional variations impacts both liberals and conservatives. These discrepancies are at the root of the recent pledge by the entire (Democrats and Republicans) Minnesota congressional delegation to announce they would oppose any health care reform that does not at least partially remedy these variations. Minnesota has a national reputation for lower than average health costs and excellent results, and Minnesota providers are quick to complain to their representatives that the payment system fails to recognize that and thus is unfair. Of course, providers and the congressional delegations from California, New York, Florida, and so on are equally adamant that the advantages enjoyed in their regions are deserved and should be left in place.
Making the System Work
There are things hospitals can do to break even or even make a profit from Medicare.For one, they can introduce programs that would reduce the number of patients who become “outliers” because they suffer complications from surgical infection, hospital acquired pneumonia, falls, mistakes, and so on. Paul O’Neill, one of George Bush’s treasury secretaries, wrote an op-ed for the New York Times urging that steps to limit these complications be incorporated in any reform, reporting that his working group had found that this could save hundreds of billions each year. Health Beat reader and commentator Lisa Lindell has written a book describing how one patient, her husband, nearly died and ran up months of extra hospital time and over a million dollars in extra expenses because of complications caused by management problems.The program described by Atul Gawande in his article “The Checklist” serves as an example of the type of program that can be implemented to prevent these problems, saving a large amount of money for very little investment.
Another way to reduce cost is to work to enhance the underlying health of patients so they do not incur higher costs and longer stays. The program created by the SMDC health system in Northeastern Minnesota to improve the health of patients with severe congestive heart failure is an example of one way hospitals can lower costs by improving management without introducing expensive new changes
In some settings, use of the electronic medical record has reduced costs by avoiding redundant services and by keeping providers better informed about patient status.
The Mayo Clinic has shown that rapid availability of consultation – obtaining help from other specialists in minutes to hours rather than hours to days – can reduce costs.
A less desirable way to contain costs is to “cherry pick” patients who will not become outliers. One way to do this is by persuading doctors to admit patients with more complicated histories to other hospitals. Being located in areas where patients tend to have fewer problems or working with doctors who tend to have patients with fewer problems – mostly by avoiding low-income people – is another. Atul Gawande, in his now- famous New Yorker article about high costs in some counties, reported cases in which doctors who were investors in for- profit hospitals steered profitable patients to their hospital while admitting high cost outlier patients to other hospitals, often public hospitals.
A more desirable way to minimize cost is simply to run a more efficient business. Hospitals can reduce their costs by streamlining processes ranging from OR throughput to billing. Most hospitals work on this all of the time, but some are better at it than others.
Appropriate Hospital Costs
The other big question regarding Medicare reimbursements to hospitals is whether hospitals are spending their money in appropriate ways. Everyone agrees that hospitals need to spend the money necessary to provide high quality care. However, many hospitals spend a great deal of money that is not directly related to patient care. More and more hospitals have invested large amounts in décor and esthetics, creating marble lobbies and hallways, building large patient rooms with features that mimic expensive hotel rooms, purchasing art installations, and so on. These amenities do not contribute to patient care. A visit to most European hospitals or to most VA hospitals illustrates that excellent care can be obtained in hospitals considerably less elaborate than many “flagship” hospitals. A few years ago I had the experience of visiting a friend who was a surgeon for Kaiser in the Bay Area. When I first saw his hospital, I was startled – it looked a lot more like a Motel 6 than a Four Seasons. Kaiser is a prospective payment system, so that when the money is gone there is no more. Kaiser also has to compete, at least partly on price, with other HMO’s and insurers in its market. That obviously results in closer attention to what is essential and what is not. However, the results attained at the hospital were excellent – according to the Dartmouth Data, better than at some of the “marble palaces” they compete with.
Salaries for hospital administrators have risen sharply in the last twenty years, with many hospital CEO’s now making seven figure salaries (and a few making eight figures,) and with lower ranked administrators paid proportional amounts. This makes its own contribution to costs.
Hospitals often invest large amounts of money in pleasing doctors who will bring them profitable patients. Many hospitals have overbuilt their angiography and OR capacity to make OR’s and angiography suites available at times when doctors prefer to operate, rather than distributing use through the day. OR’s are sometimes built to fit the personal demands of a surgeon, with side by side OR’s for other surgeons. An OR might be used only
by a single surgery group or even a single surgeon and stand vacant when they are not operating. Angiography suites and their staffs might be jammed with work from eight AM to noon, but be shut down while the doctors tend their office practices, or take time off, in the afternoon.
Hospital units are customized to please doctors in other ways. Special parking garages for physicians, expensive meeting and dining facilities, and so on are all set up to attract the “right” doctors.
In the last few years, hospital advertising has exploded. In many cities you cannot drive very far, read the newspaper, or watch TV very long without seeing expensive ads for hospitals. Despite the recession, in 2008 total advertising spending by U.S. hospitals increased to more than two and one half times what hospitals paid for ads in 2001. The costs of these ads are added into hospital overhead—in other words, the charge for your appendectomy includes the cost for the ads. Ironically, this type of advertising is often the hallmark of “overbuilding.” When hospitals wind up with excess capacity, they are then forced to compete aggressively to fill the added beds. This gives costs a double whammy, first incorporating the costs of overbuilding, then absorbing the costs of advertising dictated by the overbuilding.
There is also a well documented hospital “arms race” going on in many markets. Hospitals vie to buy the latest and most impressive equipment, regardless of utilization or cost effectiveness. Relatively new and still useful equipment is discarded because of the perception that something is better. A two year old CT scanner may be replaced because a newer and shinier model is available. In a sense, this is a form of advertising aimed at both physicians and patients, trying to sell the notion that the hospital is the best and most modern.
All of this adds significantly to hospital costs without providing any real health benefit to patients.
When looking at Medicare and hospital costs it also is worth looking at the business management issue involving the “marginal” cost of services.
What this means is that although the hospital has some fixed costs as well as some costs specific to each service provided, once a certain number of services are provided, the costs of additional services are much lower.
The cost of having one more patient admitted on a unit, or doing one more CT or MR in a day, or even of performing one more surgery in an OR is much lower than the average cost of using of these resources.
Just as a hotel can rent a vacant room for a much lower price, and an airline can reduce the price of an empty seat to fill it, hospitals could calculate reduced cost calculations when the marginal utilization costs them little. However, hospital cost calculations usually ignore this factor. The nineteenth CT or the fifth surgery is reported as if it cost the same as the first. The issue of marginal costs is complicated, but it is a management fact that exists in every industry, and health care is not an exception. Health care managers know this, and frequently consider lower payments for Medicare to be worth taking because the real costs are lower than they will generally admit.
Effective Patient Management
Finally, there is our old favorite, cost effective, efficient, and quality oriented patient management.
The data collected by the Dartmouth Atlas project have demonstrated, year after year, that some hospitals and systems can achieve better health care results at much lower costs than other systems. The main difference lies in the appropriate use of high tech diagnostic and treatment approaches.
The data clearly show that many hospitals could achieve striking reductions in cost by using more efficient approaches to managing patient care. These cost reductions could make calculations of “losses” on Medicare irrelevant.
And Another Thing…
One other consideration deserves attention.
Hospitals base their cost calculations on spreading the costs of various operating expenses evenly over all patients. However, there is at least one important area where Medicare patients actually cost hospitals considerably less than private insurance patients: the cost of billing for services.
Study after study shows that it costs hospitals 50% to 75% less to bill Medicare than to bill private insurers. In fact, for the mythical “average” hospital, the loss from Medicare of 3% to 7% may actually be cancelled out by the lower costs of billing. This is an area of hospital management where costs are actually being shifted from private insurance to Medicare, rather than the classic opposite.
The Bottom Line
The situation with Medicare payments and hospital profits is much more complicated than some people would like to suggest.
The losses many hospitals report may be real, but there is tremendous variation depending on management choices, location, and the ways in which costs are incurred.
Some hospitals are indeed losing large amounts on Medicare services, while others actually are making a profit. Most individual Medicare patients are profitable. Many others could make a profit if hospitals improved their operations.
Medicare is an excellent program, has high levels of approval from its enrollees, and has provided good care for many patients who would otherwise be excluded from the health care system. Hospitals need to be protected from true underpayment, but Medicare itself and the American public also need to be protected from poor management that leads to increased costs and poor health care.