For ailing hospital companies, President Bush's second term could prove to be a prescription for more pain.

Already, the sector has seen its health fade because of a sluggish economy that has left hospitals caring for throngs of uninsured patients who often fail to pay their bills. But the industry's condition could deteriorate even further if Bush follows through with Medicaid cuts at a time when private health insurers appear to be growing stingier as well.

Together, federal and state governments now spend almost $300 billion annually on Medicaid. But Bush hopes to cut federal spending on Medicaid by $24 billion over the next decade -- reversing a surge in Medicaid expenditures, even as the Medicaid population is expected to balloon. That could leave many more poor people without health care coverage.

To be sure, hospitals rely on Medicare and managed care companies for the bulk of their revenue. Still, they consider Medicaid an important source of cash. Indeed, some rural hospital operators, such as

Community Health

(CYH) - Get Report

and

LifePoint

(LPNT)

, generate more than 10% of their revenue from Medicaid payments.

In a brief note published just days after the recent elections, Banc of America analyst Gary Taylor portrayed the hospital industry as clearly nervous about federal health care spending. He pointed to recent comments by Rick Pollack, executive vice president of the American Hospital Association, as evidence.

"Mr. Pollack stated plainly: 'We were concerned about (2006) reimbursement risk before the election, and we're still at least equally concerned now,'" Taylor wrote.

Actually, Bush was eyeballing Medicaid cuts before his victory last week. Talk of cutbacks in the expensive program -- which covers some of the poorest and sickest people in the country -- surfaced early in the year but then slowed as the political elections approached. Now, however, the topic is expected to rise to new prominence as early as next year.

Thus Peter Young, a business consultant at HealthCare Strategic Issues, warns of an "unfavorable future" for the already wounded sector.

"From our perspective," Young says, "the industry debate

on Medicaid cuts moves from if -- now a moot point -- to the new questions: Where? How much? And when?"

Waiver of the Future

Right now, Medicaid accounts for nearly $1 in every $5 spent on health care services in the U.S.

Under current arrangements, states receive at least $1 in federal money -- and often more -- for every $1 they spend on their Medicaid programs. That formula has encouraged states to expand coverage when they can afford it and refrain from cutting back, due to the loss of federal dollars, when times are lean.

But the states, hard hit by tough economic conditions, have found themselves struggling to fund their share of the costly health care program. Therefore, they could prove receptive to "waivers" that allow them to cut federally mandated Medicaid offerings in exchange for accepting fixed payments, rather than dollar matches, from the federal government.

The new arrangement could slow the spiral in Medicaid costs that occurs when the states -- and then the feds -- keep stepping up their spending. But it could also restrict eligibility and coverage for Medicaid recipients in the process.

The Kaiser Family Foundation, which provided Medicaid data cited in this story, offered a couple of examples during a presentation on Medicaid financing in mid-April. Andy Schneider, a speaker for the group, said that 50,000 beneficiaries lost Medicaid coverage in Oregon after that state negotiated a waiver with the federal government. In addition, he said that Medicaid coverage has narrowed -- for example, paying hospitals only for emergency services -- since Utah arranged a waiver of its own.

"The waiver basically reduces benefits and imposes co-payments on parents with incomes below 50% of the federal poverty level," Schneider said. "And this, in the judgment of the Secretary of

Health and Human Services, is likely to assist in promoting the objectives of the Medicaid program."

But Young foresees a new burden on the hospitals forced to treat poor patients suddenly left with reduced -- or even no -- Medicaid coverage.

"Changes in eligibility and benefits

mean more people receiving less but still requiring health care," Young says. "And this will begin to impact all health care providers, as these people start to show up at hospitals as the uninsured."

Recipe for Disaster

Some states, pursuing cuts now, already have fights on their hands.

Mississippi has now delayed Medicaid cuts at least three times, in part because of public outcry. Meanwhile, Georgia has moved forward with big Medicaid cuts that have fueled backlash -- and dire warnings -- from the hospital industry there. A recent study by Deloitte Consulting, commissioned in part by

HCA's

(HCA) - Get Report

southeastern division, labeled the state's current health care system "unsustainable" because of inadequate funding.

Georgia has cut Medicaid payments to hospitals by $70 million over the past two years, according to the state's hospital association. The state also has reduced Medicaid eligibility for thousands, the group says.

"It's the perfect recipe for disaster," says Don Faulk, chairman of the Georgia Hospital Association, which also helped fund the study. "Georgia hospitals are caring for more people and being paid far less than what it costs to provide the care. ... This study confirms what so many hospital administrators around the state have openly feared: that the current economic system is unsustainable in the future."

But some point to Medicaid cutbacks in Texas -- already home to the highest percentage of uninsured residents in the country -- as even more severe. There, base Medicaid payments dropped by 2.5% last year, and some programs disappeared entirely, the trade publication

Hospitals and Health Networks

reported in September. Moreover, the publication adds, the state's benefits "weren't generous to begin with, ranking 49th in government spending per capita."

Fulcrum analyst Sheryl Skolnick recently questioned whether Texas in particular could be partly to blame for the escalating level of uncompensated care at urban hospital operator

Tenet

(THC) - Get Report

. But the struggling hospital chain also counts California and Florida -- two other states with big uninsured populations -- among its major markets.

Bye-Bye, Payments

Of course, Tenet faces problems beyond the uninsured. Besides multiple government probes, the company is also weathering a decline in lucrative "stop-loss" payments for insured patients who require unusually long or expensive hospital stays. Insurance companies have cut back on the payments -- now roughly 12% of Tenet's managed care revenue -- in the two years since the hospital chain's aggressive pricing strategy was exposed.

"Can you say, 'Bye-bye, $1 billion in stop-loss payments?'" Skolnick asked. "That is what appears to us to be happening here."

Still, the problems for Tenet -- and even the industry -- don't necessarily end there. Skolnick also notes that insured patients appear to be switching to cheaper health plans that pay hospitals less.

"Frankly, we see the underlying trend of the shift of benefit plans to more affordable structures and networks as a significant danger to hospital profitability and especially dangerous to THC," Skolnick wrote.

Those plans can leave patients with high deductibles and co-payments that are especially hard to collect, making the bad-debt situation even worse. Young points to all of these pressures -- Medicaid cuts, stop-loss reductions, collection problems -- as evidence of painful times ahead.

"And it's all coming about not at a slow pace but at a rapid pace," he says. "I just don't see things getting any better."

Young is keeping his eye on the Medicaid situation -- and the rise of federal waivers -- in particular. The Kaiser group is telling other industry experts to do the same.

"It's quite clear the intention on the part of the Department of Health Services is that the reform proposal will impact every provider, every beneficiary and every program now financed with Medicaid dollars in the state," Schneider said during the April 19 briefing. "These waivers can reach far into all the nooks and crannies in the Medicaid program."