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THE U.S.
HEALTHCARE
SYSTEM
Origins, Organization and
Opportunities
J O E L I. S H A L OWI T Z, M D, M B A
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CHAPTER
4
HOSPITALS AND
HEALTHCARE SYSTEMS
81
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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 (Mercury), 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 permanently 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 structures, 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 valetudinarii) 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 Christianity, 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 foundation 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 Supplementum, 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 disciple 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 νo oκoμϵ˜ıν instituit, in quo aegrotantes colligeret de plateis
et consumpta languoribus atque inedia miserorum membra refoveret.” [And first of everyone, 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 practitioners 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 “nosocomiun,” 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 testifying to the bearer’s good character.
Following the European pattern, religious sponsorship was responsible for the first hospitals 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 unquestioned 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 testimonial 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 December 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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Establishment of other hospitals in major cities followed. They included public, secular institutions (e.g., Massachusetts General Hospital, established in 1811); nonreligious
organizations for the benefit of certain nationalities (e.g., New York’s French Hospital, established 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 religious 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 elsewhere, to practice medicine.16 Racial issues also contributed to hospital development in the
United States. Care of African Americans was established around three organizational models: 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 addition 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 summarizes 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 introduction 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 antiseptic 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 American 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 payment 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 emergence 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 substantial 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 government 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 expansion 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 lobbied 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: University 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 population 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 administration) originally had a universal insurance coverage provision, which was eliminated
because of anticipated costs.22 The Hill-Burton program required states to conduct hospital 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 organizations, 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 oversight 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 healthcare 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 obligations.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 doctors.”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 benefit 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 nonprofit 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 interest 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 activities. 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 services 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 continuing 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. Government 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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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 private 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 services 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 programs. 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, particularly 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 regulators 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 competition 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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Hospitals and Healthcare Systems 93
As a result of the questionable benefit of this process, the federal government withdrew 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 provided.” 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 community; 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 incidence 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 disasters.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 institutions 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 Mecklenburg said:
Health care today is a consumer service, no different from a whole host of others . . . 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 important” 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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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 Dependency 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 requirements (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 different 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 outpatient 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 hospital 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 confusing, 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, tertiary, 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%
1.8% 1.2%
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
Percentage of spending on hospital care
a Does not include capital.
b Includes postage and telephone expenses.
c For example food, medical instruments, etc.
Source: CMS and American Hospitals Association Data. © 2018 by Statistica Used with permission.
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 community 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
Number of hospitals
500
567
6 to 24
25 to 49
50 to 99
100 to 199
200 to 299
300 to 399
400 to 499
500 or more
1,217
1,091
1,157
627
Number of beds
360
196
319
250
0
Source: American Hospital Association 2018 Hospital Data. © 2018 by Statistica. Used with permission.
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 (frequently 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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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 training 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 $1.8 billion. About
half of teaching sites that received funding—such as teaching hospitals—received funds from
more than one of the five programs.”53 (Please see Exhibit 4.6.)
Increasing economic pressures have caused many states to cut back on their GME funding.54 In addition, the federal government is considering reduction of the IME portion of its
subsidies. Of note is that the Departments of Veterans Affairs and Defense also support GME
at their own teaching hospitals.
50House Report, Number 213, 89th Congress 1 Session 32 (1965), and Senate Report, Number 404, Pt. 1 89th Congress
1 Session 36 (1965).
51Iglehart, J. K. (2012). Financing graduate medical education-mounting pressure for reform. New England Journal of
Medicine, 366, 1562–1563. 52For more details about DGME payments see: Medicare Direct Graduate Medical Education (DGME) Payments.
Retrieved May 2, 2018 from https://www.aamc.org/advocacy/gme/71152/gme_gme0001.html
53GAO. (2018, March 29). Physician workforce. HHS needs better information to comprehensively evaluate graduate
medical education funding. Retrieved May 2, 2018 from https://www.gao.gov/assets/700/690580.pdf 54Association of American Medical Colleges. (2016). Medicaid graduate medical education payments—A 50-state survey. Retrieved May 2, 2018 from https://www.documentcloud.org/documents/4392445-Medicaid-Graduate-MedicalEducation-Payments-a.html
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100 The U.S. Healthcare System
EXHIBIT 4.6. Federal Spending on Graduate Medical Education Training,
2015
Program Total GME Spending
($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 funding. March 2018. Retrieved from https://www.gao.gov/assets/700/690581.pdf
In addition to the common hospital definition, teaching hospitals also share three essential 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
0
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
Number of hospitals
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 common 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 private 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 education 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 emergency 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 number 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. Congressional 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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Hospitals and Healthcare Systems 105
■ “The incremental community benefit exceeds the tax exemption for only 62% of nonprofits. Policymakers should be aware that the tax exemption is a rather blunt instrument,
with many nonprofits benefiting greatly from it while providing relatively few community 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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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
(c) Leaders, representatives, or members of medically underserved, low income, and minority populations, 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/irsdrop/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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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 encouraging 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 engaging 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 restriction 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 services 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 rehabilitation). 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 origins 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 hospitals 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 designation: 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 “hospitals 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 discharges. (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 Medicare 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-HospitalPPS-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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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-servicesmarch-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 concerned 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 hospitals), 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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Hospitals and Healthcare Systems 111
Despite all these changes, research commissioned by CMS found that “patients transferred 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 services 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 centers, 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 exemption 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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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 [hospital] 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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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 Number of hospital systems
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)
Operator (City, State)
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
39
41
42
44
45
59
78
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-profithospital-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 facilities/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 reasons 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 companies 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-tovertically-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 competitive 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.
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New England Journal of Medicine, 364, 1790–1793.
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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, orthopedic, 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 transition 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 combination, 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 insurers 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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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-verticallyintegrate
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120 The U.S. Healthcare System
Bureaucratization. The advantage of bureaucratization is mainly seen in public institutions and in countries that have regionalized their hospitals into de facto systems. Examples
include the Veterans Administration, hospital clusters of the Hong Kong Hospital Authority, 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 divergent 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 expertise 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 management, 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 management, 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 membership 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. Scottsdale, 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
ABCDE 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 Association, 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 purchasers 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…
Customer Vendor GPO
Source: GAO (2010, August). Group purchasing organizations. Services provided to customers and initiatives 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 ownership 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 organization 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-physicianowned 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/amazonwithdrawals-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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124 The U.S. Healthcare System
Critics (especially the American Hospital Association and Federation of American Hospitals) 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 institutions 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 Medicaid 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 Ownership 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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Hospitals and Healthcare Systems 125
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 implementation 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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126 The U.S. Healthcare System
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 clinical 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 compared 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 summit 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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Hospitals and Healthcare Systems 127
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 partial 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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128 The U.S. Healthcare System
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, respectively. 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, causing 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 populations: 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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Hospitals and Healthcare Systems 129
Second, hospital-specific ceilings were set on payments.126 Finally, limits to DSH allotments 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 beginning 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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130 The U.S. Healthcare System
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 hospital 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 determined 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-onMedicaid-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-DSHAllotments-How-Could-Funding-for-Safety-Net-Hospitals-Change-in-2018.pdf
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Hospitals and Healthcare Systems 131
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 hospital 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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132 The U.S. Healthcare System
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 beneficiaries.”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 service 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 MedicareDependent 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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Hospitals and Healthcare Systems 133
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 conditions, 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 during 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 Community 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 § 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-andCertification/CertificationandComplianc/CAHs.html
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134 The U.S. Healthcare System
■ Maintain an annual average length of stay of 96 hours or less per patient for acute inpatient 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 previously 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 Payment 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 telehealth services.151
These higher payment levels (compared to Medicare inpatient and outpatient prospective 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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Hospitals and Healthcare Systems 135
■ “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 hospitals 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 Percentage of hospitals
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. Modern 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 Services (5th ed.). Retrieved May 10, 2018, from http://www.modernhealthcare.com/article/20170914/NEWS/170919931
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Hospitals and Healthcare Systems 137
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, Medicaid, 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 insurance 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 substantial. 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 providing 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 ongoing 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 alternatives 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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138 The U.S. Healthcare System
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 covered 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 delivery 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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Hospitals and Healthcare Systems 139
7. Bundled/global/packaged payments.
160 Instead of receiving a bill for multiple services 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 penalized 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 organizations 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/ACEEvaluationReport-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 outcomes 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 Managing 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 management, human resources management, information technology management, strategic planning, quality 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, activities, 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 recognize its financial benefits. It mainly derives from economies of scale.
5. Physician integration requires not just shared culture and goals between those professionals and the system but also a compensation scheme that aligns them.
6. Clinical integration is the hardest alignment to achieve. It requires that the organizations 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, Intermountain 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 structures 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 efficiency 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 number 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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Hospitals and Healthcare Systems 143
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 components)
■ 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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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
1
(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).
2
(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.
3
(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/NewAccountable-Care-Organization-Model-Opportunity-Fact-Sheet.pdf See also CMS: Medicare Program; Revisions to Payment Policies 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/medicareprogram-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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Hospitals and Healthcare Systems 145
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 infrastructure 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, integrated 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 features 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 portion 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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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 Payments (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/pioneeracofinalevalrpt.pdf
172For more details, see: CMS. Next Generation Accountable Care Organization (ACO) Model: Frequently Asked Questions. 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/MedicareFee-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 Reauthorization 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/valuebased-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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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: Net Savings$0
458 410 6 16 8 18
Net Costs
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: Net Savings$0
458 410 6 16 8 18
Net Costs
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 marketplace, 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 participating 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 reducing 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/MedicareFee-for-Service-Payment/sharedsavingsprogram/Quality_Measures_Standards.html
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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 management 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 angioplasty 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 Physicians 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-reductioninitiatives-major-program-highlights
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7. Alignment of incentives. Successful ACOs must reward physicians for practicing 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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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 information 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 distinguishes 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 considered 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 California 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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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 Pennsylvania 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 Highland 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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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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154 The U.S. Healthcare System
and more complex portfolio of tasks. Green and Griesinger200 succinctly stated that the practitioner 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 reasonable 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 specify 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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Hospitals and Healthcare Systems 155
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 organization 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 committee 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-coolto-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 nomination 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 independent 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 executives’ actual performance in meeting predetermined goals and objectives.
Principle 6. Disclosure and Integrity of Institutional Information. Disclosures made by an organization regarding 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 compensated 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 Governance 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://
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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 responsible for managing the hospital.
(c) Standard: Care of patients. In accordance with hospital policy, the governing body must ensure that the
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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(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 practices 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 benchmarks that includes indicators for clinical quality, patient safety, and patient satisfaction; and
(6) linking senior executives’ performance evaluation to quality and patient safety indicators. 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 philanthropic 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 governance to the next level. NEJM Catalyst. Retrieved May 21, 2018, from https://catalyst.nejm.org/healthcare-governancenext-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 recommendations: “ . . . 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 evaluation 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 performance. 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 committees 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 committee 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 benchmark 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 profitability, with fewer than six meetings a year being optimal.
“One limitation of the study was the potential issue of reverse causality (i.e., the governance 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 straightforward. 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 healthcare. 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 incorporating 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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