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Hospitals Brace for Medicare Blitz

Sen. Chuck Grassley wants to make the payment system harder to game, and the changes could hit the big operators.

The hospital industry could pay dearly to cure a festering sore spot.

The group has long cried out for relief from physician-owned specialty hospitals that snag lucrative cardiology and orthopedics cases for themselves. In response, however, the government is now poised to go a step further by reducing the profitability of such cases for regular and specialty hospitals alike.

Indeed, Congress is currently weighing a bipartisan bill that would dramatically alter the entire Medicare payment system. Under the proposal, Medicare would pay hospitals on the basis of their cost to treat patients rather than the amount they charge to do so.

"This bill would make corrections to the payment system so that certain cases and patients are not significantly more profitable or less profitable to treat than others," says Chuck Grassley, an Iowa Republican who chairs the powerful Senate Finance Committee. "This will improve payment accuracy for all hospitals and will better reflect the actual cost of delivering care."

Grassley's proposal, based in part on recommendations from the Centers for Medicare and Medicaid Services, would rein in the growth of specialty hospitals while undercutting certain business strategies at regular hospitals as well. The push for change comes after a hospital operator -- Dallas-based

Tenet

(THC) - Get Report

-- exploited the current system by jacking up hospital charges in order to boost corporate profits.

UBS analyst Kenneth Weakley, who first exposed Tenet's pricing scheme more than two years ago, warns of an unexpected backlash for the industry.

"If CMS is successful in altering the

diagnosis-related group system such that it achieves tight, normal distribution of profit margins across all DRG codes, then forward projections for hospital economics will likely lose ALL of their reliability," Weakley wrote last week. "Indeed, should CMS implement this change for fiscal 2007 (which begins in October 2006), as it currently intends, it would not be unfair to say that few even in the hospital industry would be able to accurately predict the ultimate impact on hospital-by-hospital reimbursement."

Already, industry executives look skittish. Since CMS first made its recommendations in early March, senior managers at a number of hospital chains -- including

Community

(CYH) - Get Report

,

LifePoint

(LPNT)

,

HCA

(HCA) - Get Report

and

Triad

TST Recommends

(TRI) - Get Report

-- have been shedding large amounts of stock. All of those stocks set new 52-week highs this spring but have since begun to retreat.

Shares of industry leader HCA, where insider selling has been especially pronounced, fell 1.2% to $53.01 on Wednesday. The stock is now off 6.5% from the peak it hit last month.

Specialty Shops

Government leaders uncovered plenty when they set out to examine specialty hospitals and their impact on the nation's health care system as a whole.

In recent months, three separate government studies have found that physician-owned specialty hospitals treat the most profitable cases while leaving mainstream hospitals to care for the rest. So did a separate study carried out by prominent Georgetown economist Jean Mitchell, whose earlier research helped lead to laws prohibiting doctors from referring patients to facilities that they own.

Those laws, however, contain an exemption that allows physicians to invest in "whole hospitals" -- as opposed to specific departments -- because their referrals, in theory, should have little impact on overall operations. But some specialists have used that exemption to invest in specialty hospitals that focus entirely on such lucrative services as cardiology, orthopedics and outpatient surgery.

Grassley's proposal, co-sponsored by Democratic Sen. Max Baucus, seeks to close that loophole. Specifically, it would ban the development of new specialty hospitals and the expansion of existing ones.

"I am an advocate of efficient and innovative health care," Baucus said, when he and Grassley introduced the bill earlier this month. "But I don't think it is fair to promote a system in which physicians can send healthier and more profitable patients to hospitals they own while referring less profitable patients with more extensive health problems to other institutions.

"The playing field needs to be level."

Hollow Victory

The regular hospital industry, hurt by physician competition and bad debt from the uninsured, has been begging for such a change. But the industry could wind up regretting its supposed victory in the end.

Like their specialty competitors, mainstream hospitals could face less attractive reimbursement for the very services -- such as cardiology -- in which they have invested the most.

"It is CMS's intent to restructure the DRG payment system such that cardiovascular margins (on Medicare patients, at least) is equal to that of general surgery or any other therapeutic category," Weakley explains. "Mathematically, CMS would like to tighten the distribution of margins across the DRG system ... a fact which, given the fixed-asset nature of the hospital industry and the capital spending strategies of the past 10 years, could prove problematic to the sector going forward."

Moreover, Weakley suggests, Medicare may simply be the first to scale back reimbursement for high-margin cases. Health maintenance organizations, he says, could follow up by seeking price reductions of their own.

In the meantime, the hospital industry is scrambling to reshape the current proposal. Even before CMS formally offered its recommendations to Congress, the Federation of American Hospitals was already arguing that a new cost-based Medicare reimbursement system would be problematic.

"It would take a complex accounting system to accurately determine costs by revenue cost centers -- a system much more complex than ever existed under cost-based reimbursement," the Federation told the government in a February letter. And "even if this were done, the cost determined by using such departmental cost-to-charge ratios still would not be accurate at the procedural level."

Weakley himself agrees that the current proposal calls for a "monumental shift" in the way that Medicare payments are calculated. He also says that CMS has scheduled the change to take place in "virtually the blink of an eye in federal terms" and goes on to suggest that the transition will take more time.

Still, he stops well short of saying that it will not happen at all.

"Some are likely to suggest that the complexity of what is being proposed is so great that the reforms suggested are NEVER going to happen," Weakley concedes. But "with a Ph.D. economist (and physician) in charge at CMS, pricing efficiency is perhaps a more serious focal point than ever at the federal level. The effort to improve pricing efficiency is likely to continue."

Unintended Consequences

And that "efficiency" could mean serious pain for the industry.

In the past, Weakley notes, health care players have suffered terribly during times of radical change. He points to the era following the Balanced Budget Act of 1997, when excessive Medicare cuts left hospitals reeling, as one example. He mentions an industry-supported payment system for nursing homes, which resulted in multiple bankruptcies, as another.

"In terms of health care, the law of unintended consequences seems often to rear its ugly head immediately following major health policy change," Weakley says. Thus, "the law of unintended consequences should not be forgotten."

Peter Young, a business consultant at HealthCare Strategic Issues, believes that hospital executives may foresee serious consequences already. He points to their recent actions -- which have coincided with multiple threats to hospital reimbursement -- as evidence for his theory.

"This could be why hospital insiders have been dumping so much stock," Young says. "Hospitals could lose a substantial portion of their revenue. ... This is critically important."