Medicare could pour salt on the wounded hospital industry.

Seeking a cure for its own financial woes, Medicare may pull the knife on hospitals in an effort to save itself. Otherwise, the tax-funded health insurance program -- forced to cover massive crowds of aging baby boomers -- could wind up bankrupt in just 15 years.

The government issued its dark prognosis, essentially cutting seven years from Medicare's life expectancy following its latest annual checkup of the big insurance program. In a startling report published Tuesday, the government warned that Medicare needs swift -- and drastic -- treatment if the program hopes to survive.

"The projections in this report continue to demonstrate the need for timely and effective action to address Medicare's financial challenges," the study concludes. "We believe that solutions can and must be found to ensure the financial integrity" of the Medicare program.

As early as this year, the study determined, Medicare will begin spending more money on health care coverage than it will actually collect from taxpayers. From there -- as expensive new drug benefits kick in -- Medicare's condition is expected to rapidly deteriorate. Under certain scenarios, the study found, Medicare could run out of money in eight short years.

To be sure, Medicare costs are rocketing. The study projects that Medicare expenditures, as a percentage of the gross domestic product, will jump from last year's 2.6% to 3.4% in 2006. The report goes on to say that Medicare will actually cost more than Social Security by 2024. By then, of course, the government expects Medicare to be insolvent unless steps are taken -- soon -- to save it.

"The early introduction of reforms increases the time available for affected individuals and organizations -- including health care providers, beneficiaries and taxpayers -- to adjust their expectations," the report states. "The sooner the solutions are enacted, the more flexible and gradual they can be."

Pain Threshold

But can hospitals tolerate the pain?

In 1999, after the government slashed Medicare spending as part of the Balanced Budget Act, hospitals struggled -- and sometimes failed -- to survive. Now the government is eyeing new Medicare cuts at a time when some hospitals, crippled by bad debt, are already bleeding.

Fulcrum analyst Sheryl Skolnick expressed concern about Tenet ( THC) in particular, even before this week's Medicare report. Tenet is trying to recover from an aggressive pricing strategy that has backfired on the company. It has already lost access to the huge "outlier" payments -- created by a Medicare loophole -- that boosted its profitability in the past.

"We remind investors that we believe cuts in Medicare reimbursement are likely to be imposed in 2005 by a Congress struggling to find the money to pay for a very expensive prescription drug plan," Skolnick wrote last week. "The implications for THC: If that happens, it couldn't happen at a worse time and could make turning the company around an even more difficult task than it already is."

Tenet's stock, currently rated neutral by Skolnick, slid 2.5% to $10.36 on Wednesday. Other hospital companies took some hits as well. Health Management Associates ( HMA), another hospital chain accused of aggressive pricing, fell 2.4% to $21.73. And HCA ( HCA), the largest player in the group, slipped 1.4% to $39.94.

Still, Caymus Partners analyst Jeff Villwock foresees more pain to come.

"I don't think the Medicare cuts are going to impact stocks immediately," Villwock told TheStreet.com on Wednesday. But the proposed changes "will start to cloud people's vision of this industry."

Some health care experts have seen a storm brewing for some time. Prudential analyst David Shove simply darkened his forecast on Wednesday.

"As we said in our First Call note on Feb. 26 ... the impending retirement of the baby boomers forces policy makers to scrutinize all Medicare payments," Shove wrote. "This Medicare report is one more reason to be nervous about the political outlook for hospitals."

Skolnick stepped up her warnings as well. She also dissected the Medicare report in an attempt to diagnose the program's problems. She determined that new Medicare reforms -- which have lifted some pharmaceutical and rural hospital stocks -- shaved two years from Medicare's life expectancy. She also concluded that Medicare's core hospital insurance program could last just 15 years, absent serious changes, even without the recent reforms.

Skolnick now believes that the "bankruptcy of Medicare" could become a hot political issue during this year's Presidential race. Still, she doesn't expect any real Medicare cuts until after the election ends.

"The implications of this for investors should be obvious: 2005 does not look like it will be a good year for hospital stocks," she wrote. "As depressing as our negative commentary on the hospital stocks may be to some, it pales in comparison to the Medicare Trustee's report. ... We remain very comfortable with our negative outlook on the sector."

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