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26–371 2006

PHYSICIAN-OWNED SPECIALTY HOSPITALS 

HEARING 

BEFORE THE

COMMITTEE ON WAYS AND MEANS 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED NINTH CONGRESS 

FIRST SESSION 

MARCH 8, 2005 

Serial No. 109–37 

Printed for the use of the Committee on Ways and Means 

( 

ii 

COMMITTEE ON WAYS AND MEANS 

BILL THOMAS, California, Chairman 

E. CLAY SHAW, JR., Florida 

NANCY L. JOHNSON, Connecticut 

WALLY HERGER, California 

JIM MCCRERY, Louisiana 

DAVE CAMP, Michigan 

JIM RAMSTAD, Minnesota 

JIM NUSSLE, Iowa 

SAM JOHNSON, Texas 

ROB PORTMAN, Ohio 

PHIL ENGLISH, Pennsylvania 

J.D. HAYWORTH, Arizona 

JERRY WELLER, Illinois 

KENNY C. HULSHOF, Missouri 

RON LEWIS, Kentucky 

MARK FOLEY, Florida 

KEVIN BRADY, Texas 

THOMAS M. REYNOLDS, New York 

PAUL RYAN, Wisconsin 

ERIC CANTOR, Virginia 

JOHN LINDER, Georgia 

BOB BEAUPREZ, Colorado 

MELISSA A. HART, Pennsylvania 

CHRIS CHOCOLA, Indiana 

CHARLES B. RANGEL, New York 

FORTNEY PETE STARK, California 

SANDER M. LEVIN, Michigan 

BENJAMIN L. CARDIN, Maryland 

JIM MCDERMOTT, Washington 

JOHN LEWIS, Georgia 

RICHARD E. NEAL, Massachusetts 

MICHAEL R. MCNULTY, New York 

WILLIAM J. JEFFERSON, Louisiana 

JOHN S. TANNER, Tennessee 

XAVIER BECERRA, California 

LLOYD DOGGETT, Texas 

EARL POMEROY, North Dakota 

STEPHANIE TUBBS JONES, Ohio 

MIKE THOMPSON, California 

JOHN B. LARSON, Connecticut 

RAHM EMANUEL, Illinois 

ALLISON H. GILES, Chief of Staff 

JANICE MAYS, Minority Chief Counsel 

SUBCOMMITTEE ON HEALTH 

NANCY L. JOHNSON, Connecticut, Chairman 

JIM MCCRERY, Louisiana 

SAM JOHNSON, Texas 

DAVE CAMP, Michigan 

JIM RAMSTAD, Minnesota 

PHIL ENGLISH, Pennsylvania 

J.D. HAYWORTH, Arizona 

KENNY C. HULSHOF, Missouri 

FORTNEY PETE STARK, California 

JOHN LEWIS, Georgia 

LLOYD DOGGETT, Texas 

MIKE THOMPSON, California 

RAHM EMANUEL, Ilinois 

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public hearing records 

of the Committee on Ways and Means are also published in electronic form. The printed 

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prepare both printed and electronic versions of the hearing record, the process of converting 

between various electronic formats may introduce unintentional errors or omissions. Such occurrences are inherent in the current publication process and should diminish as the process 

is further refined. 

iii 

C O N T E N T S 

Advisory of March 1, 2005 announcing the hearing ............................................. 2 

WITNESSES 

Medicare Payment Advisory Commission, Glenn M. Hackbarth, Chairman ..... 5 

Centers for Medicare and Medicaid Services, Center for Medicare Management, Tom Gustafson, Ph.D., Deputy Director .................................................. 16 

Saint David’s Healthcare Partnership, Jon Foster ............................................... 36 

American Medical Association, William G. Plested III, M.D. .............................. 41 

Cedars-Sinai Medical Center, William W. Brien, M.D. ........................................ 49 

MedCath Corporation, Jamie Harris ..................................................................... 53 

Baylor Healthcare System, Gary Brock ................................................................. 61 

SUBMISSIONS FOR THE RECORD 

Bettis, Richard, Texas Hospital Association, Austin, Texas, letter ..................... 77 

Calkins, D.J., Guadalupe Valley Hospital Board of Managers, Seguin, Texas, 

statement .............................................................................................................. 83 

Castle, James, Ohio Hospital Association, Columbus, Ohio, letter ..................... 84 

Coyle, Carmela, American Hospital Association, statement ................................ 86 

Dauphine ́, Damien, North Texas hospital, Lewisville, Texas, letter ................... 91 

Fetter, Trevor, Tenet Healthcare Corporation, Dallas, Texas, statement .......... 92 

Friesen, Shawn, American College of Surgeons, statement ................................. 95 

Grant, James, American Surgical Hospital Association, San Diego, statement 97 

Johnston, Jr., Ben, Focus on Therapeutic Outcomes, Knoxville, Tennessee, 

letter ...................................................................................................................... 130 

Jones, Steven, Little Rock, Arkansas, statement .................................................. 134 

Kerrigan, Karen, Small Business & Entrepreneurship Council, statement ....... 135 

Orient, Jane, Association of American Physicians & Surgeons, Tucson, Arizona, statement .................................................................................................... 136 

Strayer III, John, National Center for Policy Analysis, statement ..................... 137 

(1) 

PHYSICIAN-OWNED SPECIALTY HOSPITALS 

TUESDAY, MARCH 8, 2005 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON WAYS AND MEANS, 

SUBCOMMITTEE ON HEALTH, 

Washington, DC. 

The Subcommittee met, pursuant to notice, at 4:07 p.m., in Room 

B–318, Rayburn House Office Building, Hon. Nancy L. Johnson, 

(Chairman of the Subcommittee) presiding. 

[The advisory announcing the hearing follows:] 

2 

ADVISORY 

FROM THE COMMITTEE ON WAYS AND MEANS 

SUBCOMMITTEE ON OVERSIGHT 

FOR IMMEDIATE RELEASE CONTACT: (202) 225–1721 

March 8, 2005 

No. HL–2 

Johnson Announces Hearing on Physician-Owned 

Specialty Hospitals 

Congresswoman Nancy L. Johnson (R–CT), Chairman, Subcommittee on Health 

of the Committee on Ways and Means, today announced that the Subcommittee will 

hold a hearing on physician-owned specialty hospitals, following the release of the 

2005 report of the Medicare Payment Advisory Commission (MedPAC). The hearing will take place on Tuesday, March 8, 2005, in B–318 Rayburn House Office Building, beginning at 4:00 p.m. 

In view of the limited time available to hear witnesses, oral testimony at this 

hearing will be from invited witnesses only. Witnesses will include Glenn 

Hackbarth, Chairman of MedPAC, and representatives from groups affected by 

Medicare’s payment policies. However, any individual or organization not scheduled 

for an oral appearance may submit a written statement for consideration by the 

Committee and for inclusion in the printed record of the hearing. 

BACKGROUND: 

In recent years, there has been increasing growth of specialty hospitals owned, 

in part, by physicians. Such facilities focus primarily on the performance of cardiac, 

surgical and orthopedic procedures. Proponents contend that these facilities provide 

a range of benefits, including increased efficiency, competition, better medical outcomes, and improved patient satisfaction. Critics of specialty hospitals contend that 

physician owners at these facilities select more profitable patients and procedures, 

which adversely impacts the resources of community hospitals. Critics also believe 

physician ownership creates conflicts of interest and may increase utilization and 

spending of services. Medicare payments for inpatient procedures at hospitals are 

determined by grouping medical procedures into more than 500 diagnosis-related 

groups (DRGs), with the goal of providing appropriate payments based on the type 

of medical condition and resources required to treat the condition. 

The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 

(MMA) (P.L. 108–173) responded to questions surrounding the growth of these facilities by imposing a moratorium until June 8, 2005, that prohibits the opening of 

new facilities in which a physician maintains an ownership interest. The MMA permitted existing specialty hospitals to operate. Also, the MMA requires MedPAC to 

issue a report by March 8, 2005, on cost differences, the financial impact of specialty 

hospitals on community hospitals, patient selection, and recommendations to update 

the DRG structure. In addition, the MMA requires the Secretary of the U.S. Department of Health and Human Services to issue a report by March 8, 2005, on in part, 

quality and differences in uncompensated care between specialty and community 

hospitals. 

FOCUS OF THE HEARING: 

The hearing will focus on physician-owned specialty hospitals, identification of potential problems and an examination of potential solutions. The MedPAC will 

present findings from its report to Congress on physician-owned specialty hospitals. 

The second panel will provide input from affected parties, including testimony from 

3 

witnesses with experience in specialty hospitals, community hospitals and physician-referral issues. 

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f 

Chairman JOHNSON. Welcome everyone. We gather today to 

discuss the serious issue of physician-owned specialty hospitals. We 

will begin to explore today the results of the Medicare Payment Advisory Commission’s (MedPAC), the report to Congress on physician-owned specialty hospitals. We will also hear from a representative of the Centers for Medicaid and Medicare Services regarding 

their preliminary results and the perspectives of various interested 

parties. 

In recent years there has been increasing growth in the specialty 

hospital area. Such facilities focus on the performance or cardiac, 

4 

surgical and orthopedic procedures. Proponents contend that these 

facilities provide a wide range of benefits, including increased efficiency, competition, better medical outcomes, improved patient and 

provider satisfaction. 

Critics of specialty hospitals contend that physician owners at 

these facilities select more profitable patients and procedures 

which adversely impacts the resources of community hospitals. 

Critics also believe physician ownership creates a conflict of interest and may increase utilization and spending on services. These 

issues are important, and given the nature of the facilities and 

treatments at issue, compel us to consider the manner in which 

Medicare pays for inpatient procedures at hospitals and whether 

changes to the payment system are needed to provide accuracy and 

prevent waste. The Medicare Prescription Drug Improvement and 

Modernization Act of 2003 imposed a moratorium until June 8th, 

2005 that prohibits the opening of new specialty hospitals while allowing existing specialty hospitals to operate, and allowing those 

under development to apply for a waiver. The moratorium expires 

and is something we must consider soon. 

We appreciate the efforts of MedPAC in issuing its timely report 

on physician-owned hospitals. MedPAC makes a variety of findings 

and recommendations which we will explore today. On our first 

panel we are happy to have MedPAC’s Chairman, Mr. Glenn 

Hackbarth, here today with us to discuss the findings set forth in 

MedPAC’s report. In addition, although we have been advised that 

the Secretary’s report on specialty hospitals is not yet available, we 

are pleased to hear comments from Mr. Thomas Gustafson, who is 

the Deputy Director of the Center for Medicare Management and 

for the Centers of Medicaid and Medicare Services, who will provide limited testimony on their preliminary research data. His testimony will not and is not intended to provide any conclusions 

about the data, and is not to be considered a substitute for the Secretary’s report, which we anticipate to be issued in the near future. 

On our second panel we are pleased to hear from representatives 

from the physician hospital and specialty hospital communities. 

They will provide varied perspectives on physician-owned specialty 

hospitals, the Medicare payment structure and potential improvements to the system for the benefit of Medicare beneficiaries, providers and taxpayers. Mr. Stark, I now welcome you. 

Mr. STARK. Thank you, Madam Chair. You are quite right, it is 

an important topic. My concern is that the growth of specialty hospital phenomena or whatever you choose to call it, could impact the 

structure of our medical care delivery system. In essence these facilities are pulling profit centers out of community hospitals and 

over time could cause a real disruption in the financing and the fiscal health, financial health of these hospitals. 

There aren’t many of these specialty hospitals now, but if financial incentives are motivating a lot of for-profit corporations and 

physicians to team up and create heart hospitals, orthopedic hospitals, surgery hospitals, and the moratorium we passed has stalled 

this, but I do not think we have much time to act. The industry 

publications indicate there could be 100 institutions waiting in the 

wings to jump if in fact the moratorium expires, and I expect we 

would have trouble putting that genie back in the bottle once it 

5 

opened. The specialty hospitals generate huge returns for their investors, mostly doctors, the other half by the people who have organized them. The question is, I do not know if there is any information that they are any better for patients. The food I understand 

is better, but that is hardly the issue. And are they good for the 

medical care delivery system as a whole? That I think is the real 

question. 

We enacted the Physician Self-Referral Laws because of overwhelming evidence that health care providers who personally profit 

from referrals will increase the number of such referrals, not surprising I don’t suppose to any of us. When those laws were enacted 

physician-owned specialty hospitals basically did not exist. We included the whole hospital exception in the law because of the broad 

based entities in which it would be hard to prove that ownership 

caused inappropriate referral patterns, but we explicitly prohibited 

ownership in a subdivision of that hospital, as we say, a hospital 

within a hospital, and because it would cause just such a conflict. 

I submit to you that today’s physician-owned specialty hospitals are 

nothing more than freestanding subdivisions of a hospital. 

I would like to go on record in support of the petition by the Federation of American Hospitals urging Health and Human Services 

to update their regulations to make clear that these physicianowned specialty hospitals do not meet the whole hospital exception. 

Today we will hear from MedPAC about their recommendations. I 

believe their proposal to readjust the payment system to eliminate 

the obvious financial incentives that encourage these specialty hospitals make good sense. But I still believe that realigning the payment system won’t be enough to solve the inherent problem of selfinterest, and it is a positive change and one we should proceed 

with. 

MedPAC has also recommended and extension of the moratorium. At a minimum it is vital that we extend this moratorium 

until we have a legislative solution to the very real problems posed 

by the physician-owned specialty hospitals. Finally, I would like to 

note that we have a wide breadth of groups in agreement that 

something should be done to curb the growth of these physicianowned specialty hospitals. I would like to point to page 145 of the 

President’s Budget, where it states, quote, ‘‘The Administration will 

seek to refine the inpatient hospital payment system and related 

provisions of regulations to ensure a more level playingfield between specialty and non-specialty hospitals.’’ 

On the day when Pete Stark, Chip Kahn and President Bush all 

agree that something needs to be done, I think we can create a policy that Congress can pass, and I look forward to hearing from the 

witnesses today. Thank you, Madam Chair. 

Chairman JOHNSON. Thank you, Pete. Mr. Hackbarth? 

STATEMENT OF GLENN M. HACKBARTH, J.D., CHAIRMAN, 

MEDICARE PAYMENT ADVISORY COMMISSION 

Mr. HACKBARTH. Chairman Johnson, Mr. Stark, other members of the Subcommittee, it is good to see you again and I appreciate the opportunity. Chairman Johnson well summarized the 

basic issues here, the view of the proponents of physician-owned 

specialty hospitals as well as the opponents. 

6 

Our findings on the performance of physician-owned specialty 

hospitals are based on data drawn from 2002. That was the most 

recent data available when we began our study. In the 2002 data 

there were 48 hospitals that met our test for specialization and 

minimum Medicare volume. In addition to looking at that data, we 

also conducted site visits to Austin, Texas, Wichita, Kansas, and 

Sioux Falls, South Dakota. 

The data that we have before us are limited in three important 

respects. First of all we have a small number of hospitals, 48 hospitals, and many of those hospitals are very small institutions. Second, 2002 was at an early stage in the development of the specialty 

hospital phenomenon. Third, MedPAC did not look at any data on 

quality of care in specialty hospitals since that assignment was 

given to CMS under the MMA mandate. 

As was alluded to earlier, we also make recommendations on refining the payment system for hospitals overall. I want to be clear 

that those recommendations are not based on this limited data set, 

but rather on a broader analysis of Medicare claims and cost reports, so the foundation for those recommendations we think is 

very strong indeed. As I proceed with my comments if it is okay 

I will make reference to a couple of figures that are in the testimony that I hope everybody has in front of them. On page 3 of my 

testimony, there is a map that shows you where specialty hospitals 

are located, both the ones that we studies in 2002 and ones that 

we know of that have been developed since 2002. In 2002 almost 

60 percent of the specialty hospitals were in four States, South Dakota, Kansas, Oklahoma and Texas, so they were quite concentrated. Even if you look at the hospitals that have been developed since they are still quite geographically concentrated. You can 

see many States have no physician-owned specialty hospitals for a 

variety of reasons. 

Today we estimate that there are more than 100 physicianowned specialty hospitals, and more, as Mr. Stark pointed out, may 

be in the wings. Our findings were as follows. Heart hospitals tend 

to focus on diagnosis-related groups (DRGs), with a greater than 

average expected profit. On the other hand, orthopedic and surgical 

specialty hospitals tend to focus on DRGs that have a slightly less 

than average expected profit. All three types of specialty hospitals, 

heart, orthopedic and surgical, however, tend to treat patients 

within those diagnosis categories that are less severe cases, and as 

a result have higher expected profits. 

If you turn to page 7 in my testimony, you will find Table 1 that 

summarizes the data that we found on this issue, and pardon me 

for how detailed and complicated it is. But the basic point is that 

the column labeled DRGs has a factor that describes the expected 

profitability based on the diagnosis of the patient. So, if you look 

at heart hospitals and then specialty, under the DRG column it 

says 1.06. So, that means if the hospital had an average level of 

cost just based on the diagnosis of the patients, the DRGs they are 

in, the expected profitability would be 6 percent above average. 

The next column over labeled ‘‘Patient severity’’ says that if you 

look at the patients within any given DRG and the severity of their 

illness, what is the effect of that on expected profitability. So, in 

the case of specialty heart hospitals the patient severity factor is 

7 

another 3 percent above average expected profit. And then you 

combine those two in the last column to get 109 or 9 percent higher 

than average expected profitability. So, all three types of hospitals, 

as you look down that last column, have better than average expected profitability when you take into account both the DRGs and 

the severity of illness of the patients involved. So, that was one set 

of findings. A second is that in 2002, the year that we looked at, 

specialty hospitals tended to draw their patients from community 

hospitals as opposed to increasing the amount of services provided 

overall. So, they were taking patients that otherwise would have 

gone for their surgery to a community hospital, treating them in 

a specialty hospital, as opposed to increasing the overall amount of 

surgery in the community. 

Now, we did find some evidence, some indications, that there 

might be increased utilization, but there were not enough data to 

allow us to draw conclusions, statistically significant conclusions. 

So, this is something that we think is worth watching and further 

study. Another finding is that the community hospitals competing 

with specialty hospitals are able to recover relatively quickly from 

the impact of losing patients to the specialty hospital through a 

combination of strategies, lowering costs, adding new services and 

the like, although that might be more difficult for hospitals, community hospitals that are in smaller communities. 

Next we found that the cost of specialty hospitals are not lower 

than those of community hospitals, although the average length of 

stay for the patients is in fact lower in specialty hospitals than in 

community hospitals. In fact, the data showed that the cost of specialty hospitals were higher than community hospitals, but again, 

the differences were not statistically significant. So, you ask yourself, how can it be that they have higher cost per case and lower 

average length of stay? There might be a variety of reasons for 

that, more staff per patient, higher salaries for staff, high start up 

costs and the like could possibly explain that combination. 

Finally, we found that specialty hospitals serve proportionately 

fewer Medicaid patients than community hospitals do. Based on 

those findings we have the following recommendations. First of all, 

we recommend that the DRG payment system be refined to better 

match payments with the expected cost of care for different types 

of patients. We have several specific recommendations on how to 

do that, several of which are directed at how the DRG weights are 

calculated. The weights are the factors that determine how the 

payments vary based on DRG. And then another recommendation 

is that we incorporate a severity adjustment in the system so that 

patients that are more severely ill, have more complicated illness, 

carry with them higher payments from the Medicare Program. 

If you turn to page 8 of my testimony and Figure 2, a series of 

bar graphs, this graph illustrates the impact of proposed payment 

reforms. On the far left-hand side of the graph you see current policy, and what that signifies is that if you look at the middle bar 

over current policy, about 35 percent of the dollars paid out in the 

Medicare Program are in DRGs currently, where the expected profitability is between plus and minus 5 percent of the average. So, 

that is the status quo. That is where we are today. The different 

sets of bars indicate various proposed refinements to the system. 

8 

If you go all the way to the far right-hand side that is the cumulative effect of all of our proposed changes, and you see that there, 

as a result of the payment reforms, 86 percent of the payments 

would be for categories where the profitability, expected profitability is within plus or minus 5 percent of the average. So, there 

would be a much more accurate payment system. 

We think these are very, very important changes. Indeed these 

are changes that we would recommend be made in Medicare even 

if physician-owned specialty hospitals did not exist. They make the 

payment system fairer to hospitals and ultimately therefore better 

we believe for patients. Because these changes shift dollars around 

in the system there are winners and losers. We recommend that 

they be implemented with a transition period. The winners and losers are interesting. You are familiar with how in our regular reports to Congress we analyze the impact of various proposals, and 

we often look at how urban hospitals are affected or rural hospitals 

are affected or teaching and non-teaching hospitals are affected. 

Well, what we find in analyzing the impact of these changes is that 

there would be winners and losers that cut across those categories. 

In other words, some urban hospitals would benefit from these 

changes, but some would lose Medicare dollars as a result of these 

changes. Some rural hospitals would benefit and some would lose. 

Some teaching hospitals would benefit and some would lose. 

Obviously, the reason that we are proposing them is that the 

winners deserve more money because they are caring for patients 

that have higher expected cost. The ones that would be losing 

Medicare dollars would lose because they are carrying patients that 

are not expected to be as costly and so they should be receiving 

lower payments. Our next recommendation is that the Congress 

authorize the Secretary of Health and Human services to permit 

and then regulate what we refer to as gain-sharing arrangements 

between physicians and hospitals. We believe it is very important 

for physicians and hospitals to have the opportunity to work together and mutually benefit from successes in reducing cost and 

improving quality. we believe that is particularly true in that we 

and others are recommending that Medicare begin incorporating 

payment adjustments for quality. Those gains can be best accomplished through collaboration of physicians and hospitals, but right 

now the rules prevent them from sharing in gains in efficiency or 

gains in quality improvement. We think that is a barrier, an impediment to improvement, and we think that Congress ought to authorize the Secretary to permit that gain sharing, albeit within 

clearly-defined set of rules that would protect quality of care and 

prevent the dollars from being used to reward inappropriate increases in admissions and the like. This too we would recommend 

even if specialty hospitals did not exist. 

Finally, we recommend an extension of the current moratorium 

on the development of specialty hospitals so Congress has ample 

opportunity to consider our recommendations and CMS then has 

ample opportunity to implement them. In addition, the extension 

of the moratorium would give us additional time to analyze the cost 

and quality of specialty hospitals. Even after our recommended 

changes, MedPAC has residual concerns about self-referral by physicians to hospitals in which they have an ownership interest. Our 

9 

concern is that that ownership interest could have an undue impact on clinical decisionmaking about who gets what care at what 

location. Rather than rule out physician-owned specialty hospitals, 

however, based on that alone, we think would do well to carefully 

examine, continue to examine whether these institutions can help 

us lower cost and improve quality. If in fact they were able to do 

that, then we would weigh those potential gains against the concerns raised by self-referral, and then make a judgment. 

Right now we are concerned that the data available to reach a 

definitive judgment about physician-owned specialty hospitals is 

too limited to make a final judgment, and we could benefit from 

some more information. Thank you very much, and I look forward 

to your questions. 

[The prepared statement of Mr. Hackbarth follows:] 

Statement of Glenn M. Hackbarth, Chairman, Medicare Payment Advisory 

Commission 

Chairman Johnson, Congressman Stark, distinguished Subcommittee members. I 

am Glenn Hackbarth, chairman of the Medicare Payment Advisory Commission 

(MedPAC). I appreciate the opportunity to be here with you this afternoon to discuss 

physician-owned specialty hospitals. 

Proponents claim that physician-owned specialty hospitals are the focused factory 

of the future for health care, taking advantage of the convergence of financial incentives for physicians and hospitals to produce more efficient operations and higherquality outcomes than conventional community hospitals. Detractors counter that 

because the physician-owners can refer patients to their own hospitals they compete 

unfairly, and that such hospitals concentrate on only the most lucrative procedures 

and treat the healthiest and best-insured patients—leaving the community hospitals 

to take care of the poorest, sickest patients and provide services that are less profitable. 

The Congress, in the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA), imposed an 18-month moratorium that effectively halted 

the development of new physician-owned specialty hospitals. That act also directed 

MedPAC and the Secretary of the Department of Health and Human Services to report to the Congress on certain issues concerning physician-owned heart, orthopedic, 

and surgical specialty hospitals. 

To answer the Congress’s questions, MedPAC conducted site visits, legal analysis, 

met with stakeholders, and analyzed hospitals’ Medicare cost reports and inpatient 

claims from 2002 (the most recent available at the time). From its empirical analyses, MedPAC found that: 

• Physician-owned specialty hospitals treat patients who are generally less severe 

cases (and hence expected to be relatively more profitable than the average) and 

concentrate on particular diagnosis-related groups (DRGs), some of which are 

relatively more profitable. • They tend to have lower shares of Medicaid patients than community hospitals. • In 2002, they did not have lower costs for Medicare inpatients than community 

hospitals, although their inpatients did have shorter lengths of stay. • The financial impact on community hospitals in the markets where physicianowned specialty hospitals are located was limited in 2002. Those community 

hospitals competing with specialty hospitals demonstrated financial performance comparable to other community hospitals. • Many of the differences in profitability across and within DRGs that create financial incentives for patient selection can be reduced by improving Medicare’s 

inpatient prospective payment system (IPPS) for acute care hospitals. 

These findings are based on the small number of physician-owned specialty hospitals that have been in operation long enough to generate Medicare data. The industry is in its early stage, but growing rapidly. Some of these findings could change 

as the industry develops and have ramifications for the communities where they are 

located and the Medicare program. We did not evaluate the comparative quality of 

care in specialty hospitals, because the Secretary is mandated to do so in a forthcoming report. 

We found that physicians may establish physician-owned specialty hospitals to 

gain greater control over how the hospital is run, to increase their productivity, and 

10 

to obtain greater satisfaction for them and their patients. They may also be motivated by the financial rewards, some of which derive from inaccuracies in the Medicare payment system. 

Our recommendations concentrate on remedying those payment inaccuracies, 

which result in Medicare paying too much for some DRGs relative to others, and 

too much for patients with relatively less severe conditions within DRGs. Improving 

the accuracy of the payment system would help make competition more equitable 

between community hospitals and physician-owned specialty hospitals, whose physician-owners can influence which patients go to which hospital. It would also make 

payment more equitable among community hospitals that currently are advantaged 

or disadvantaged by their mix of DRGs or patients. Some community hospitals have 

invested disproportionately in services thought to be more profitable, and some nonphysician owned hospitals have specialized in the same services as physician-owned 

specialty hospitals. 

We also recommend an approach to aligning physician and hospital incentives 

through gainsharing, which allows physicians and hospitals to share savings from 

more efficient practices and might serve as an alternative to direct physician ownership. Because of remaining concerns about self-referral; need for further information 

on the efficiency, quality, and effect of specialty hospitals; and the time needed to 

implement our recommendations, the Commission also recommends that the Congress extend the current moratorium on specialty hospitals until January 1, 2007. 

How many and where 

We found 48 hospitals in 2002 that met our criteria for physician-owned specialty 

hospitals: 12 heart hospitals, 25 orthopedic hospitals, and 11 surgical hospitals. (Altogether there are now approximately 100 specialty hospitals broadly defined, but 

some opened after 2002 and did not have sufficient discharge data for our analysis; 

others are not physician-owned or are women’s hospitals that do not meet our criteria for surgical hospitals.)Specialty hospitals are small: the average orthopedic 

specialty hospital has 16 beds and the average surgical specialty hospital has 14. 

Heart hospitals are larger, averaging 52 beds. 

Many specialty hospitals do not have emergency departments (EDs), in contrast 

to community hospitals where the large majority (93 percent) do. Those that have 

EDs differ in how they are used, and that may influence how much control the hospital has over its schedule and patient mix. For example, 8 of the 12 heart hospitals 

we examined have EDs, and the heart hospitals we visited that had EDs were included in their area’s emergency medical systems’ routing of patients who required 

the services they could provide. In contrast, even when surgical and orthopedic specialty hospitals have EDs, they are often not fully staffed or included in ambulance 

routings. 

Specialty hospitals are not evenly distributed across the country (Figure 1). Almost 60 percent of the specialty hospitals we studied are located in four states: 

South Dakota, Kansas, Oklahoma, and Texas. Many of the specialty hospitals that 

are under construction or have opened since 2002 are located in the same states and 

markets as the specialty hospitals we studied. As the map shows, specialty hospitals 

are concentrated in states without certificate-of-need (CON) programs. 

11 

Motivations for forming physician-owned specialty hospitals and critic objections 

Physician control over hospital operations was one motivation for many of the 

physicians we spoke with who were investing in specialty hospitals. In the physician-owned specialty hospitals we studied, the cardiologists and surgeons want to 

admit their patients, perform their procedures, and have their patients recover with 

minimal disruption. Physician control, they believe, makes this possible in ways 

community hospitals cannot match because of their multiple services and missions. 

Control allows physicians to increase their own productivity for the following reasons: 

• fewer disruptions to the operating room schedule (for example, delays and canceling of cases that result from emergency cases), • less ‘‘down’’ time between surgeries (for example, by cleaning the operating 

rooms more efficiently), • heightened ability to work between two operating rooms during a ‘‘block’’ of operating room time, and • more direct control of operating room staff. 

The other motivation to form specialty hospitals is enhanced income. In addition 

to increased productivity resulting in more professional fees, physician investors 

also could augment their income by retaining a portion of the facility profits for 

their own and others’ work. Although some specialty hospitals have not made distributions, the annual distributions at others frequently have exceeded 20 percent 

of the physicians’ initial investment, and the specialty hospitals in our study had 

an average all-payer margin of 13 percent in 2002, well above the 3 to 6 percent 

average for community hospitals in their markets. 

Critics contend that much of the financial success of specialty hospitals may 

revolve around selection of patients. Physicians can influence where their patients 

receive care, and physician ownership gives physician-investors a financial incentive 

to refer profitable patients to their hospital. If the payment system does not adequately differentiate among patients with different expected costs, and the factors 

determining cost, such as severity of illness, can be observed in advance, then the 

physician has an incentive to direct patients accordingly. At the extreme, some community hospitals claimed physicians sometimes transferred low complexity patients 

out of the community hospitals to specialty hospitals that the physicians owned, 

while transferring high complexity patients into the community hospitals. Referrals 


Insert 26371A.001
12 

of healthier (more profitable) patients to limited-service specialty hospitals may not 

harm less complex patients. Nonetheless, critics argue that referral decisions should 

not be influenced by financial incentives, and therefore, they object to physician 

ownership of specialty hospitals. Critics also argue that eventually community hospitals’ ability to provide less profitable services (which are often subsidized by more 

profitable services) would be undermined. 

Restrictions on physician self-referral have a long history in the Medicare program. The anti-kickback statute, the Ethics in Patient Referrals Act (the Stark law), 

and their implementing regulations set out the basic limitations on self-referral and 

create exceptions. The primary concern was that physician ownership of health care 

providers would create financial incentives that could influence physicians’ professional judgment and lead to higher use of services. In addition, self-referral could 

lead to unfair competition if one facility was owned by the referring physician, and 

competing facilities were not. Because hospitals provide many kinds of services, an 

exception was created that allowed physicians to refer patients to hospitals in which 

they invest. This is the ‘‘whole hospital’’ exception. Physician investors have a greater opportunity to influence profits at single-specialty hospitals—which generally provide a limited range of services—than at full-service hospitals. 

Do physician-owned specialty hospitals have lower costs? 

We compared physician-owned specialty hospitals to three groups of hospitals. 

Community hospitals are full service hospitals located in the same market. Competitor hospitals are a subset of community hospitals that provide at least some of the 

same services provided by specialty hospitals in that market. And Peer hospitals are 

specialized, but not physician owned. 

After controlling for potential sources of variation, including patient severity, we 

found that inpatient costs per discharge at physician-owned specialty hospitals are 

higher than the corresponding values for peer, competitor, and community hospitals. 

However, these differences were not statistically significant. 

Lengths of stay in specialty hospitals were shorter, in some cases significantly so, 

than those in comparison hospitals. Other things being equal, shorter stays should 

lead to lower costs. The apparent inconsistency of these results raises questions 

about what other factors might be offsetting the effects of shorter stays. Such factors 

might include staffing levels, employee compensation, costs of supplies and equipment, initial start-up costs, or lack of potential economies of scale due to smaller 

hospital size. These results could change as the hospitals become more established 

and as the number of specialty hospitals reporting costs and claims increases. 

Who goes to physician-owned specialty hospitals, and what happens to 

community hospitals in their markets? 

Critics of specialty hospitals contend that physicians have financial incentives to 

steer profitable patients to specialty hospitals in which they have an ownership interest. These physicians may also have an incentive to avoid Medicaid, uninsured, 

and unusually costly Medicare patients. Critics further argue that if physicianowned hospitals take away a large share of community hospitals’ profitable patients, 

community hospitals would not have sufficient revenues to provide all members of 

the community access to a full array of services. 

Supporters counter that the specialty hospitals are engaging in healthy competition with community hospitals and that they are filling unmet demand for services. 

They acknowledge that community hospital volumes may decline when they enter 

a market, but claim that community hospitals can find alternative sources of revenue and remain profitable even in the face of competition from physician-owned 

specialty hospitals. We found: 

• Physician-owned heart, orthopedic, and surgical hospitals that did not focus on 

obstetrics tended to treat fewer Medicaid patients than peer hospitals and community hospitals in the same market. Heart hospitals treated primarily Medicare patients, while orthopedic and surgical hospitals treated primarily privately insured patients. 

• The increases in cardiac surgery rates associated with the opening of physicianowned heart hospitals were small enough to be statistically insignificant for 

most types of cardiac surgery. It appears that specialty hospitals obtained most 

of their patients by capturing market share from community hospitals. 

• Though the opening of heart hospitals was associated with slower growth in 

Medicare inpatient revenue at community hospitals, on average, community 

hospitals competing with physician-owned heart hospitals did not experience 

unusual declines in their all-payer profit margin. 

13 

Note that most specialty hospitals are relatively new, and the number of hospitals 

in our analysis is small. The impact on service use and community hospitals could 

change over time, especially if a large number of additional specialty hospitals are 

formed. 

Do specialty hospitals treat a favorable mix of patients? 

Specialty hospitals may concentrate on providing services that are profitable, and 

on treating patients who are less sick—and therefore less costly. Under Medicare’s 

IPPS, payments are intended to adequately cover the costs of an efficient provider 

treating an average mix of patients, some with more and some with less complex 

care needs. But if differences in payments do not fully reflect differences in costs 

across types of admissions (DRGs) and patient severity within DRGs, some mixes 

of services and patients could be more profitable than others. Systematic bias in any 

payment system, not just Medicare’s, could reward those hospitals that selectively 

offer services or treat patients with profit margins that are consistently above average. We found: 

• Specialty hospitals tend to focus on surgery, and under Medicare’s IPPS, surgical DRGs are relatively more profitable than medical DRGs in the same specialty. 

• Surgical DRGs that were common in specialty heart hospitals were relatively 

more profitable than the national average DRG, those in orthopedic hospitals 

relatively less profitable, and those in specialty surgical hospitals had about average relative profitability. 

• Within DRGs, the least severely ill Medicare patients generally were relatively 

more profitable than the average Medicare patient. More severely ill patients 

generally were relatively less profitable than average, reflecting their higher 

costs but identical payments. Specialty hospitals had lower severity patient 

mixes than peer, competitor, or community hospitals. 

• Taking both the mix of DRGs and the mix of patients within DRGs into account, specialty hospitals would be expected to be relatively more profitable 

than peer, competitor, or community hospitals if they exhibited average efficiency. 

Table 1 shows the expected relative profitability for physician-owned specialty 

hospitals and their comparison groups. The expected relative profitability for a hospital is: the ratio of the payments for the mix of DRGs at the hospital to the costs 

that would be expected for that mix of DRGs and patients if the hospital had average costs—relative to the national average expected profitability over all cases. It 

is not the actual profitability for the hospital. 

Heart specialty hospitals treat patients in financially favorable DRGs and, within 

those, patients who are less sick (and less costly, on average). Assuming that heart 

specialty hospitals have average costs, their selection of DRGs results in an expected relative profitability 6 percent higher than the average profitability. Heart 

hospitals receive an additional potential benefit (3 percent) from favorable selection 

among patient severity classes. As a result, their average expected relative profitability value is 1.09. 

Reflecting their similar concentration in surgical cardiac cases, peer heart hospitals also benefit from favorable selection across DRGs, though not as much as specialty heart hospitals. However, peer heart hospitals receive no additional benefit 

from selection among more- or less-severe cases within DRGs. Both specialty heart 

and peer heart hospitals have a favorable selection of patients compared with community hospitals in the specialty heart hospitals’ markets, as well as with all IPPS 

hospitals. 

14 

Note: IPPS (inpatient prospective payment system), APR–DRG (all-patient refined 

diagnosis-related group), DRG (diagnosis-related group). Expected relative profitability measures the financial attractiveness of the hospital’s mix of Medicare cases, 

given the national average relative profitability of each patient category (DRG or 

APR–DRG severity class). The relative profitability measure is an average for each 

DRG category, based on cost accounting data. Thus, small differences (for example, 

1 or 2 percent) in relative profitability may not be meaningful. Specialty hospitals 

are specialized and physician owned. Peer hospitals are specialized but are not physician owned. Competitor hospitals are in the same markets as specialty hospitals 

and provide some similar services. Community hospitals are all hospitals in the 

same market as specialty hospitals. aSignificantly different from peer hospitals using a Tukey mean separation test and a p<.05 

criterion. bSignificantly different from nonpeer community hospitals using a Tukey mean separation 

test and a p<.05 crition. 

Source: MedPAC analysis of Medicare hospital inpatient claims and cost reports from CMS, 

fiscal year 2000–2002. 

In contrast to the heart hospitals, neither orthopedic specialty hospitals nor their 

peers seem to have a favorable DRG selection. However, by treating a high proportion of low-severity patients within their mix of DRGs, specialty orthopedic hospitals 

show selection that appears to be slightly favorable overall (1.02). Surgical specialty 

hospitals show a very favorable selection of patients overall (1.15) because they also 

treat relatively low-severity patients within the DRGs. 

Payment recommendations 

The Congress asked the Commission to recommend changes to the IPPS to better 

reflect the cost of delivering care. We found changes are needed to improve the accuracy of the payment system and thus reduce opportunities for hospitals to benefit 

from selection. We recommend several changes to improve the IPPS. 

The Commission recommends the Secretary should improve payment accuracy in 

the IPPS by: 

• refining the current DRGs to more fully capture differences in severity of illness 

among patients, 

• basing the DRG relative weights on the estimated cost of providing care rather 

than on charges, and 

• basing the weights on the national average of hospitals’ relative values in each 

DRG. 

All of these actions are within the Secretary’s current authority. 


Insert 26371a.002
15 

The commission also recommends the Congress amend the law to give the Secretary authority to adjust the DRG relative weights to account for differences in the 

prevalence of high-cost outlier cases. 

Taken together, these recommendations will reduce the potential to profit from 

patient and DRG selection, and result in payments that more closely reflect the cost 

of care while still retaining the incentives for efficiency in the IPPS. Figure 2 shows 

that the share of IPPS payments in DRGs that have a relative profitability within 

5 percent of the national average would increase from 35 percent under current policy to 86 percent if all of our recommendations were implemented. At the hospital 

group level, under current policy, heart hospitals’ expected relative profitability from 

their combination of DRGs and patients is above the national average profitability 

for all DRGs and patients. Following our recommendations, that ratio would be 

about equal to the national average. Physician-owned orthopedic and surgical hospitals would show similar results. 

Note: DRG (diagnosis-related group), APR–DRG (all-patient refined diagnosis-related group). 

Source: MedPAC analysis of Medicare hospital inpatient claims and cost reports 

from CMS, fiscal year 2000–2002. 

These payment system refinements would affect all hospitals—both specialty hospitals and community hospitals—and many would see significant changes in payments. A transitional period would mitigate those effects and allow hospitals to adjust to the refined payment system. Thus, the Commission recommends the Congress and the Secretary should implement the payment refinements over a transitional period. 

Making these payment system improvements and designing the transition will not 

be simple tasks. We recognize that the Centers for Medicare & Medicaid Services 

(CMS) has many priorities and limited resources, and that the refinements will 

raise some difficult technical issues. These include the potentially large number of 

payment groups created, possible increases in spending from improvements in coding, rewarding avoidable complications, and the burden and time lag associated 

with using costs rather than charges. Nevertheless, certain approaches that we discuss in this report, such as reestimating cost-based weights every several years instead of annually, could make these issues less onerous. The Congress should take 

steps to assure that CMS has the resources it needs to make the recommended refinements. 

Recommendations on the moratorium and gainsharing 

The Commission is concerned with the issue of self-referral and its potential for 

patient selection and higher use of services. However, removing the exception that 

allows physician ownership of whole hospitals would be too severe a remedy given 

the limitations of the available evidence, although we may wish to reconsider it in 

the future. Our evidence on physician-owned specialty hospitals raises some concerns about patient selection, utilization, and efficiency, but it is based on a small 

sample of hospitals, early in the development of the industry. We do not know yet 

if physician-owned hospitals will increase their efficiency and improve quality. We 


Insert 26371a.003
16 

also do not know if, in the longer term, they will damage community hospitals or 

unnecessarily increase use of services. The Secretary’s forthcoming report on specialty hospitals should provide important information on quality. Further information on physician-owned specialty hospitals’ performance is needed before actions 

are taken that would, in effect, entirely shut them out of the Medicare and Medicaid 

market. In addition, the Congress will need time during the upcoming legislative 

cycle to consider our recommendations and craft legislation, and the Secretary will 

need time to change the payment system. Therefore, the Commission recommends 

that the Congress extend the current moratorium on specialty hospitals until January 1, 2007. The current moratorium expires on June 8, 2005. Continuing the moratorium will allow time for efforts to implement our recommendations and time to 

gather more information. 

Aligning financial incentives for physicians and hospitals could lead to efficiencies. 

Physician ownership fully aligns incentives; it makes the hospital owner and the 

physician one in the same, but raises concerns about self-referral. Similar efficiencies might be achieved by allowing the physician to share in savings that would 

accrue to the hospital from reengineering clinical care. Such arrangements have 

been stymied by provisions of law that prevent hospitals from giving physicians financial incentive to reduce or limit care to patients because of concerns about possible stinting on care and quality. Recently, the Office of Inspector General has approved some narrow gainsharing arrangements, although they have been advisory 

opinions that apply only to the parties who request them. 

The Commission recommends that the Congress should grant the Secretary the 

authority to allow gainsharing arrangements between physicians and hospitals and 

to regulate those arrangements to protect the quality of care and minimize financial 

incentives that could affect physician referrals. 

Gainsharing could capture some of the incentives that are animating the move to 

physician-owned specialty hospitals while minimizing some of the concerns that direct physician ownership raises. Permitting gainsharing opportunities might provide 

an alternative to starting physician-owned specialty hospitals, particularly if the incentives for selection were reduced by correcting the current inaccuracies in the 

Medicare payment system. 

f 

Chairman JOHNSON. Thank you very much. Dr. Gustafson? 

STATEMENT OF THOMAS A. GUSTAFSON, PhD, DEPUTY DIRECTOR, CENTER FOR MEDICARE MANAGEMENT, CENTERS FOR 

MEDICARE & MEDICAID SERVICES 

Mr. GUSTAFSON. Thank you, Mrs. Johnson, Mr. Stark and distinguished Members of the Committee. I appreciate the invitation 

to testify today. I am here to present preliminary results from the 

technical analysis that will underlie the CMS report mandated by 

MMA that we expect to send to you shortly. I must emphasize that 

the quantitative findings that I will discuss here are tentative. The 

technicians are in the back room continue to twiddle the dials on 

this and the numbers may move around a little bit. But we believe 

that the qualitative nature of the results will not change materially, and the Administration will proceed to develop policy recommendations once this analysis is in hand. 

Our study conducted a considerable amount of new data relative 

to the performance and impact of specialty hospitals. We made site 

visits to six market areas around the country. Included in these 

were 11 of the 59 cardiac, surgery and orthopedic specialty hospitals that were paid by Medicare at the end of 2003. These market 

areas were selected to represent a range of circumstances in which 

specialty hospitals now operate. 

Within each market area we interviewed specialty hospital managers, physician owners, staff. We also talked with representatives 

of community hospitals in the area to assess patient satisfaction 

17 

which is one of the measures that Congress asked us to look at. We 

looked at patient focus groups of those beneficiaries who had been 

treated in specialty hospitals. We also examined referral patterns 

for all specialty hospitals, not just those that were in the six market areas I described, but all of the 59, using Medicare claims data 

for 2003, so it was a little bit later than the analysis, so the data 

was a little bit later than the analysis that MedPAC embarked on. 

And we also drew on information on financial relations based on 

information we acquired from the individual hospitals and for tax 

records. 

One major conclusion which I think comports very well with 

what MedPAC discovered is that there are very clear differences 

between cardiac hospitals on the one hand and surgery and orthopedic hospitals on the other. Cardiac hospitals are larger, have a 

higher average daily census, about 40. They tend to have emergency rooms and other features that are usually associated with a 

community hospital such as community outreach programs. About 

two-thirds of the patients treated in these facilities were Medicare 

beneficiaries, which is higher than what you would expect in a 

community hospital. And in the hospitals in the study the ownership by physicians as a group averaged about 34 percent. Typically 

a national corporation or a not-for-profit hospital in the area owns 

the majority share of these hospitals. The average ownership share 

by an individual physician was about 1 percent. So, in other words, 

34 percent in the aggregate, about 1 percent for each individual 

physician. 

Turning now to surgical and orthopedic hospitals. These tended 

to more closely resemble ambulatory surgical centers. Their primary business appeared to be with outpatient services. They are 

much smaller than the other hospitals. Their average daily census 

is about 5. And physicians together generally own a comparatively 

large share. Our average showed that to be about 80 percent, and 

the average share for an individual physician was a little over 2 

percent. 

Medicare patients account for about 40 percent of the inpatient 

days in these facilities, which is more typical of the community hospital average. Unfortunately, the small number of inpatient cases 

at these hospitals, the surgery and orthopedic hospitals, prevented 

us from drawing very robust conclusions about this group on several of the dimensions that we were asked to look at. Turning to 

our preliminary results we discovered that the majority of Medicare patients in most specialty hospitals are referred or admitted 

by a physician owner. These physicians do not, however, refer their 

patients exclusively to the specialty hospitals in which they participate in the ownership. They also refer a similar, although slightly 

lower proportion of their patients to local community hospitals. 

Overall, the Medicare cardiac patients treated in community hospitals were more severely ill than those treated in the cardiac specialty hospitals in most of the study sites. There was a little bit of 

variation here. 

Now, these results, the results I just described, held generally for 

patients admitted both by physicians with ownership in specialty 

hospitals and by other physicians in the area, indicating that we 

could discover no difference here in the referral patterns by physiVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00021 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
18 

cian owners and non-owners. There was a little bit of variation 

again with cardiac hospitals in some areas having higher average 

severity than the community hospitals, but the general picture was 

of more severely ill patients in the community hospitals and no difference in referral pattern. 

For surgery and orthopedic hospitals the number of cases involved was too small to draw definitive conclusions, but the preliminary results are suggestive of a similar pattern. We then 

turned to claims analysis. This involved all of the hospitals that I 

mentioned earlier, the 59 hospitals, not just the 11 in the study 

areas. And we examined the claims from these hospitals against a 

set of quality indicators from the AHRQ and their methodology. 

Our preliminary findings showed that the measures of quality at 

cardiac hospitals were generally at least as good and in some cases 

better than at local community hospitals. Complications and mortality rates were lower at the cardiac specialty hospitals, even 

when adjusted for the severity of the caseload in the two different 

hospitals. We were unable to make a statistically valid assessment, 

or at least have not yet been able to make a statistically valid assessment because of the small number of discharges relating to 

surgical and orthopedic hospitals. 

We examined patient satisfaction, as I mentioned earlier. This 

was through focus groups of the patients at the specialty hospitals. 

This was extremely high for all of the hospitals in questions. The 

Medicare beneficiaries that we talked with enjoyed large private 

rooms and a number of other amenities, and seemed to enjoy their 

experience at the hospitals. We did not do a comparison group with 

the community hospitals in the same areas. We used proprietary 

financial information we had acquired from the specialty hospitals 

in the study to examine the taxes that they paid and the uncompensated care as a proportion of net revenues. This was again 

something that we were asked to do by the MMA. And discovered 

that relative to their net revenues, specialty hospitals only provide 

about 40 percent of the share of uncompensated care that the local 

community hospitals provided. Balancing this, however, the specialty hospitals paid significant real estate and property taxes as 

well as income and sales taxes. The nonprofit community hospitals—most of the hospitals in the communities we were looking 

at were nonprofit—of course did not pay these taxes. 

If you added this up, the total proportion of net revenue that specialty hospitals devoted to the sum of uncompensated care and 

taxes significantly exceeded the proportion of net revenue that community hospitals devoted to uncompensated care. You have just 

heard from Mr. Hackbarth about the MedPAC report. I think it 

would be fair to summarize our reading of it so far. It is that we 

don’t see any particular inconsistency. I think we are finding much 

the same, the same underlying reality. We are looking at some different things than they were, but I think the Congress can take 

some comfort that we are finding things that are very, very similar. 

We have MedPAC’s recommendations under review and will be 

considering those as we form the administration’s recommendations. That concludes my remarks and I look forward to your questions. 

[The prepared statement of Mr. Gustafson follows:] 

19 

Statement of Tom Gustafson, Ph.D., Deputy Director, Center for Medicare 

Management, Centers for Medicare and Medicaid Services 

Chairwoman Johnson, Representative Stark, distinguished committee members, 

thank you for inviting me to testify today about physician-owned specialty hospitals. 

At the Centers for Medicare & Medicaid Services (CMS), we remain deeply committed to improving the quality of patient care and to increasing the efficiency of 

Medicare spending. As you know, how Medicare pays for medical services can have 

important impacts on quality and medical costs, for our beneficiaries and for our 

overall health care system. By carefully examining interactions between physicians 

and hospitals, we can consider how the financial incentives created by the Medicare 

program might be redirected to improve quality. To that end, Section 507 of the 

Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) 

requires HHS to study a set of important quality and cost issues related to specialty 

hospitals, and to report to Congress on our findings. I am here today to present the 

preliminary results from the technical analysis that will underlie the CMS report 

for Section 507. 

CMS Study 

Specifically, MMA required HHS to study referral patterns of specialty hospital 

physician-owners, to assess quality of care and patient satisfaction, and to examine 

the differences in uncompensated care and tax payments between specialty hospitals 

and community hospitals. CMS contracted with RTI International to conduct the 

technical analysis. At this time, we are reporting on the factual findings of the RTI 

analysis. Any policy recommendations on this issue will have to be developed once 

the report on the analysis is finalized. 

While national data were used for some aspects of this analysis, some questions 

related to quality, cost, and community impact as mandated by the MMA required 

the detailed analysis of data that have not been previously available. Consequently, 

the analysis involved the collection of a considerable amount of new data related 

to the performance, and impact of specialty hospitals. The analysis included information about the environment in which specialty hospitals and community hospitals 

in the same geographic areas operate, and sensitive and proprietary non-public data 

on such issues as ownership. To conduct this detailed analysis, site visits were made 

to 6 market areas (Dayton, OH; Fresno, CA; Rapid City, SD; Hot Springs, AR; Oklahoma City, OK; and Tucson, AZ) around the country These markets included 11 of 

the 59 cardiac, surgery, and orthopedic specialty hospitals that were in operation 

as approved Medicare providers by the end of 2003. These market areas were selected because they were thought to represent a range of the circumstances in which 

specialty hospitals operate. Within each market area, specialty hospital managers, 

physician owners, and staff were interviewed. Executives at several local community 

hospitals also were interviewed, in order to evaluate their views and concerns with 

respect to the specialty hospitals. To assess patient satisfaction with specialty hospitals, the study used patient focus groups composed of beneficiaries treated in cardiac, surgery, and orthopedic hospitals. 

Referral patterns for all specialty hospitals were analyzed using Medicare claims 

data for 2003. The inpatient hospital quality indicators developed by the Agency for 

Health Research and Quality (AHRQ) were used to assess quality of care at the 

study hospitals and local community hospitals in the 6 study sites. Data obtained 

from Internal Revenue Service (IRS) submissions and financial reports, as well as 

from the hospitals themselves, were used to estimate total tax payments and uncompensated care for these hospitals. 

Cardiac Hospitals Differ from Surgery and Orthopedic Hospitals 

The empirical evidence clearly shows that cardiac hospitals differ substantially 

from surgery and orthopedic hospitals. Compared to surgery and orthopedic hospitals, cardiac hospitals tend to have a higher average daily census, an emergency 

room, and other features, such as community outreach programs. The average daily 

census of the 16 cardiac hospitals nationwide was 40 patients. All the cardiac hospitals that were operational in 2003 reported that they were built exclusively for 

cardiac care. Cardiac hospitals treated 34,000 Medicare cases in 2003, and Medicare 

beneficiaries account for a very high proportion (about two-thirds) of inpatient days 

in those hospitals nationwide. In aggregate, within our sample, physicians own 

about a 49 percent share in cardiac hospitals; typically, a corporation such as 

MedCath or a non-profit hospital owns the majority share. In the study hospitals, 

the aggregate physician ownership averaged approximately 34 percent for the cardiac hospitals in the study. The average ownership share per physician in those hospitals was 0.9 percent, with individual ownership share per physician ranging 

20 

from.1 percent to 9.8 percent, with a median of 0.6 percent and an average per physician share of 0.9 percent. 

Surgery and orthopedic hospitals more closely resemble ambulatory surgical centers, focusing primarily on outpatient services. Their aggregate average daily census 

of inpatients is only about 5 patients. Physicians generally own a large share of the 

interest, averaging 80 percent in aggregate for the surgery and orthopedic hospitals 

in the study. The average ownership share per physician is 2.2 percent, with individual ownership shares per physician ranging from 0.1 percent to 22.5 percent, 

with a median of 0.9 percent. The balance is typically owned by a non-profit hospital 

or national corporation. Medicare patients account for about 40 percent of the inpatient days in these facilities. The small number of inpatient cases at surgery and 

orthopedic hospitals precluded the development of meaningful findings for this 

group on several of the dimensions of performance that we examined. 

Preliminary Results 

At this time, we would like to present the preliminary findings of our technical 

analysis. While we are still finalizing some aspects of the study, we do not expect 

the results to change significantly. 

Our findings on physician-owner referral patterns indicate that the majority of 

Medicare patients in most specialty hospitals are referred or admitted by a physician owner, but that these physicians do not refer their patients exclusively to the 

specialty hospitals that they own. They also refer a similar but slightly lower proportion of their patients to the local community hospitals. 

Overall, the Medicare cardiac patients treated in community hospitals were more 

severely ill than those treated in cardiac specialty hospitals in most of the study 

sites. This generally was true for patients admitted both by physicians with ownership in specialty hospitals and by other physicians without such ownership, indicating no difference in referral patterns for physician owners and non-owners. However, there was some variation, with cardiac hospitals in some areas having higher 

average severity than in the community hospitals. Although the number of cases 

was too small to draw definitive conclusions for surgery and orthopedic patients, the 

difference in the proportion of severely ill patients treated in community hospitals 

was greater for the surgery and orthopedic patients than for the cardiac patients. 

The analysis of patients transferred out of cardiac hospitals did not suggest any 

particular pattern. The proportion of patients transferred from cardiac hospitals to 

community hospitals is about the same, around one percent, as the proportion of patients transferred between community hospitals. The proportion of patients transferred from cardiac hospitals to community hospitals who were severely ill was similar to patients in the same diagnosis related group (DRG) who were transferred between community hospitals. The number of cases transferred from surgery and orthopedic hospitals was too small to derive meaningful results on this type of analysis. 

Based on claims analysis using the AHRQ quality indicators and methodology, 

preliminary findings show that measures of quality at cardiac hospitals were generally at least as good and in some cases were better than the local community hospitals. Complication and mortality rates were lower at cardiac specialty hospitals 

even when adjusted for severity. Because of the small number of discharges, a statistically valid assessment could not be made for surgery and orthopedic hospitals. 

Patient satisfaction was extremely high in both cardiac hospitals and surgery and 

orthopedic hospitals, as Medicare beneficiaries enjoyed large private rooms, quiet 

surroundings, adjacent sleeping rooms for family members if needed, easy parking, 

and good food. Patients also had very favorable perceptions of the clinical quality 

of care they received at the specialty hospitals. 

We also used proprietary financial information provided by the specialty hospitals 

in the study that allowed the calculation of their taxes paid and their uncompensated care as a proportion of net revenues. Relative to their net revenues, specialty 

hospitals provided only about 40 percent of the share of uncompensated care that 

the local community hospitals provided. However, the specialty hospitals paid significant real estate and property taxes, as well as income and sales taxes, while 

non-profit community hospitals did not pay these taxes. As a result, the total proportion of net revenue that specialty hospitals devoted to both uncompensated care 

and taxes significantly exceeded the proportion of net revenues that community hospitals devoted to uncompensated care. 

Medicare Payment Advisory Commission (MedPAC) Report 

The MMA also required a complementary MedPAC study of certain issues related 

to the payments, costs, and patient severity at specialty hospitals. Based on our iniVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00024 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
21 

tial review of their report, there are several preliminary findings in our analysis 

that are consistent with their results: 

• Both analyses found specialty hospitals generally treat less severe cases than 

community hospitals. The CMS analysis found this difference did not appear to 

be related to referrals by physician owners of less severe patients compared to 

referrals by other community physicians. • Additionally, MedPAC’s analysis of the payer shares for specialty and community hospitals is consistent with the CMS finding that specialty hospitals provide less uncompensated care than community hospitals as a whole. In addition, 

the CMS analysis found that specialty hospitals pay a substantial proportion of 

their net revenues in taxes, so that total payments for uncompensated care plus 

taxes are a higher proportion of total revenues at specialty hospitals. • MedPAC’s analysis also found large differences in relative profitability across 

severity classes within DRGs, which create financial incentives to select low severity patients. MedPAC has recommended refining the DRGs to reduce these 

incentives and we are currently evaluating their recommendations. 

Conclusion 

Madame Chair, thank you for this opportunity to discuss the technical findings 

that will be incorporated into our report on physician-owned specialty hospitals. We 

have been thoroughly studying this important topic, with extensive collection and 

analysis of new data, as part of our ongoing efforts to provide a strong factual foundation for implementing policy decisions that help patients get the high quality 

health care possible at the lowest cost. We will act expediently to incorporate these 

findings to complete our study and prepare our final results and recommendations 

for your review. As part of our careful evaluation of this multi-dimensional issue, 

we are also assessing what authority we have in this area to assure the best possible alignment of Medicare’s financial incentives with our goal of improving quality 

of care provided to our beneficiaries while avoiding unnecessary costs. CMS looks 

forward to continuing to work with you closely on this issue. I thank the committee 

for its time and would welcome any questions you may have. 

f 

Chairman JOHNSON. Thank you very much, both of you. I appreciate your testimony and the thoughtfulness of it and the data 

you have been able to develop. It does leave holes, and my conclusion is we are well down the road but we have a lot of work to do. 

Mr. Hackbarth, I am very interested int refining of the DRGs that 

you propose. I do think that we need to know more about the winners and losers, and I wonder whether MedPAC had discussed or 

thought through the issue of budget neutrality? 

Mr. HACKBARTH. Since these are changes in the DRG weights 

and the severity adjustment, these would be budget neutral 

changes. They redistribute payments within the system in a budget 

neutral way to better match payments to expect a cost for different 

types of patients. So, yes, it is budget neutral. 

Chairman JOHNSON. It is my recollection that MedPAC has 

commented on the growing number of negative margin hospitals or 

low margin hospitals, and I personally am watching a lot more very 

ill medical patients stay in the hospital longer, Medicare medical 

patients. And I hate to see yet another mechanism that attributes 

more money to something we can calculate and takes it from these 

longer-held patients who are sick but are not having operations, 

procedures, you know, the kind of thing that attract dollars. I think 

we really have to look at that as we move forward. 

Mr. HACKBARTH. Could I just make a comment on that? One 

of the types of problems that we see in the current system is that 

since the DRG weights are based on charges, we think we are overpaying for services, DRGs, where there are lots of ancillary services 

involved. And surgical cases would be one example of that, where 

22 

we think that there might be a pattern of overpayment. By the 

same token we may be underpaying for patients that have a different mix of services, medical patients of various types. So, we 

think that there are obviously some mistakes in the system and 

some types of patients aren’t carrying enough dollars with them, 

and the purpose of these refinements is to level out that 

playingfield, again, not just for specialty hospitals, but even among 

community hospitals. 

Chairman JOHNSON. I think that could be very useful. It just 

has to be done with a lot of thought and I am not sure budget neutrality is fair or right. Your testimony, however, appears to me not 

to address the other half of the problem which is selection by 

payor, and there is some evidence that these hospitals do select not 

only the payors, the people who pay, as opposed to the people who 

don’t, but the payors that pay better than the payors who pay 

worse. I don’t see anything in your proposals that really well addresses this aspect of the disparity, because as we have talked 

about a number of times, occupancy is crucial to a hospital’s profitability and occupancy by paying patients is crucial to a community 

hospital’s well-being. 

Mr. HACKBARTH. Consistent with our statutory assignment, 

MMA, we looked at how Medicare pays these institutions, and also 

at the number of Medicaid patients they treat. And as I reported, 

we found that they do care for disproportionately fewer Medicaid 

patients. We did not look specifically at uncompensated care, nonpaying patients, because that assignment was given to CMS. 

Chairman JOHNSON. Do you have any comment on that, Dr. 

Gustafson? 

Mr. GUSTAFSON. Yes. We did discover some information about 

uncompensated care. I summarized the point a few minutes ago, 

and the report will go into this in greater detail. 

Chairman JOHNSON. Thank you. Now, did either of you look at 

selection amongst payors, not the government, private payors, and 

the variation amongst payors? There is some indication that organizations are sensitive to who are the good payors and who are the 

bad payors. 

Mr. HACKBARTH. We did not look at that. Given the amount 

of time available and the resources, we focused on the narrow statutory mandate. 

Chairman JOHNSON. And also I am not so sure that this was 

common in 2002. It may have been some enrichment in the art. 

Mr. GUSTAFSON. I think we examined it only to the extent that 

we looked at the Medicare share and consequently the complement 

of that is that provided by either Medicaid or private payors or by 

uncompensated care. So, I believe our report will provide some detail on that, but we didn’t go into it in depth. 

Chairman JOHNSON. This issue of the length of stay and the 

failure to show any reduction in cost is a concern because if competition is to improve quality and reduce costs, and the quality 

jury, I will be interested to see your report in greater detail. But 

I would have to say that in extensive talks with thoracic surgeons, 

which I hope to share with the Subcommittee Members in a seminar setting. It was very interesting the tremendous progress they 

have made in quality, and they can make it in a community hosVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00026 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
23 

pital setting just as easily in a brandnew facility. Which I think 

leads us to the question of if investing in this new capital from our 

point of view does not result in a reduction in costs, the what are 

the implications of that for the overall cost of the Medicare system? 

Mr. HACKBARTH. Well, because unfortunately the limited data 

at our disposal, the small number of hospitals and so on, as I said, 

we couldn’t draw definitive conclusions about how costs compared. 

We did find that the costs were higher, not lower, but that was not 

a statistically significant result. So, that is the sort of question that 

with more time and more data we might be able to provide a more 

compelling answer. 

Chairman JOHNSON. And last, very briefly, did you look at 

whether or not there were waiting lists at the existing cardiac programs that the specialty hospital then served, or was it—it is a little hard to look at this in 2002 because there was not much time— 

but you are saying that the community hospital recovered from the 

blows. There are two things that it seems to me we don’t know. We 

don’t know whether they recovered from the blow by substituting 

higher cost services that we will now pay for, and dropping services 

to low income pieces that were—we don’t know whether they lost 

their ability to cross-subsidize Ob/Gyn wards or particularly OB 

wards of pediatric wards. So, I think we need to look at lot more. 

Did you look at that at all, Dr. Gustafson? 

Mr. GUSTAFSON. I am not aware that we did, although the site 

visits I believe were fairly comprehensive. I didn’t go on any of 

them myself. 

Chairman JOHNSON. I think we do need more information 

about what happened at these community hospitals. I think we 

need more information about whether there were waiting lists for 

current services, whether this was a need induced response or 

whether this was a profit induced response. Thank you. And I have 

taken too much time, so you do not need to respond to that. Mr. 

Stark? 

Mr. STARK. Mr. Hackbarth, has MedPAC closed the door on a 

future recommendation that the whole hospital exemption be eliminated, or is that still open? 

Mr. HACKBARTH. No, we haven’t closed that door. We would 

like to make a final recommendation as it were on that based on 

more definitive evidence on cost and quality in specialty hospitals. 

Mr. STARK. Specialty hospitals that are fueled by self-referral or 

specialty hospitals in which—— 

Mr. HACKBARTH. Here I am talking specifically about the physician-owned specialty hospitals. 

Mr. STARK. Do you have a concern or do you share my concern 

about allowing the moratorium to expire before Congress passes or 

CMS acts without legislation and payment changes are recommended? 

Mr. HACKBARTH. Very much so. 

Mr. STARK. So, you think we should keep the—— 

Mr. HACKBARTH. We think it is very important to extend the 

moratorium. 

Mr. STARK. Until such time as we resolve the issue? 

Mr. HACKBARTH. Yes. 

24 

Mr. STARK. Is MedPAC still concerned in general about self-referral to physician-owned facilities or these diagnostic facilities or 

whatever? Is there still some evidence that ownership tends to encourage higher utilization? 

Mr. HACKBARTH. Yes. We are concerned about that. We are 

open to the possibility that specialization and the sort of engagement that you get through ownership could help improve efficiency 

and quality, and we don’t think that we had sufficient information 

to reach definitive judgments on those issues. And as we have discussed often in these hearings, our view of the status quo is that 

it is not all that great. There is a lot of inefficiency in the system 

and a lot of unevenness in quality, so we don’t want to definitively 

rule out a development that may help us on those fronts unless we 

have really compelling information to do so. 

Mr. STARK. There has been some discussion in somebody’s testimony about the fact that the specialty hospitals do better, and they 

perhaps have equivalent mortality. Dr. Gustafson, you only looked 

at four heart hospitals, right? 

Mr. GUSTAFSON. On the quality measures we looked at all 15, 

sir. 

Mr. STARK. All 15 what? 

Mr. GUSTAFSON. All 15 heart hospitals. 

Mr. STARK. There are only 15 of them? 

Mr. GUSTAFSON. There were only 15 in 2003, sir. Actually, let 

me correct that. There were 16. 

Mr. STARK. Did you look, Mr. Hackbarth, at the, I guess the 

invasiveness of the procedures? Has there been any study about 

whether more invasive procedures were used for somebody with the 

same diagnosis in one hospital or another? 

Mr. HACKBARTH. What we did, Mr. Stark, was look at different 

types of patients, and we broke them in—we looked at all heart 

surgeries in general, and then we looked at three particular categories, one that we identified as a high profit type of case, and 

then a medium profit and a low profit, and tried to see whether the 

patterns of care differed in the communities where there were physician-owned specialty hospitals. And with one exception, we did 

not find a statistically significant difference. 

Mr. STARK. I am going to ask you to comment on Mr. Gustafson’s study here, but you are suggesting the mortality rate—Mr. 

Gustafson suggested that the mortality rate between cardiac and 

community hospitals was similar when adjusted for severity, but 

that the readmission rate for cardiac specialty hospitals was higher 

on average I gather. 

Mr. GUSTAFSON. That is correct. 

Mr. STARK. So, if we already know that you are putting the 

more complex sicker patients in the community hospitals and the 

healthier patients in the cardiac hospitals, wouldn’t you expect that 

they would have lower readmission rates in the specialty hospitals 

if their quality of service is as good? I mean there is something 

here about doing your callbacks, for which I suspect they get to 

charge again. They do not do callbacks free like my Ford dealer, 

do they? You go back a second time, you pay a second time, right? 

So, I know that maybe they didn’t put the drain plug in properly, 

25 

so you can come back and get another oil change, but I mean, is 

it—did you take that into account, Dr. Gustafson? 

Mr. GUSTAFSON. Well, I mean, we think the admissions would 

be a source of concern, certainly. 

Mr. STARK. Okay. But, so you still think that all the readmissions for healthier patients didn’t make the care worse in the cardiac hospital—— 

Mr. GUSTAFSON. Well, I mean, it is a complex set of measures 

that were employed here insofar as the mortality seems to be one 

you would want to pay particularly close attention to, and so we 

did. Readmission is a different nature of problem. And I would say 

that the differences we are talking about here are not startling. 

They are significant, but not necessarily startling. And community 

hospitals vary a fair bit in some of these factors as well. 

Mr. STARK. Mr. Hackbarth? 

Mr. HACKBARTH. I just want it to be clear, the reason that I 

wasn’t responding to your question is that the quality piece of the 

work was assigned to CMS. So, we did not specifically—— 

Mr. STARK. No, I was asking you about readmissions, though, 

from a cost basis. I mean, if you have some guy coming back two 

and three times, and they are healthier, it sounds to me like that 

could be more cost—— 

Mr. HACKBARTH. That is unquestionably a problem if that happens. The extent to which it does happen, I don’t know, since we 

didn’t look at that issue. 

Mr. STARK. Thank you. 

Chairman JOHNSON. Mr. McCrery. 

Mr. MCCRERY. Thank you, gentlemen, for your testimony, although I must say it doesn’t really tell us exactly where to go on 

this issue. And I hear you saying that you need more time and 

more resources to give us more definitive guidance—which is fine. 

And you are suggesting that we keep the moratorium in place until 

we can act on your recommendations, I suppose with respect to the 

DRG changes. How long do you anticipate keeping the moratorium 

in place? Is it totally dependent on congressional action, on the 

DRG front? 

Mr. HACKBARTH. Our proposal is to extend it to January 1, 

2007. Some of the changes that we propose could be done under existing statutory authority. One of the refinements that we propose 

requires new legislative authority, as we read the law. So, on some 

of them, as soon as CMS has the opportunity to review our work 

and reach conclusions about it, they could begin on today, tomorrow, whenever that point it. In terms of when we might know 

more, we used 2002 data because that was the most recent available when we began our study. As Tom reported, CMS, because 

they started a little bit later, had 2003 data. Before the end of this 

calendar year, we should have 2004 data, which would give us, obviously, a more significant database to look at some of these questions. So, I am not just saying somewhere out in the distant future. 

I think it need not be that far in the distant future. 

Mr. MCCRERY. So, you are saying that the moratorium ought 

to be in place at least until we make the DRG changes and you 

have more time and more data to examine to report back to us once 

again on this issue. 

26 

Mr. HACKBARTH. In particular we are emphasizing that we 

think the moratorium ought to stay in place until we can refine the 

payment system so there is not an opportunity to profit simply 

from patient selection. That is the most important point. So, long 

as it is extended, that will also give us time to look at some additional data on these cost and quality issues while we are waiting. 

I want to be clear—the fact that we might have 2002, 2003, and 

2004 data doesn’t necessarily mean that we will be able to provide 

the absolute right answer to these questions, but we will be able 

to answer them with a bit more confidence than we can today. 

Mr. MCCRERY. Well, one thing that I hope you will focus on 

with the new data is this issue of self-referral. Because the data 

that you have presented to us today, at least to me, doesn’t indicate 

that self-referral is a problem with these specialty hospitals, with 

physician ownership averaging, I think your study says 4 percent 

on an individual basis and, Dr. Gustafson, yours says 2 percent or 

1 percent, depending on the type of specialty hospital. That doesn’t 

seem to me to be a huge problem in terms of self-referral. 

Mr. HACKBARTH. Well, as I said in response to Mr. Stark’s 

question, we are concerned about self-referral. 

Mr. MCCRERY. In general. 

Mr. HACKBARTH. Yes, as a matter of principle. We have not 

seen the CMS data, and so we are eager to see the information that 

they have developed on self-referral and quality. So, that is very 

much a question in our mind. 

Mr. MCCRERY. But you did look at utilization rates. 

Mr. HACKBARTH. We did, yes. 

Mr. MCCRERY. And what were your findings there between the 

two? 

Mr. HACKBARTH. Well, what we did was compare rates of utilization for particular procedures in communities that have physician-owned specialty hospitals and those that do not. And what we 

found was that the general pattern was what you would expect 

consistent with the physician-owned hospitals doing more highprofit things, but the differences were not statistically significant— 

except in one case for one procedure, we did find a statistically significant difference. 

Mr. MCCRERY. Well, Madam Chair, it would be interesting to 

know if the percentage of physician ownership, the average percentage of physician ownership has gone up since 2002. That to me 

would be a very interesting piece of data for you to retrieve from 

your ongoing study. 

Mr. GUSTAFSON. Well, if I could comment just on that briefly, 

the moratorium introduced by the MMA has effectively prevented 

that from happening. 

Mr. MCCRERY. Well, but that wasn’t in effect in 2003 and 2004. 

Mr. GUSTAFSON. It started in—it became effective with the 

passage of the MMA in late 2003. 

Mr. MCCRERY. All right. But you are going to have a lot more— 

well, was the MMA in 2003? 

Mr. GUSTAFSON. December 8, 2003. Right? 

Mr. MCCRERY. So, you got one more year of data, 2003, without 

a moratorium. 

Mr. GUSTAFSON. That is correct. 

27 

Mr. MCCRERY. And it would be interesting to see the proliferation of these hospitals in that intervening year and if there has 

been any change in physician ownership, average physician ownership. Because the data that you have, so far to me, doesn’t day anything negative about physician ownership, self-referral, utilization 

rates, any of that—any of the bugaboos that we were supposed to 

be on the watch for. So, let us see if increased data puts the lie 

to the data that you already have, the conclusions, at least, that 

can be reached based on the data you have. Thank you. 

Chairman JOHNSON. To that point, though, the charts that you 

showed do show that these hospitals do attract less severely ill patients in their category. So, what you have to know is what is the 

referral mechanism here and is the referral mechanism influenced 

by ownership. And you don’t actually comment on that in particular. 

Mr. HACKBARTH. We did not look at the effect of ownership. 

CMS did look at that issue. 

Chairman JOHNSON. Do you want to repeat your comments on 

that? 

Mr. GUSTAFSON. The basic picture is that when we examined 

physician ownership patterns and referral patterns related to physician ownership, we discovered no significant difference between 

the behavior of physicians that were owners of the specialty hospitals and physicians that were not owners of the specialty hospitals. So, there was no there there. 

Mr. HACKBARTH. You might imagine that there are at least 

two different types of forces at work in determining where the patients go. One theory is that they are getting less sick patients because of the ownership incentive. There are other possibilities, one 

of which is that specialization itself inherently means that you are 

going to get a different selection of patients. Because, for example, 

patients that have lots of co-morbidities that need services beyond 

the cardiac service would more naturally go to the community hospital, where there are those other services. In fact, that may be the 

patient’s preference. Whereas if they are a pure cardiac case, the 

patient might say I want to go to the cardiac hospital. So, that has 

nothing to do with the physician’s ownership, but rather how patients sort themselves out across a system where you have different 

types of institutions. 

Chairman JOHNSON. I hope to come back to this subject. We 

will turn next to Mr. Doggett. 

Mr. DOGGETT. Thank you, Madam Chair. Just referring back, 

Dr. Gustafson, to a portion of the President’s budget that was already referenced in an earlier statement, where the Administration 

says that it will refine the payment system and related provisions 

to ensure a more level playingfield between specialty and non-specialty hospitals. Does that mean that the Administration believes 

that the playing field at present is not level or even or fair between 

the two? 

Mr. GUSTAFSON. I would say that would be a fair characterization, sir. 

Mr. DOGGETT. Is the Administration fully committed to not permitting the moratorium to expire before you have an opportunity 

28 

to complete all your technical work and make appropriate recommendations and changes? 

Mr. GUSTAFSON. We have not arrived at a position on the moratorium yet, sir. 

Mr. DOGGETT. Well, if the playingfield is not level or even fair 

at present, and you let the moratorium expire, what will be the immediate effect? 

Mr. GUSTAFSON. That is a speculative question, sir. I think 

that it would be likely that nascent hospitals that are now expecting to enter this market may proceed to do so; on the other hand, 

they may be deterred by the possibility of our action or your action, 

and that might have a chilling effect. 

Mr. DOGGETT. Well, you would expect that there would be some 

additional hospitals that would take advantage of the uneven playing field, wouldn’t you? 

Mr. GUSTAFSON. That could very well happen, sir. 

Mr. DOGGETT. Why is the Administration, given its statements, 

not fully committed to the extension of the moratorium? 

Mr. GUSTAFSON. All I can tell you is that we have not—beyond 

the statement that you were just citing, we have not reached any 

policy conclusions relative to what our recommendations will be to 

the Congress. As my remarks earlier indicated, we are waiting 

until the analysis is complete. We expect to have a report that we 

are able to deliver to you within a matter of weeks. We are very 

cognizant that June 8th is the expiration of the moratorium and we 

appreciate the problem that presents us all in terms of addressing 

that question. 

Mr. DOGGETT. Well, not only that it is the expiration date, but 

that the Congress needs to act to pass a law before that time. 

Mr. GUSTAFSON. Yes. I appreciate that, sir. 

Mr. DOGGETT. And as slow as things move around here sometimes, if we started this afternoon it wouldn’t be unusual that it 

could take near that time if there were any dispute over this matter. 

Mr. GUSTAFSON. I quite agree, sir. 

Mr. DOGGETT. I am interested as well in the findings that either of you have made at this point about any differences that exist 

in these types of hospitals and their delivery of services—particularly uncompensated care and Medicaid care, because I have a lot 

of poor people in my district. Can you comment on that further? 

Mr. HACKBARTH. The piece of that that we were asked to look 

at was Medicaid, and then CMS was asked to look at uncompensated care. And what we found on Medicaid is that the specialty 

hospitals treat proportionally fewer Medicaid patients. 

Mr. DOGGETT. Can you quantify that? 

Mr. HACKBARTH. Not off the top of my head. But the differences were quite substantial. 

Mr. DOGGETT. And with reference to the uncompensated care, 

Dr. Gustafson? 

Mr. GUSTAFSON. Yes, we did look at that, sir. And our conclusion, again preliminary here, was that specialty hospitals provided 

about 40 percent of the share of uncompensated care that we saw 

in local community hospitals in the same area. 

Mr. DOGGETT. About 40 percent. 

29 

Mr. GUSTAFSON. That is correct. 

Mr. DOGGETT. So, it is a pretty substantial difference. 

Mr. GUSTAFSON. Yes, sir. 

Mr. DOGGETT. Thank you very much. 

Mr. HACKBARTH.—which table to look at. And what we found 

was that heart specialty hospitals had on average 4 percent Medicaid—this is share of hospital discharges—whereas community 

hospitals in the same market had an average of 15 percent of their 

discharges being Medicaid. In the case of orthopedic hospitals, specialty hospitals had 1 percent Medicaid versus 16 percent for the 

community hospitals. 

Mr. DOGGETT. One percent versus 16 percent. 

Mr. HACKBARTH. That is right. And then for the surgical, I 

think they were too small and there were too few discharges to 

really have a meaningful result. 

Mr. DOGGETT. So, while there may be some notable exceptions 

to that with hospitals, the playingfield for poor people between 

these hospitals is very different. 

Mr. HACKBARTH. Yes, and I think we did, in fact, find that 

there was some significant variation in some cases. So, there were 

some individual specialty institutions that had much higher Medicaid caseloads than these. But this is the average. 

Mr. DOGGETT. I think I have one of those as well, where a specialty hospital is really reaching out trying to include poor people, 

but for the survey as a whole it looks like a rather stark disparity. 

Chairman JOHNSON. Mr. Johnson. 

Mr. JOHNSON. Thank you, Madam Chairman. Well, I think you 

all are waffling all over the place. Thank you for being here today. 

I am concerned about the extension of the moratorium. It is my understanding that of the 100 or so specialty hospitals, they have 1 

percent of the cardiac market, 2 percent of the orthopedic market. 

Is that correct? 

Mr. HACKBARTH. Are you talking about on a nationwide basis 

or within—— 

Mr. JOHNSON. Yes. 

Mr. HACKBARTH. I don’t know. 

Mr. GUSTAFSON. I can confirm your figure on cardiac. It is 

about, in fact, .95 percent of the national market. I don’t have comparable figures on the others. 

Mr. JOHNSON. Well, it seems to me, you know, according to 

your little chart, the bulk of your specialty hospitals are around the 

middle of the country. How do you account for that? 

Mr. HACKBARTH. I think that a significant factor in that is 

State law. 

Mr. JOHNSON. Is what? 

Mr. HACKBARTH. State law. If you look at the map, I think we 

show on here States that have certificate of need. They are the 

shaded States. And there are relatively few, if any—just a couple 

specialty hospitals in States that have certificate of need laws. Another factor is State licensing laws. Some of the States where in 

fact there are a lot of specialty hospitals have basically made accommodation for them in their licensing requirements, making it 

easier to develop the sort of smaller institution that may not have 

all of the capabilities of a full-service hospital. Then there are some 

30 

States that explicitly prohibit physician ownership of hospitals. So, 

there are a variety of State laws that influence this pattern. 

Mr. JOHNSON. Then why does the Federal Government need to 

get involved? You know, it begs the question why do we need a government-mandated extension of a moratorium that the States are 

handling pretty well, it looks like to me, themselves. Seems like 

you didn’t talk to, but the patients pick hospitals, too. You know 

that. 

Mr. HACKBARTH. Yes. 

Mr. JOHNSON. And especially in the area I am from, the Dallas 

area, you know there is a ton of them in that area. And they will 

choose a hospital, it doesn’t matter whether it is a specialty hospital or a community hospital. They are going to go where the best 

docs are. I do. And I think most people do. So, I don’t think that 

the Federal Government can prescribe how specialty hospitals operate. I mean, if you have a cardiac hospital or an orthopedic hospital or some other form of specialty hospital out there and it is 

competing with a larger hospital that has multiple services, and 

people choose to go there, what is wrong with that? This is America. 

Mr. HACKBARTH. Well, the table, Table 1 on page 7, indicates 

why we think this is an issue for the Medicare Program. These institutions are consistently treating patients that are healthier, less 

severely ill, with consequences for the Medicare Program. So, what 

we are saying is that, at a minimum, allow the time to level the 

playingfield so that there aren’t undue profit opportunities. At a 

minimum, that is what we think ought to be done through an extension of the moratorium regardless of how you come down on the 

issues of self-referral and whether that is good or bad. 

Mr. JOHNSON. Well, if you think changing the DRG will help, 

you know, it seems to me you don’t need a moratorium to do that. 

We just change the DRG and it fixes it, according to you. 

Mr. HACKBARTH. I am sorry, I didn’t follow that. What we are 

saying is that the competition ought to occur on a level 

playingfield—— 

Mr. JOHNSON. I heard you. 

Mr. HACKBARTH.—that does not exist today. It will take time 

to accomplish that, and hence an extension of the moratorium is 

appropriate, from our perspective. 

Mr. JOHNSON. Okay. I happen to disagree with you. Do you 

have a comment on that subject? 

Mr. GUSTAFSON. No, sir. 

Mr. JOHNSON. Thank you very much. 

[Laughter.] 

Mr. JOHNSON. Thank you, Madam Chair. 

Chairman JOHNSON. Mr. Thompson. 

Mr. THOMPSON. Mr. Hackbarth, you had mentioned in a summary that there is limited fiscal impact on community hospitals 

from the specialty hospitals, but you qualified it by saying ‘‘at this 

time’’ or ‘‘thus far.’’ Is that qualifier in there because you see something coming down the road in the not-too-distant future that could 

in fact fiscally impact the communities? 

Mr. HACKBARTH. Well, the qualifier, again, is because we are 

analyzing such a limited amount of data. So, what we did in this 

31 

particular instance was look at the profitability of hospitals, community hospitals that face competition from specialty hospitals, as 

compared to community hospitals that don’t face that kind of competition, and compare their financial results. And in doing that, 

what we found was that they looked pretty similar. The bottom line 

financial performance, in other words, of the hospitals facing specialty hospital competition was about the same as those that were 

not facing that competition. But we have a relatively small number 

of data points. 

Mr. THOMPSON. Do you anticipate that changing? 

Mr. HACKBARTH. I honestly do not know. The second qualification, you recall, that I mentioned was that it may be more difficult 

for a community hospital in a smaller community to respond to the 

competition. Because among the strategies used are, well, we lost 

some of our cardiac cases, we might develop other services to help 

offset that loss. And if you have a small population to work with, 

those opportunities may be fewer. 

Mr. THOMPSON. So, will you bifurcate any recommendations 

that might be forthcoming? Small community versus larger communities? 

Mr. HACKBARTH. I don’t know, Mr. Thompson. Ideally what we 

would have is some more information to work from. 

Mr. THOMPSON. Do you have any idea—I think Mr. Doggett 

started on this, but if the moratorium were to expire, do you have 

any idea or give us any idea of what would happen in regard to 

the construction of additional facilities? 

Mr. HACKBARTH. I don’t know. I assume an important factor 

would be what the specialty hospital potential investors thought 

about the likelihood of changes might be. So, if they were convinced 

that, for example, these payment changes were going to be made 

that would take out a lot of the additional profitability of the business, that might reasonably affect their willingness to invest, their 

expected return on the investment. If on the other hand they saw 

the changes as being unlikely, then there might be a great influx. 

They might say, oh, we are over this hurdle, now is the time to 

rush in. So, a lot depends on how they read your actions and HHS’s 

potential actions. 

Mr. THOMPSON. Thank you. And Dr. Gustafson, you had mentioned this link between the amount of taxes that the specialty hospitals pay vis-a-vis the uncompensated care that they provide. 

What is the link? 

Mr. GUSTAFSON. We were asked to look at both of those factors. It—— 

Mr. THOMPSON. But the taxes don’t somehow offset the care 

that the community facilities provide—property tax and local taxes. 

How do they—what is the relationship between the two? 

Mr. GUSTAFSON. Well, I can only speculate that the drafters of 

this provision were interested in the total return to the community 

as a whole from these hospitals, and so wanted to look at both of 

these factors. 

Mr. THOMPSON. Thank you. 

Mr. HACKBARTH. Mr. Thompson, could I just add one additional point? I mentioned that future investment might depend on 

what they thought was likely to happen with the payment refineVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00035 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
32 

ments. You know, another factor is the gains-sharing proposal. 

What we heard in our site visits was that—from physicians who invested in these hospitals, we often heard that they did it because 

they felt frustrated with their existing circumstances in the community hospital. And what they wanted was an opportunity, A, for 

change and, B, to participate in the benefit from that. And if we 

offered an alternative path of gains-sharing sanctioned by the program within a defined set of rules to protect quality, we might create an alternative path that would then affect decisions among 

physicians about whether to engage in this sort of activity. 

Mr. THOMPSON. Thank you. 

Chairman JOHNSON. Mr. Hayworth. 

Mr. HAYWORTH. Madam Chairman, thank you. It is an honor 

to be on the Subcommittee and to open with this clearly non-controversial topic for us now. 

[Laughter.] 

Mr. HAYWORTH. Mr. Hackbarth, let me return to the topic my 

colleague from Texas was dealing with and try to get more amplification of your testimony. You discussed extending the moratorium 

until the DRG payments are reformed. But after that point, do you 

envision lifting the moratorium? 

Mr. HACKBARTH. As I said, I think before you came in, Mr. 

Hayworth, even with those payment reforms in place, the Commission has some residual concern about the issue of self-referral to 

institutions with a physician as an ownership interest—whether 

that is in the interest of the patient or whether clinical decisions 

could be inappropriately influenced. So, that is a concern. What we 

would like to be able to do, on the other hand, is weigh that potential risk against whether these hospitals can improve quality and 

reduce costs, so that we have the pluses and minuses in a more definitive way to judge. And in order to make that definitive judgment, we think there is more information required. We have not 

as yet seen any of the quality information that CMS has developed. 

We are hearing about it for the first time today. Obviously, that is 

a critical factor in assessing whether this is a form of delivery that 

ought to be accepted or whether it is one that ought to be ruled 

out. 

Mr. HAYWORTH. Dr. Gustafson, anything you would care to 

amplify from the findings that might be of interest to MedPAC and 

all of us assembled here in that regard? 

Mr. GUSTAFSON. I don’t really have too much more to say 

about the quality findings. We are hastening to complete our report 

and will have that to you as quickly as possible. I will note that 

we are already examining the recommendations that the Commission has put forward about revising the DRGs. We have our analysts at work on this. There are a number of complexities within 

that sphere that we are going to have to examine and will take us 

a while not only to reach conclusions about the desired direction, 

but to do the technical work necessary to implement that in the 

system. So, that you can see the statement in the President’s budget indicated our receptivity to these ideas. We will probably not be 

able to push it too far for the next cycle of rulemaking, but would 

be anticipating it at a process level, assuming the policy will is 

there to be able to move more energetically for fiscal year 2007. 

33 

Mr. HAYWORTH. Gentlemen, for both of you, this question. As 

the community hospital attracts patients with more co-morbidities, 

what do you see as the most equitable way to compensate for that? 

Mr. HACKBARTH. Two points. First of all, I want to be clear 

that not all community hospitals are alike. You know, we are always talking about averages and there is a tendency to say, well, 

everybody in that average is the same. Community hospitals differ 

significantly in the mix of patients, including the severity of illness. 

That is why we believe that these payment changes we are talking 

about are important to make, even if physician specialty hospitals 

didn’t exist. Then in direct response to your question, we think that 

these payment changes will directly address that question. If patients are sicker, they will come with more dollars attached to 

them, under our proposals. If they are less sick, the amount that 

the hospital is paid would go down relative to today. The system 

would be much more accurate in matching payments to the expected costs of different types of patients. 

Mr. HAYWORTH. Dr. Gustafson, any thoughts on that? 

Mr. GUSTAFSON. I have nothing to add, sir. 

Mr. HAYWORTH. Okay. I thank you. Madam Chairman, I thank 

you for the time. 

Chairman JOHNSON. Thank you. Mr. Stark has a follow-on 

question? 

Mr. STARK. Yes, I wanted to direct this to Mr. Hackbarth just 

to see if you would speculate for us a little bit. Set aside the kickback or the referral thing, which I think is a separate issue, almost, from the specialty hospitals. They are combined in much of 

this, but they can be separate issues. 

If you take the specialty hospital’s pitch to its end point, you are 

basically deconstructing—or cannibalizing, depending on what you 

think about it—a community hospital. If you took that to its extreme, you might hear some of that from Baylor, but you might 

find that our community hospitals become a series of—you know, 

free-standing emergency room, a block away from the rest of it, but 

a free-standing emergency with its own kitchen, its own laundry. 

And a free-standing—there are some free-standing birthing hospitals, basically what Columbia used to be. And a free-standing— 

so you get a whole bunch of these little pods around town, each 

with its own—I see some overhead problems there. They each have 

to have their own kitchen, their cleaning crew, their landscaping 

crew. But this would be a sea change in how hospitals operate and 

how they are financed. And I am not sure the hospitals are ready 

for that. And I am not sure we are ready to, in effect, suggest that 

or allow it to happen without some concern. 

So, I guess what I want to know is, do you see just in the overall 

financial survival of all hospitals, whether it is teaching hospitals 

or little 10-bed rural hospitals, that have been built over the years 

on cost-sharing or cost-shifting—and they have, just like the profit 

guy has gone out and started other services to bring in extra revenues to help carry the hospital. Now, if we deconstruct them, are 

we going to cause a whole bunch of problems that maybe we are 

better off not doing? And I just see, you know, if one group could 

pull out, another can pull out. And then pretty soon ought we not 

to, if that is going to happen, do it with some foresight so it just 

34 

doesn’t accidentally end up costing us a lot more or cause a lot of 

problems for, say, inner-city community hospitals that deal mostly 

with the poor? What would happen to them? Do you have any 

sense—forget about the referrals—just on what—is this a good 

trend? 

Mr. HACKBARTH. Well, I am not sure that it logically goes to 

that end, where every full-service hospital is taken apart into component parts—for the reasons that you mention. I do know that 

there are some economies of scale. Patients present not always 

with one illness, but maybe multiple illnesses that require convergence of different services. And so I can more readily envision a 

world where we have a mixture of full-service and specialty institutions. In that world, the key to determining whether it is a harmful 

development or a positive development is, is the payment system 

fair? So, when the full-service hospital treats that patient that has 

not just heart disease but also diabetes and, you know, multiple 

things, are they fairly compensated for that difficult case? Our concern is that in the current Medicare payment system, they are not, 

and that is why we want to refine the system to more accurately 

pay. If you have more accurate payment in place, then I think that 

the potential for full-service to compete evenly with specialized institutions is much greater. If you don’t have that in place, it could 

be harmful. That is why we recommend extending the moratorium 

until we can improve the payment system. 

Mr. STARK. Thank you. Thank you, Madam Chair. 

Chairman JOHNSON. Mr. McCrery has a follow-on. 

Mr. MCCRERY. Well, just to underscore that point, you stated 

that you would be in favor of changing the DRG even if it weren’t 

for the existence of specialty hospitals. 

Mr. HACKBARTH. That is right. 

Mr. MCCRERY. And it seems to me that among all of your conclusions that you have been able to draw, based on the data you 

have been able to retrieve, that is really the only problem that 

stuck out to you, was the disparity in the severity of cases between 

the specialty hospitals and the community hospitals. 

Mr. HACKBARTH. Yes. And part of the reason that we can be 

so much more definitive about that issue is, as I said at the outset, 

when we were looking at the DRG refinement, the payment refinement, we are not looking just at a database of 48 hospitals in 2002. 

We are looking at the overall Medicare claims in a cost report database. And so we can say with great conviction that the system 

needs improvement. 

Mr. MCCRERY. Thank you. 

Chairman JOHNSON. All right, to follow up on their two comments—I appreciate and understand the gains-sharing recommendation and the enrichment of the DRGs. But all you are 

talking about in enrichment of the DRGs is a level playingfield in 

orthopedic surgery or heart problems. I am interested in equal responsibilities. What do you do if the community hospital has bigger 

responsibilities for which we don’t pay? How are you going to fix 

your DRGs to take into account hospital delivery of non-Medicare 

services on which the community depends? OB is a big loser, usually; pediatrics is a loser; psychiatric is a loser. The emergency 

rooms often are a loser. LifeStar is a loser. So, if we fix that in one 

35 

area but we don’t notice that we rely on our community hospitals 

for a lot more, I have thought a lot about how could we compensate 

the big community hospitals for their larger responsibilities. I 

haven’t found any way, actually, to do that accurately. 

Now, if you are going to leave them with higher overhead for all 

these things that the community depends on them for, then they 

are never going to be competitive. With the managed care payers, 

you know, they are never going to be competitive; they will always 

be able to undercut, do a better deal. So, I think the long-term implications of not being able to create a competition that is fair is 

very serious and, in the end, will be an access issue for us. 

Mr. HACKBARTH. I understand and share your concerns. Two 

reactions to it. First of all, I think it is critically important to keep 

coming back to the fact that not all community hospitals are alike. 

That is sort of a catch-all category. 

Chairman JOHNSON. Right. 

Mr. HACKBARTH. It is not uncommon, setting aside physicianowned specialty hospitals, for there to be debates within the community-hospital community, as it is here defined, about who is caring a disproportionate share of these public-good burdens—for-profit community hospitals against not-for-profit community hospitals, 

or one not-for-profit community hospital in the suburbs compared 

to one in the inner city. These issues are important issues, but they 

long predate physician-owned specialty hospitals. Stopping physician-owned specialty hospitals won’t solve those problems. 

Chairman JOHNSON. No, but allowing any—I mean, this was a 

problem with surgery centers. Allowing someone to pull out the 

high profit does have a consequence for everybody else. I won’t pursue that, but I do think that is a big issue that we need to know 

about because access is reduced. There is some indication that 

overall demand increases quite substantially as you create more 

opportunities for service, and we had that from Wenberg and others. So, if we just let all these opportunities for service develop, we 

can expect to pay a lot more for a lot more services. But I wanted 

to ask you, Dr. Gustafson, because as I understand it, these specialty hospitals do not have to reveal who their investors are. I was 

interested that you seem to have figured out who the investor/doctors were. And do you also know whether or not the other doctors 

were allowed to invest? I mean, are we seeing something in which 

only the doctors who could bring referrals are allowed to invest, or 

are all doctors allowed to invest? 

Mr. GUSTAFSON. The information we had on ownership of 

these hospitals was derived from our case studies. We don’t have 

any regular reporting mechanism that provides that information to 

us. We basically had to go and ask the folks what the answers 

were. And they were generally forthcoming on that subject. I don’t 

know if we have nay information on the second matter you raised 

about who was allowed to invest. 

Chairman JOHNSON. The sort of word on the street is that only 

those who can bring referrals are allowed to invest, and I needed 

to know whether that is true or not true. Thank you very much, 

gentlemen. I hope you will pursue some of the issues that we have 

been unable to get complete information on. Thank you very much. 

Very interesting. 

36 

Chairman JOHNSON. The next panel, please. Next and last 

panel. Jon Foster, President and Chief Executive Officer of St. David’s HealthCare Partnership, Austin, Texas; Bill Plested, American Medical Association; William Brien, Cedars-Sinai Hospital, 

Los Angeles; Jamie Harris, MedCath Corporation, Charlotte, North 

Carolina; Gary Brock, Chief Operating Officer of Baylor Health 

Care System. 

Gentlemen, we are going to proceed right through all of your testimony so we will be able to hear it all before we have to go vote, 

and then we will invite questions. So, we will start with Mr. Foster, the CEO of St. David’s HealthCare Partnership in Austin, 

Texas. 

STATEMENT OF JON FOSTER, PRESIDENT AND CHIEF EXECUTIVE OFFICER, ST. DAVID’S HEALTHCARE PARTNERSHIP, 

AUSTIN, TEXAS 

Mr. FOSTER. Thank you, Madam Chairman and Mr. Stark, 

members of the Subcommittee. My name again is Jon Foster. I am 

the President and CEO of the St. David’s HealthCare Partnership, 

which is a four-hospital system providing high-quality care to the 

1.4 million residents of Austin and central Texas. I am pleased to 

be here today to discuss one of the most critical issues, I believe, 

facing community hospitals, which are physician-owned specialty 

hospitals. My remarks will focus on four key points: First, physician-owned specialty hospitals operate more like subdivisions or departments of full-service hospitals. Second, physician ownership of 

subdivisions or departments of hospitals are already illegal. Third, 

physician ownership coupled with their ability to self-refer represents a conflict of interest and it is anti-competitive. And, fourth, 

Medicare payment adjustments are not a solution to this problem 

but, rather, closing the legal loophole that allows for these facilities 

is. 

Specialty hospitals largely limit their care to just one type of 

service, often cardiac, orthopedic, or surgical services, which guarantee high profit margins while avoiding essential but unprofitable 

community services such as emergency rooms. Studies by the GAO 

and MedPAC found that a majority of specialty hospitals do not 

have fully functioning, fully staffed, 24-hour emergency rooms. The 

reason, of course, is because emergency rooms are the primary portal through which indigent and Medicaid patients get admitted to 

most hospitals. In 2003, 41 percent of the 200,000 patients seen in 

St. David’s emergency departments were indigent or Medicaid patients. Clearly, specialty hospitals are not whole hospitals but, 

rather, more like subdivisions or departments of hospitals that 

focus on the most profitable patients. 

Under current law, physicians are permitted to have an ownership interest in an entire whole hospital but not a subdivision of 

a hospital. The regulatory theory here is that any referral by a 

physician who has a stake in an entire hospital would not financially benefit as directly from the referrals he or she makes to that 

hospital, and as such, it would dilute the potential conflict of interest that exists. 

However, a physician’s ownership in a subdivision of a hospital 

is deemed to be illegal due to the ability of the owning and referVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00040 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
37 

ring physician to more directly control the financial results of that 

subdivision. In my professional opinion, specialty hospitals are not 

whole hospitals; rather, they are more like subdivisions of hospitals, essentially cardiac, surgical, or orthopedic wings that have 

been removed from full-service hospitals. As such, I believe physician referral to specialty hospitals in which they have an ownership interest is as much a violation of the anti-referral laws as 

would be physician ownership in a hospital subdivision. 

Let me be clear. As a business leader in central Texas, I am committed to free and fair competition. Community hospitals routinely 

compete for patients on the basis of quality, service, physician relations, and the latest medical technologies. However, true competition requires a level playingfield. The business model of a physician-owned specialty hospital depends upon the control of referrals 

by its physician owners. Highly lucrative specialty hospital investment opportunities are typically granted only to physicians able to 

refer patients and not to investors from the general public. Not 

long ago, I came across one such deal in an offering to physician 

investors for a specialty facility in Austin, Texas. The offering suggested that physician investors investing an initial amount of $4 

million could project to earn $55 million over 6 years, and that is 

an astounding 1,400-percent return on their investment. 

It eludes me how there can be free and fair competition when 

under Federal law St. David’s is prohibited from offering physician 

ownership in specialty wings of hospitals, but specialty hospitals 

can do so and induce patient referrals through physician ownership. MedPAC was certainly correct in recognizing the problems inherent in physician ownership of specialty hospitals. However, its 

policy response, which focuses exclusively on refinements to DRG 

payment systems, is, I believe, inadequate. I would like to State 

again that as President and chief executive officer of the fifth largest employer in Austin, where we employ over 5,000 people 

throughout central Texas, I welcome competition. However, the underlying economics of these facilities which rely upon referrals from 

physician owners would not change materially simply because of 

refinements to the DRG payments. I fear that a wholesale refinement of the DRG system could have the unintended consequence 

of doing more damage to full-service hospitals, even hospitals in 

markets where currently no specialty hospitals exist. As such, it is 

my belief that not only should the current specialty hospital moratorium be extended, but it is also my hope that Congress will close 

the loophole in the anti-referral law that allows for the exploitation 

of the whole-hospital exception, which is, of course, the very behavior that anti-referral laws were attempting to prevent. Thank you 

for your time, and I would be happy to answer any questions. 

[The prepared statement of Mr. Foster follows:] 

Statement of Jon Foster, President and Chief Executive Officer, Saint 

David’s Healthcare Partnership, Austin, Texas 

Good afternoon. My name is Jon Foster, and I am the President and CEO of St. 

David’s HealthCare Partnership [the ‘‘Partnership’’ or ‘‘St. David’s’’]. The Partnership is an affiliation between the not-for-profit St. David’s HealthCare System and 

the Hospital Corporation of America, the nation’s largest provider of health care. We 

are proud to provide high quality, compassionate care through four full-service 

acute-care hospitals, ranging in size from 150 to 500 beds, in Austin, Texas—St. David’s Medical Center, North Austin Medical Center, South Austin Hospital, and 

38 

Round Rock Medical Center. We are a regional system with an eighty-year history 

of serving the more than 1.4 million residents of Central Texas. Recognizing the importance of our role in the community, not only do we provide a vital charity care 

program, but we also have made significant investments in essential state-of-theart health care services, such as transplant, open heart, neurosurgery, rehabilitation, psychiatric care, and neonatal intensive care. 

I am delighted to be here this afternoon to discuss the unique problems created 

by physician ownership of and self-referral to specialty hospitals. I view this as one 

of the most critical issues facing full-service community hospitals today. By injecting 

self-referral into the clinical process, physician-owned specialty hospitals undermine 

and complicate the delivery of responsible, effective health care decisions. 

Within the past several years, physician-owned specialty hospitals have emerged 

to capitalize on an unintended loophole in the anti-referral laws. The business 

model of a physician-owned specialty hospital depends upon the control of referrals 

by its physician owners. More to the point, these arrangements tilt the competitive 

playing field by providing physician-owners with strong monetary incentives for referring carefully selected patients to the facilities in which the physicians have ownership interests, while leaving less profitable cases to be handled by the local community hospitals. 

Physicians owning a financial interest in a specialty hospital tend to direct to 

their facilities only the most attractive patients—those with private health insurance and those who are less sick. However, those same specialists tend to refer 

underinsured or uninsured patients, as well as those with higher acuity, to full-service community hospitals for treatment, which is administered with little to no reimbursement of costs. Full-service hospitals then are left without adequate resources 

to treat the sickest patients. The unethical practice of patient selection does not 

serve the American health care system, it does not serve community hospitals, and 

most importantly, it does not serve the best interests of the patients in our care. 

I believe that the only way to solve this problem is to close the loophole in federal 

law by permanently banning physician ownership of and self-referral to specialty 

hospitals. The success of these facilities depends entirely upon the physician owners’ 

referrals, and this type of relationship is exactly what the anti-referral laws are attempting to prevent. 

Being the CEO of a large health care system, I certainly understand the pressures 

faced by both hospitals and physicians. We all must overcome numerous obstacles 

just to keep open the doors to quality patient care—the constraints of often unpredictable and inadequate Medicare and Medicaid reimbursement, increasing insurance premiums, pressures of managed care, demanding regulatory burdens, and oncall requirements, just to name a few. Within this demanding environment, it is understandable that some physician specialists would be seduced by a specialty hospital’s promise of incomparable personal financial gain. However, I believe that each 

of these challenges requires a comprehensive solution aiming to reform a fractured 

health care system, not an anti-competitive solution in the form of self-referral to 

specialty hospitals, which ultimately impacts patient access to health care. 

Self-Referral At Issue 

As the CEO of four full-service community hospitals in a vigorous healthcare market, I am committed to supporting free and fair competition. True competition, however, requires a level playing field. St. David’s, and other full-service community 

hospitals nationwide, routinely compete for patients on the basis of quality of care, 

physician recruitment, and provision of the latest medical technologies. Yet the recent proliferation of physician-owned specialty hospitals in Texas and across the 

country has dramatically altered the delivery of health care services by stifling fair 

competition and even threatening the viability of certain vital health care services 

nationwide. 

The existence of specialty hospitals is not the problem. Instead, it is the physician 

ownership of and self-referral to these facilities that creates an uneven playing field 

and directly harms full service community hospitals. In recent years, physicianowned specialty hospitals built across the country are distorting the marketplace 

wherever they appear. These facilities limit their care to just one type of service— 

often cardiac, orthopedic, or surgical care—which guarantees high profit margins, 

while avoiding essential but unprofitable community services, such as emergency 

rooms and burn units. 

Ownership interest in these facilities is typically granted only to physicians who 

are able to refer patients, not to any investors from the general public. Referring 

physicians are given sweetheart equity arrangements at bargain basement rates. 

For example, in a proposal offered to potential physician investors in Austin SurVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00042 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
39 

gical Hospital, referring specialists with an initial investment of $4 million were 

projected to earn $55 million over six years—an amazing 1,400 percent return on 

investment. 

By contrast, full-service hospitals, like those in the Partnership, are prohibited by 

federal laws from offering physicians an ownership interest in the specialty wings 

or subdivisions of our hospitals. In fact, offering a physician any ‘‘inducement’’ for 

referrals would land me in jail. These laws prohibit me from giving specialists at 

my hospital more than $300 in gifts per year, none of which could be given in exchange for a referral. Fair competition under the interpretation of existing rules 

simply would be impossible. 

The ‘‘whole hospital’’ loophole in the anti-referral laws permits specialty hospitals 

to cherry pick only the most profitable patients, leaving high-cost patients, individuals on Medicaid, and the uninsured to community hospitals. The Government Accountability Office (‘‘GAO’’) and the Medicare Payment Advisory Commission 

(‘‘MedPAC’’) have found clear evidence of this behavior, concluding that physician 

ownership and self-referral result in favorable patient selection. Because of their adverse financial impact, self-referrals to physician-owned specialty hospitals threaten 

the long-term viability of our full-service community hospitals. 

Commitment to Community 

In this anti-competitive environment, full-service community hospitals struggle to 

achieve the level of care that we desire to provide, and that our communities expect. 

When specialty hospitals drain essential resources from full-service community hospitals, they particularly harm our capacity to provide emergency care and other 

vital health services over time. 

St. David’s believes that maintaining a fully functioning and fully staffed twentyfour hour emergency department is part of our commitment to the community. In 

2003, we received 204,023 visits to our emergency department. From what I have 

witnessed in Austin, and from what I have seen nationwide, physician-owned specialty hospitals simply do not share in the full compliment of critical ED services, 

which full-service hospitals consider as a responsibility and commitment to their 

communities. 

As the Members of this Committee are well aware, America’s hospital emergency 

rooms are quickly becoming our de facto public healthcare system, the primary point 

of access to quality healthcare services for the nation’s uninsured. Hospitals 

equipped with emergency rooms must provide medical evaluation and required 

treatment to everyone, regardless of their ability to pay. Since the advent in recent 

years of these physician-owned specialty hospitals, which skim profitable service 

areas for low-risk patients, this burden has grown even heavier. While specialty hospitals treat the most profitable patients, full-service hospitals are left with the task 

of handling uninsured and high-risk patients within their community. At St. David’s, 41 percent of patients that visited our emergency department in 2003 were 

indigent or Medicaid patients. Maintaining this essential community service for 

those who need it most also means contending with a regular population of those 

with little or no health care options. Moreover, this population often seeks emergency room care only once an illness has reached a level of acuity that makes their 

case more complex and costly. 

A 2003 study by the GAO sheds considerable light on the attitude of specialty hospitals toward emergency services. According to the GAO, a majority of specialty hospitals do not have fully functioning, fully staffed, twenty-four hour emergency 

rooms. The GAO study reveals that while nine in ten of all full-service community 

hospitals maintain an emergency department to address any medical concern that 

walks or is carried through its doors, half of specialty hospitals do not provide emergency services. Even among those specialty hospitals that do have emergency departments, GAO found that the care provided was almost entirely within the specialty hospital’s field. 

By opting not to operate fully functioning emergency departments, specialty hospitals enjoy a high degree of self-selection, which allows them to treat a healthier 

and better paying patient population with fewer complications and shorter lengths 

of stay. For example, at the Heart Hospital of Austin, only six percent of those admitted through their ‘‘ED’’ in 2003 were Medicaid or indigent patients; in contrast, 

25 percent of those admitted through St. David’s ED were Medicaid or indigent patients. This practice is highlighted in a recent quote from Patricia Porras, President 

and CEO of Austin Surgical Hospital who stated, ‘‘Structurally, there is an ED department, however, we will not pursue a public ER, and we will not be tied into 

an EMS system.’’ 

40 

Moreover, GAO and MedPAC separately found that specialty hospitals treat a 

much smaller share of Medicaid patients than do community hospitals within the 

same market area. In its results, MedPAC found that physician-owned specialty 

hospitals treat far fewer Medicaid recipients than do community hospitals in the 

same market—75 percent fewer for heart hospitals and 94 percent fewer for orthopedic hospitals. 

The departure of specialists who relocate their practices from full-service community hospitals to physician-owned specialty facilities causes an additional strain on 

specialty coverage for full-service hospitals. Communities expect full-service hospital 

emergency departments to maintain a complete state of readiness around the clock, 

every day of the year. On-call requirements for specialists ensure adequate staffing 

outside normal work hours, as well as on holidays and weekends for hospital emergency departments. The lack of physician specialists to provide coverage at full-service community hospitals has compromised the ability of those hospitals to provide 

twenty-four hour emergency services. 

Fiscal Impact on St. David’s HealthCare Partnership 

The loss of specialists willing to cover on-call responsibilities poses a significant 

cost to community hospitals nationwide. Prior to the development of physicianowned specialty hospitals within the Austin area, our specialists largely accepted 

on-call responsibilities as a pro-bono commitment to their community. However, the 

development of these facilities has further forced the Partnership to pay certain of 

our specialists $1,000 per night for their emergency on-call services, even though we 

have already lost their profitable referrals to one of the three physician-owned specialty hospitals. 

Proponents of physician-owned specialty hospitals claim that their presence in a 

community generates efficiencies and lowers costs. This could not be further from 

the truth. MedPAC found that specialty hospitals do not have lower Medicare costs 

per case, even though they treat healthier patients for a shorter period of time than 

full-service community hospitals. In addition, when specialty hospitals enter a community, their services are generally duplicative and impose significant cost burdens 

on the full-service hospitals, which must both compete and continue to meet the 

needs of the community. At St. David’s alone, the cost of lost patient volume, the 

cost of recruiting additional specialists and nurses, and the cost of on-call coverage 

will total a staggering $20.3 million per year. These health care resources would 

better have been spent to meet other essential community healthcare needs. 

Physician-Owned Specialty Hospitals Are Diverting Needed Resources from 

Full-Service Community Hospitals 

Full-service community hospitals long have used funds generated by profitable 

services to subsidize the losses suffered by unprofitable services. Only by maintaining the successful product lines are full-service hospitals able to subsidize other critical but less profitable services, such as trauma and burn centers, as well as fund 

special programs for delivering care to uninsured and underinsured patients. By removing the most profitable services from full-service community hospitals, physician-owned specialty facilities have a monetary incentive to refer only those betterfunded and less severely ill patients. This leaves the uninsured, underinsured and 

more severely ill patients to be treated by community hospitals, often without adequate (or any) compensation. While paying and less severely ill patients are diverted 

to physician-owned specialty facilities, community hospitals are left with the burden 

of caring for a higher percentage of the uninsured, underinsured, and the sickest 

patients, yet with fewer resources to cover the vast and unreimbursed costs involved. 

Solution: Self-Referral Loophole Closure 

Allowing for the continuation of these unethical financial arrangements between 

referring physicians and specialty hospitals is tantamount to purchasing admissions. I understand that Congress is weighing recommendations by MedPAC that 

would seek to level the playing field through Medicare payment adjustments. While 

I would certainly advocate for more accurate and appropriate Medicare reimbursement, I think it is important to recognize that Medicare payment adjustments alone 

will not level the playing field and will not solve the exploitation of this loophole. 

MedPAC was correct in recognizing the problems inherent in physician ownership 

of specialty hospitals, and the need to prevent such conflicts of interest; however, 

its policy response, which focused on refinements of Medicare’s DRG payment system, is inadequate. As an operator of acute care hospitals, I can assure the ComVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00044 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
41 

mittee that simply adjusting the DRG’s will only marginally reduce the profitability 

of self-referral. It is the owner and referral relationship that creates patient selection. The underlying economics of these facilities, which relies upon referrals from 

physician owners, would not change materially. Furthermore, while some modifications may be warranted, we have to be careful that the wholesale refinement of the 

DRG system, which MedPAC proposes, could threaten the original reasons for and 

subsequent achievements of the Prospective Payment System we have in place 

today—that is, rewarding efficient providers. While payment refinements will not 

solve the self-referral problem, I can tell you that the massive redistribution of 

funds nationwide would have the unintended consequence of hurting some full service community hospitals, even in markets where there are now no physician-owned 

specialty hospitals. We have to be extremely careful about a solution this broad in 

scope that in my opinion does not address the central problem of physician self-referral. 

Conclusion 

Ultimately, the only effective solution for St. David’s and for hospitals nationwide 

demands an amendment to the anti-referral laws. These laws generally prohibit 

physician referrals for services to entities in which the physician has an ownership 

interest. The intent of this prohibition was to establish and maintain thriving marketplace for health care, free of conflicts of interest and protecting the integrity of 

the Medicare program. Under current law, physicians are permitted to have an ownership interest in an entire inpatient hospital, but not a subdivision of a hospital. 

Any referral by a physician who has a stake in an entire hospital would produce 

little personal economic gain, because hospitals tend to provide a diverse and large 

group of services. However, a physician’s ownership in a subdivision of a hospital 

would not sufficiently dilute the potential conflict of interest. 

The ‘‘whole hospital’’ exception was intended to allow physician ownership in a 

comprehensive health facility, as long as that ownership interest is in the entire facility, not merely a subdivision. Congress never contemplated the emergence of specialty hospitals, which essentially have turned the entire concept of the ‘‘whole hospital’’ exception on its head. In my professional opinion, specialty hospitals are not 

whole hospitals; rather they are subdivisions of hospitals—essentially cardiac, surgical, or orthopedic wings—that have been removed from the full service hospital. 

As such, I believe physician referral to specialty hospitals in which they have an 

ownership interest is as clear violation of the anti-referral laws as would be physician ownership in a hospital subdivision. Simply put, under the present interpretation of the ‘‘whole hospital’’ exception, physician-owned specialty hospitals are exploiting an unintended loophole to engage in precisely the financial arrangement 

that Congress intended to prohibit. This situation must be changed. 

Not only must the current moratorium be extended, but also it is my hope that 

Congress will close the loophole in anti-referral legislation that allows for self-referral to these facilities. The whole hospital exception loophole is not in the best interest of our patients, and it will continue to undermine the vital health care services 

your communities expect from your full-service community hospitals. 

Thank you for your time, and I’d be glad to answer any questions. 

f 

Chairman JOHNSON. Dr. Plested? 

STATEMENT OF WILLIAM G. PLESTED III, M.D., AMERICAN 

MEDICAL ASSOCIATION, CHICAGO, ILLINOIS 

Dr. PLESTED. Thank you, Madam Chair. Madam Chair, Mr. 

Stark, and Members of the Committee, my name is Bill Plested. I 

am the immediate past Chair of the Board of Trustees of the American Medical Association and a practicing thoracic and cardiovascular surgeon in Santa Monica, California. The AMA would like 

to express our appreciation to you for calling this hearing. Recently, several factors have led to an increase in physicians’ desire 

to invest in specialty hospitals. In particular, many physicians are 

frustrated with hospital control of management and investment decisions that directly affect quality of patient care. Physicians too 

42 

often have little or no involvement in governance and management, 

control over how to reinvest profits, and influence over scheduling 

and staffing needs. 

Physicians need more control over the care their patients receive. 

Investing in specialty hospitals enables physicians to increase productivity, improve scheduling of procedures for patients, maintain 

desired staffing levels, increase nurse-to-patient ratios, and purchase state-of-the-art equipment, all of which improve the quality 

of patient care. 

Studies support the premise that focusing on a specific area of 

service can lead to higher quality and lower cost as a result of more 

expert and efficient care. By performing high volumes of specific 

services, specialty hospitals perfect those tasks, increase accountability for the quality of patient care, lower fixed costs, quickly respond to patient needs, and re-engineer the delivery process as necessary. The bottom line is that patient satisfaction with specialty 

hospitals is extremely high. The recent growth in the number of 

specialty hospitals has led to concern among general hospitals, and 

that concern is competition. Although some hospitals have started 

their own specialty hospitals, the hospital industry has responded 

mainly by attacking physician ownership of the hospitals in an attempt to eliminate competition. General hospitals claim that physicians have a conflict of interest when they invest in specialty hospitals where they refer patients. They claim that such referrals 

amount to channeling patients to these hospitals. Ironically, hospitals are the one that channel patients because they cannot refer 

patients. 

They channel patients in several ways: by purchasing physician 

practices and directing physician referrals to the hospital; by operating health plans with network referral requirements; and by 

adopting policies that force physicians to only refer patients to 

their facilities. We have provided examples of these channeling 

practices as an exhibit to our written statement. There is no data 

to support the claim that physician ownership of and referrals to 

specialty hospitals conflicts with the best interests of their patients. 

Physicians are ethically and legally permitted to own a hospital 

and to refer patients there if they treat patients at that hospital. 

General hospitals also claim that competition from specialty hospitals will hurt them financially by reducing their most profitable 

services, which they use to subsidize unprofitable services. The 

data does not support this claim either. MedPAC’s analysis found 

that general hospitals that compete with specialty hospitals have 

demonstrated financial performance that is comparable to other 

general hospitals. Even if a hospital could prove financial harm, 

the answer is not to eliminate competition and support cross-subsidization of services. The answer is exactly the opposite: to support competition and to eliminate cross-subsidization. 

The Federal Trade Commission and the Department of Justice 

share this view. They recommend the elimination of this cross-subsidization. The AMA supports the changes in the DRG payments 

to more accurately reflect the relative costs of hospital care and 

eliminate the need for cross-subsidization of services by general 

hospitals. We strongly support and encourage competition as a 

means of promoting high-quality, cost-effective health care. ThereVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00046 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
43 

1The MMA defined specialty hospitals as those primarily or exclusively engaged in cardiac, 

orthopedic, surgical procedures and any other specialized category of services designated by the 

Secretary. 2See U.S. General Accounting Office, Specialty Hospitals: Information on National Market 

Share, Physician Ownership, and Patients Served, GAO–03–683R (April 18, 2003); and U.S. 

General Accounting Office, Specialty Hospitals: Geographic Location, Services Provided, and Financial Performance, GAO–04–167 (October 22, 2003). 

fore, the AMA believes that the moratorium on physician referrals 

to specialty hospitals should not be extended. Patients should continue to benefit from increased choice and the competition that results from specialty hospitals. Thank you again for the opportunity 

to provide our views. 

[The prepared statement of Mr. Plested follows:] 

Statement of William G. Plested III M.D., American Medical Association, 

Chicago, Illinois 

Chairman Johnson and Members of the Subcommittee, the American Medical Association (AMA) appreciates the opportunity to provide our views today regarding 

physician owned specialty hospitals. 

The AMA would like to take this opportunity to commend you, Chairman Johnson, for holding this hearing on physician owned specialty hospitals. As you may 

know, hospitals that provide care for a specific type of a patient or a defined set 

of services are not new. Specialty hospitals have been in existence for most of the 

latter half of the twentieth century. Yet more recently, numerous market and environmental factors have led to the increase in physicians’ desire to own and operate 

these hospitals. Since 1995, the number of specialty hospitals has grown significantly. This growth has led to concern among general hospitals who must compete 

with these facilities. 

The AMA strongly supports and encourages competition between and among 

health facilities as a means of promoting the delivery of high-quality, cost-effective 

health care. Consistent with AMA Council on Ethical and Judicial Affairs Opinion 

E–8.032, we support health facility ownership and referral by physicians if they directly provide care or services at the facility. The growth in specialty hospitals is 

an appropriate market-based response to a mature health care delivery system and 

a logical response to incentives in the payment structure for certain services. 

The AMA also supports changes in the inpatient and outpatient Medicare prospective payment systems to more accurately reflect the relative costs of hospital care, 

thus eliminating the need for cross-subsidization. In addition, we support policy 

changes that would help ensure the financial viability of safety-net hospitals so they 

can continue to provide adequate access to health care for indigent patients. Together, these changes would ensure the continued financial stability of general and 

safety net hospitals. Therefore, the AMA believes there is no need to extend the 

moratorium on physician referrals to specialty hospitals. 

BACKGROUND 

As this subcommittee is aware, the Medicare Prescription Drug, Improvement, 

and Modernization Act of 2003 (MMA) imposed an 18-month moratorium on referrals of Medicare and Medicaid patients by physicians investors in certain specialty 

hospitals not already in operation or under development as of November 18, 2003.1

The MMA required the Medicare Payment Advisory Commission (MedPAC), in consultation with the Government Accountability Office (GAO), and the Secretary of 

the Department of Health and Human Services (HHS) to conduct studies of specialty hospitals and report their findings and recommendations to Congress. 

According to the GAO,2 there are 100 existing specialty hospitals—hospitals that 

focus on cardiac, orthopedic, women’s medicine, or on surgical procedures. This 

number excludes numerous other specialty hospitals that have been in existence for 

some time, such as eye and ear hospitals, children’s hospitals, and those that specialize in psychiatric care, cancer, rehabilitation, and respiratory diseases. Of the 

100 specialty hospitals identified by the GAO and 26 others under development in 

2003, there were various owners/investors, including both hospitals and physicians. 

Seventy percent had some degree of physician ownership. One-third of these specialty hospitals were joint ventures with corporate partners, one-third were joint 

ventures with hospitals, and one-third were wholly owned by physicians. 

44 

3Kelly J. Devers, Linda R. Brewster and Paul B. Ginsburg, Specialty Hospitals: Focused Factories or Cream Skimmers? HSC Issue Brief Number 62, April 2003. 4 A Comparative Study of Patient Severity, Quality of Care and Community Impact at 

MedCath Heart Hospitals, The Lewin Group, February 2004. 

FACTORS CONTRIBUTING TO THE GROWTH OF SPECIALTY HOSPITALS 

There are numerous market and environmental factors that have contributed to 

the growth of specialty hospitals, including: 

• Many physicians are frustrated over hospital control of management decisions 

and investment decisions that affect their productivity and the quality of patient care. Physicians often have little or no involvement in governance and 

management, control over reinvestment of profits in new equipment, or influence over scheduling and staffing needs for cases performed in the operating 

room. They believe that hospitals are not collaborating with them to align hospital processes or engage in joint ventures. Physicians who invest in specialty 

hospitals are able to increase their productivity, improve scheduling of procedures for patients, maintain appropriate staffing levels, and purchase desired 

equipment, all of which improve the quality of patient care. • Medicare and private insurer payment rates are perceived to be relatively high 

for certain services, often exceeding hospital costs associated with these services, and relatively low for other hospital services. • Payments for physician professional services have declined while the costs of 

medical practice, such as professional liability premiums, have continued to escalate substantially. As a result, some physicians have sought to increase their 

practice revenues with the facility fees or technical component payments derived from investment in a specialty hospital. • Advances in technology (e.g., minimally invasive surgery) have allowed care to 

be provided in a variety of settings. • Data shows that facilities that focus on certain procedures and perform a significant number of them have better quality outcomes. • Availability of business partners to provide capital and management expertise. 

EFFICIENCY, QUALITY AND PATIENT SATISFACTION 

For various reasons, specialty hospitals have achieved better quality, greater efficiency, and higher patient satisfaction than general hospitals. Specialty hospitals 

are able to achieve production economies by taking advantage of high volumes of 

a narrow scope of services, and by lowering fixed costs by reengineering the care 

delivery process. Managerial and clinical staff at specialty hospitals focus on a relatively narrow set of tasks, thus providing the capability to perfect those tasks and 

benefit from increased accountability for the quality of care provided to patients. According to the Center for Studying Health System Change, the health services literature supports the premise that ‘‘focused factories’’ can lead to higher quality and 

lower costs as a result of more expert and efficient care.3

Managers of specialty hospitals consistently report the factors they perceive as 

critical to achieving high quality patient outcomes: high volume and high nursing 

intensity.4

Specialty hospitals tend to have higher nurse-patient ratios despite the fact that 

physicians at specialty hospitals contend that they spend about 30% of their operating expenses on labor, compared to 40 to 60% for general acute-care hospitals. 

Physician control and facility design also tend to increase productivity and quality. Specialty hospitals improve patient access to specialty care by providing additional operating rooms, cardiac-monitored beds, and diagnostic facilities. Specialty 

hospitals offer newer equipment, more staff assistance and more flexible operating 

room scheduling, thereby increasing productivity and physician autonomy over their 

schedules. Patients are therefore able to benefit from the higher productivity and 

increased flexibility in scheduling their procedures. 

Specialty hospitals are well positioned to address projected increases in demand 

for cardiac, orthopedic, and surgical services because they are a more efficient and 

effective way to deliver the services. In 2002, for example, 500,000 patients were diagnosed with congestive heart failure. With the estimated number of Americans at 

risk of cardiovascular disease projected to mushroom over the next decade, cardiovascular surgeons and cardiologists will need to see twice as many patients in ten 

years as they see today. Aging of the population, population growth, higher functioning and higher quality of life expectations associated with the baby boom generation are driving increased demand for cardiac, orthopedic, and surgical services. 

The greater efficiency of specialty hospitals will better enable physicians to care for 

45 

5 Editorial, In the (Specialty) Hospital, Wall Street Journal, Jan. 3, 2005. 6 A Comparative Study of Medicare Payments Per Episode of Cardiac Care for Patients at 

MedCath Heart Hospitals and Other Hospitals With Open Heart Surgery Programs, The Lewin 

Group, July 2002. 7Impact of MedCath Heart Hospitals on MSA Cardiology Inpatient Utilization Rates, The 

Lewin Group, August 2001. 

these patients. Furthermore, the GAO found that 85 percent of specialty hospitals 

are located in urban areas and tend to locate in counties where the population 

growth rate far exceeds the national average.5 Patient satisfaction with specialty 

hospitals has been very high. They enjoy relatively greater convenience and comfort, 

such as lack of waiting time for scheduled procedures, readily available parking, 24 

hour visiting for family members, private rooms, more nursing stations that are 

closer to patient rooms, decentralized ancillary and support services located on patient floors, and minimized patient transport. Specialty hospitals have engaged in 

extensive collection of data on quality and patient satisfaction, and use the data to 

modify care processes. Because of the smaller size and narrow focus of specialty hospitals, they are more nimble and flexible to quickly respond to modify care processes 

as perceived necessary. 

HOSPITAL INDUSTRY RESPONSE TO INCREASED COMPETITION 

As physicians began seeking greater involvement in the governance and management of patient services provided at hospitals, many who ultimately became investors in specialty hospitals tried initially to form joint ventures with hospitals to expand the availability of cardiology and orthopedic services. In many cases, the hospitals declined to enter into joint ventures with physicians. In other cases, the hospitals opened units or specialty hospitals of their own. By and large, however, general hospitals have become staunch opponents of physician owned specialty hospitals. 

According to the GAO, the financial performance of specialty hospitals tended to 

equal or exceed that of general hospitals in fiscal year 2001.6 The 55 specialty hospitals with available financial data tended to perform better than general hospitals 

when revenues and costs from all lines of business and all payers were included. 

When the focus was limited to Medicare inpatient business only, specialty hospitals 

appeared to perform about as well as general hospitals.7

General hospitals and their respective national and state hospital associations feel 

threatened by the growth of specialty hospitals and physician-owned ambulatory facilities, (e.g., ambulatory surgery centers, GI labs, imaging facilities, radiation oncology centers). Although they claim to support healthy competition, general hospitals 

have recently engaged in an aggressive assault on facilities owned and operated by 

physicians which they have characterized as ‘‘niche-providers.’’ 

The three core strategies the hospital industry is employing to address physician 

ownership of specialty hospitals are: 

• Preemptive strike strategy—The hospital establishes its own specialty hospital 

and addresses some of the physician concerns, but does not offer physicians an 

opportunity for investment. Some hospitals also implement this strategy when 

a competing hospital or health system decides to build its own specialty hospital. 

• Joint venture strategy with local physicians—The hospital recognizes a competitive threat from members of its medical staff or other local physicians and decides to engage in a joint venture with them rather than facing a total loss of 

the service. 

• Fight physicians that try to open a competing facility by building barriers—The 

hospital aggressively limits the potential for developing competing services by 

implementing actions to restrict physicians’ capabilities to do so (e.g., adopting 

‘‘economic credentialing’’ or ‘‘exclusive credentialing’’ policies that revoke or 

refuse to grant medical staff membership or clinical privileges to any physicians 

that has an indirect or direct financial investment in a competing entity). 

The hospital industry has engaged in numerous focused strategies to prohibit physicians from opening a competing facility. At the state level, hospitals have initiated 

several different types of legislative strategies to limit physician-owned specialty 

hospitals. These initiatives include, but are not limited to, the following: 

• Adopting legislation banning the creation of any facility that focuses on cardiac 

care, orthopedic services or cancer treatment. (Florida) 

• Proposing legislation prohibiting physicians from having a financial ownership 

in specialty hospitals. (Ohio and Washington) 

46 

8The hospital associations, however, claim otherwise by distorting AMA ethical opinion E– 

8.032. They claim that it prohibits physician referrals to facilities in which they have an ownership interest unless there is a demonstrated need in the community. (July 6, 2004 letter to 

members of Congress from the Federation of American Hospitals (FAH) and the American Hospital Association (AHA)) The AMA quickly set the record straight, but the hospital associations 

continue to distort AMA policy. (August 4, 2004 letters from Michael D. Maves, MD, MBA to 

House Energy and Commerce Committee, House Ways and Means Committee and Senate Finance Committee.) Although a demonstrated need in the community is one ethical justification 

for a referral to a facility that one owns, it is a mischaracterization of AMA ethical opinion to 

state that it is the only justification. 

• Proposing legislation to expand Certificate of Need (CON) requirements to include other physician-owned facilities such as ambulatory surgery centers and 

diagnostic imaging facilities. (Minnesota) 

• Resisting efforts to repeal CON legislation. (Iowa) 

• Proposing legislation and or regulations requiring specialty hospitals (but not 

other hospitals) to provide emergency departments and/or accept Medicare, 

Medicaid, and uninsured patients. (Washington) 

• Individual general hospitals have implemented a variety of strategies and tactics to discourage members of their medical staff from investing in competing 

physician-owned specialty hospitals. These initiatives include, but are not limited, to the following (See also Exhibit A): 

• Adopting economic/exclusive credentialing/conflict of interest policies and medical staff development plans that revoke or refuse to grant medical staff membership or clinical privileges to any physicians or other licensed independent 

practitioner that has an indirect or direct financial investment in a competing 

entity. 

• Hospital-owned managed care plans denying patient admissions to competing 

specialty hospitals. 

• Requiring health plans to sign an exclusive managed care contract or otherwise 

discouraging them from contracting with competing facilities. 

• Removing physicians that have a financial interest in a competing facility from 

their referral and on-call panels. Refusing to cooperate with specialty hospitals, 

(i.e., refusing to sign transfer agreements). 

• Requiring primary care physicians employed by the hospital or vertically integrated delivery system to refer patients to their facilities or those specialists 

that are closely affiliated with the hospital/health care delivery system. 

• Requiring subspecialists to utilize the hospital/vertically integrated delivery systems facilities for all of their medical group’s referrals, for specified services 

such as outpatient surgery and procedures, all imaging and laboratory work, 

therapy, and inpatient admissions. 

• Hiring in-house specialists to build ‘‘centers of excellence’’ or service lines, sometimes intentionally competing with its own medical staff members. 

• Limiting access to operating rooms and cardiac catheterization labs of those 

physicians that have a financial interest in a competing entity. 

• Removing competing physicians from extra assignments at the hospital, such as 

directors of departments or reading EKGs, ultrasounds, echocardiography, and 

x-rays. 

The hospital industry’s overarching message is that physicians who invest in a 

specialty hospital have a conflict of interest. They use this to justify their strategies 

to eliminate legitimate competition. However, physicians are ethically and legally 

permitted to invest in and refer patients to health facilities. 

Current public policy generally prohibits physicians from profiting from their referral decisions absent a legitimate justification for the referral. AMA ethical opinion E–8.032, ‘‘Conflicts of Interest: Health Facility Ownership by a Physician,’’ delineates two scenarios where physicians may appropriately make patient referrals to 

health facilities in which they have an ownership interest. First, it sets forth a general rule that physicians may appropriately make such referrals if they directly provide care or services at the facility in which they have an ownership interest. Second, it describes a separate situation where physicians may appropriately make 

such referrals, which arises when a needed facility would not be built if referring 

physicians were prohibited from investing in the facility. In the latter case, the appropriateness of the referrals would not depend upon whether the physicians have 

personal involvement with the provision of care at the facility, but whether there 

is a demonstrated need for the facility. Physician ownership of specialty hospitals 

and referral of patients for treatment at such facilities fits squarely within this ethical opinion.8

47 

9See generally 42 U.S.C. 1395nn., 42 CFR 411.350–411.361, 42 U.S.C. 1320a–7b, and 42 CFR 

1001.952. 10 Charles N. Kahn III, A Health-Care Loophole, Washington Times, February 3, 2005. 11GAO, supra note 2. 

In addition to ethical policy, physician self-referral laws and other fraud and 

abuse laws, such as the federal anti-kickback statute, permit physician ownership 

of treatment facilities and referrals to such facilities under various circumstances.9The physician self-referral law, for instance, permits physician ownership and referral of patients to hospitals where the physician is authorized to perform services at that hospital. The hospital associations refer to this exception as 

a ‘‘loophole’’ to bolster their efforts to eliminate the ability of physician owned facilities to compete with their member hospitals. Yet, the exceptions and safe harbors 

have been carefully enacted and promulgated over the years. There is no data to 

support hospital industry claims that physicians are inappropriately referring their patients to specialty hospitals. 

In fact, it is disingenuous for the hospital industry to claim that physicians have 

a conflict of interest when many general hospitals engage in self-referral practices. 

One hospital association claims that a ‘‘community hospital that tried to buy admissions in this way would be outlawed.’’ 10Ironically, however, general hospitals often 

channel patients to their facilities and services. They do this mainly by acquiring 

primary care physician practices or by employing primary care physicians, and requiring those physicians to refer all of their patients to their facilities for certain 

services such as x-ray, laboratory, therapy services, outpatient surgery, and inpatient admissions. They also require such referrals by physicians under certain contractual arrangements or by adopting policies that require members of the medical 

staff to utilize their facilities. (See Exhibit A) 

Hospitals value these controlled referral arrangements to such a degree that they 

maintain them despite the fact that many of these primary care practices and other 

physician arrangements operate at a loss for the hospital. The hospitals are frequently willing to subsidize these practices with profits derived from other departments and services provided by the hospital or health system. 

Hospital efforts to control referrals would pose as much a concern as would physician self-referral if it were proven that such referrals led to an inappropriate increase in utilization. Worse yet, by dictating to whom physicians may refer, the hospital governing body or administration takes medical decision-making away from 

physicians. This runs counter to patient expectations, introduces financial concerns 

into the patient-physician relationship, imposes upon the professionalism of physicians, and can run counter to what the physician believes is in the best interest of 

the patient. These hospital self-referral practices also limit patient choice. 

The AMA is very concerned about efforts by hospitals and health systems to control physician referrals and believes they pose a number of significant concerns. To 

reduce the interference in the patient-physician relationship, the AMA believes that 

disclosure requirements for physician self-referral, where applicable, should also 

apply to hospitals and integrated delivery systems that own medical practices, contract with group practices or faculty practice plans, or adopt policies requiring members of the medical staff to utilize their facilities and services. 

Despite claims by the hospital associations that physician ownership of specialty 

hospitals is a conflict of interest, the data does not support their assertions. The 

Medicare Payment Advisory Commission (MedPAC) found no evidence that overall 

utilization rates in communities with specialty hospitals rose more rapidly than in 

other communities. In addition, of the specialty hospitals identified by the GAO with 

some degree of physician ownership, the average share owned by an individual physician was less than two percent. Of particular significance, the GAO found that the 

majority of physicians who provided services at specialty hospitals had no ownership 

interest in the facilities. Overall, approximately 73 percent of physicians with admitting privileges at specialty hospitals were not investors in those hospitals.11 Therefore, the vast majority of physicians who admit patients to specialty hospitals receive no additional financial incentives to do so. Further, of those physicians who 

do have an ownership interest in the hospital, there is no evidence that their referrals are inappropriate or have increased utilization. 

Specialty hospitals with physician investors believe that the playing field is actually tilted in support of nonprofit hospitals. Nonprofit hospitals are exempt from federal and state income taxes and local property taxes and have access to tax-exempt 

financing. Most nonprofit hospitals also receive Medicare and Medicaid DSH payments. 

On the whole, the impact of specialty hospitals has not proven to be harmful to 

patients or to general hospitals. Specialty hospitals represent about two percent of 

48 

12 Id. 13Schneider, et al., supra note 4. 14Federal Trade Commission and Department of Justice, Improving Health Care: A Dose of 

Competition, July 23, 2004. 

all short-term, acute care hospitals.12 The most recent Medicare discharge data indicate that the 80 specialty hospitals in existence in 2001 accounted for slightly less 

than one percent of Medicare spending for inpatient services. MedPAC also found 

that the financial impact on community hospitals in the markets where physician 

owned specialty hospitals are located has been limited. These hospitals have managed to compensate for any losses of patients and revenues and demonstrate financial performance comparable to other community hospitals. Another study found 

that general hospitals residing in markets with at least one specialty hospital actually have higher profit margins than those that do not compete with specialty hospitals.13 MedPAC also found that specialty hospitals have forced community hospitals to become more competitive, and that specialty hospitals are an attractive alternative for patients and their families. 

COMPETITION SHOULD BE PROMOTED AND CROSS-SUBSIDIES SHOULD 

BE ELIMINATED 

The AMA continues to have serious concerns about the tactics being employed by 

hospitals in their attempts to eliminate competition by prohibiting physician referrals to specialty hospitals in which they have an ownership interest. The AMA believes that the growth in specialty hospitals is an appropriate market-based response to a mature health care delivery system and a logical response to incentives 

in the payment structure for certain services. If general inefficiencies exist in the 

hospital industry, this type of market response will create an incentive for general 

hospitals to increase efficiencies to compete. If the cross-subsidies that hospitals use 

from profitable services are truly enabling them to provide unprofitable services, 

these cross-subsidies should be eliminated by making payments adequate for all 

services. 

The Center for Studying Health System Change, Professor Ted Frech (Department of Economics, University of California at Santa Barbara), the Federal Trade 

Commission (FTC) and the Department of Justice (DOJ) believe there are inherent 

problems in using higher profits in certain areas of care to cross-subsidize uncompensated care and essential community services. Recommendation 3 of the July 

2004 FTC/DOJ Report on Competition and Health Care states: 

Governments should reexamine the role of subsidies in health-care markets in 

light of their inefficiencies and the potential to distort competition. Health-care markets have numerous cross subsidies and indirect subsidies. Competitive markets 

compete away the higher prices and profits needed to sustain such subsidies. Competition cannot provide resources to those who lack them, and it does not work well 

when providers are expected to use higher profits in certain areas to cross-subsidize 

uncompensated care. In general, it is more efficient to provide subsidies directly to 

those who should receive them to ensure transparency.14

Support for specialty hospitals in no way diminishes the important role of the 

general hospital in the community. Emergency and safety net care are important 

and necessary aspects of hospital care—and general and non-profit hospitals should 

be adequately reimbursed for these and other essential services. The AMA does not 

believe that cross-subsidization by high-profit service lines is the appropriate method to fund community health and medical services. To ensure that hospital payments better compensate for these services so that safety-net hospitals receive proper funding, Congress should change the Medicare Hospital Prospective Payment 

System to minimize the need for cross-subsidization and accurately reflect relative 

costs of hospital care. 

MedPAC is expected to recommend that CMS improve payment accuracy in the 

hospital inpatient prospective payment system (PPS) by refining the hospital Diagnosis Related Group (DRG) payments to more fully capture differences in severity 

of illness among patients, basing the DRG relative weights on the estimated cost 

of providing care rather than on charges, and basing the weights on the national 

average of hospitals’ relative values in each DRG. MedPAC will also recommend 

that Congress give the Secretary the authority to adjust the DRG relative weights 

to account for differences in the prevalence of high cost outlier cases. Finally, 

MedPAC will recommend that Congress and the Secretary should implement the 

case mix measurement and outlier policies over a transitional period. 

The AMA supports such recommendations and believes that such payment 

changes will go a long way towards leveling the playing field and promoting full and 

49 

fair competition in the market for hospital services. Consistent with Council on Ethical and Judicial Affairs Opinion E–8.032, the AMA supports health facility ownership by physicians if they directly provide care or services at the facility. The AMA 

also supports competition between and among health care facilities because it promotes the delivery of high-quality, cost-effective health care. 

In addition, the AMA believes that further policy changes are necessary to protect 

America’s public safety net hospitals. Safety-net hospitals provide a significant level 

of care to low-income, uninsured, and/or vulnerable populations. Public hospitals in 

the largest metropolitan areas are considered key safety-net hospitals. These hospitals make up only about 2% of all the nation’s hospitals, yet they provide more 

than 20% of all uncompensated care. Compared with other urban general hospitals, 

safety-net hospitals are nearly five times as likely to provide burn care, four times 

as likely to provide pediatric intensive care, and more than twice as likely to provide 

neonatal intensive care. Safety-net hospitals are also more likely than other urban 

general hospitals to offer HIV/AIDS services, crisis prevention, psychiatric emergency care, and other specialty care. 

Safety-net hospitals rely on a variety of funding sources. However, to finance the 

significant portion of uncompensated care, safety-net hospitals rely on local or state 

government subsidies, Medicaid and Medicare Disproportionate Share Hospital 

(DSH) payments, cost shifting, and other programs. As a group, safety-net hospitals 

are in a precarious financial position because they are uniquely reliant on governmental sources of financing. 

The AMA believes that CMS should correct the flawed methodology for allocating 

DSH payments to help ensure the financial viability of safety-net hospitals so they 

can continue to provide adequate access to health care for indigent patients. In addition, the current reporting mechanism should be modified to accurately monitor the 

provision of care by hospitals to economically disadvantaged patients so that policies 

and programs targeted to support the safety net and the populations these hospitals 

serve can be reviewed for effectiveness. Medicare and Medicaid subsidies and contracts related to the care of economically disadvantaged patients should be sufficiently allocated to hospitals on the basis of their service to this population in order 

to prevent the loss of services provided by these facilities. The AMA recognizes the 

special mission of public hospitals and supports federal financial assistance for such 

hospitals, and believes that where special consideration for public hospitals is justified in the form of national or state financial assistance, it should be implemented. 

CONCLUSION 

There is no evidence that general hospitals are suffering as a result of the growth 

of physician owned specialty hospitals. Specialty hospitals increase competition in 

the hospital industry and provide patients with more choice—forcing existing hospitals to innovate to keep consumers coming to them. This is a win-win situation 

for patients. Supporting health delivery innovations that enhance the value of 

health care for patients is the only way to truly improve quality of care while reigning in health care costs. 

Based on the MedPAC and FTC/DOJ recommendations and the limited data currently available on physician ownership of specialty hospitals, the AMA believes 

that patients will be better served if Congress does not act to extend the 

moratorium on physician referrals to specialty hospitals in which they 

have an ownership interest. After the payment changes take effect, 

MedPAC, HHS and others should continue to monitor specialty hospitals 

and the impact on general hospitals and patient care. 

We appreciate the opportunity to testify on this important issue. We urge the 

Subcommittee and Congress to consider the recommendations we have discussed 

today. We are happy to work with the Subcommittee and Congress as it considers 

these important matters. 

f 

Chairman JOHNSON. Thank you very much, Dr. Plested. Dr. 

Brien? 

STATEMENT OF WILLIAM W. BRIEN, M.D., CEDARS-SINAI 

MEDICAL CENTER, LOS ANGELES, CALIFORNIA 

Dr. BRIEN. Madam Chairman, Mr. Stark, Members of the Subcommittee, I am Dr. William Warren Brien, director of orthopedic 

50 

surgery and the clinical chief of the Department of Surgery at Cedars-Sinai Medical Center in Los Angeles. I am here today to share 

my concerns about the impact physician-owned, limited-service hospitals can have on patient access to essential medical services. 

As an orthopedic surgeon, I have a unique perspective on today’s 

topic. Several of the physician-owned, limited-service hospitals 

were started by orthopedic surgeons. But let me be clear. Many 

physicians do not agree with the practices of some of our colleagues 

who own these hospitals and exploit a loophole in the Federal law 

by referring carefully selected patients to their own facilities. This 

raises serious concerned about conflicts of interest, a physician’s 

own financial interest versus the best care for patients. Of equal 

concern is the impact on our broader health care system, in particular, how these practices threaten the Los Angeles’ already fragile emergency and trauma care system. 

Cedars-Sinai Medical Center is a 900-bed, not-for-profit, fullservice hospital that serves as a local community hospital, a tertiary regional referral center for complex patient care, a Level I 

trauma center, and a major research, education, and training hospital. Each year we provide about $100 million in charity care. As 

a Level I trauma center, we are required to have physicians on call 

24 hours a day, 7 days a week in all of our departments. Last year, 

we treated more than 75,000 people in our emergency Department 

and handled an additional 1,500 trauma cases, half involving uninsured patients. 

Los Angeles’ physician-owned, limited-service hospitals offer no 

trauma care and only severely limited emergency services, if at all. 

In my opinion, they should not even be called ‘‘hospitals’’ but, rather, be called ‘‘limited-access facilities.’’ The physicians who own 

them carefully select and refer only those patients with private, 

commercial, or Medicare health coverage. The only services they 

offer are high-revenue-producing surgical procedures. In the last 2 

years, nine community hospitals in the Los Angeles area closed. 

Last year, the county closed the Level I trauma center at the Martin Luther King, Jr., Medical Center. These losses have created a 

significant strain on the Los Angeles County trauma system and 

the Cedars-Sinai participation in this trauma system and raised serious access-to-care issues that will only worsen if limited-access facilities are allowed to proliferate. 

Some existing community hospitals will close their high-cost 

emergency rooms. Others will close altogether because they cannot 

remain financially solvent. Our area’s trauma system would face a 

complete collapse as fewer hospitals are left to handle an increased 

number of emergency cases. Fewer operational trauma centers 

mean more patients will die needlessly during longer transports in 

search of the available trauma centers. limited-access facilities also 

jeopardize general emergency care for everyone. Physicians who 

own them often refuse to participate in emergency on-call duty at 

other community hospitals, leaving full-service hospitals struggling 

to maintain specialty coverage in their emergency departments. 

And Los Angeles is not the only place in the country where this 

is a problem. 

As a physician, I also worry about the safety of some of our patients treated by limited-access facilities which often treat only sinVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00054 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
51 

gle conditions. When patients suffer complications following surgeries at these facilities, such as blood clots or heart attacks, they 

must transfer them to full-service hospitals for treatment. Both the 

GAO and MedPAC have found disturbing patterns in the operation 

of physician-owned, limited-access facilities that reflect exactly 

what Congress feared: physician owners refer only healthier patients with good health insurance, were less likely to offer emergency services while focusing on well-paying medical procedures. 

And MedPAC found that these facilities are not less expensive than 

full-service community hospitals. 

Despite what our opponents say, full-service hospitals do not 

take issue with the formation of limited-access facilities when supported by community need, and we do not take issue when physicians own them. It is when physicians refer their patients to the 

facilities that they own. This creates a conflict of interest with serious health and economic repercussions for communities everywhere. Madam Chairman, I respectfully urge Congress to protect 

health care access for all patients by extending the current moratorium on these limited-access facilities until a permanent ban on 

physician self-referral to physician-owned, limited-access facilities 

can be put into place. Thank you, and I will be happy to respond 

to your questions. 

[The prepared statement of Mr. Brien follows:] 

Statement of William Brien, M.D., Cedars-Sinai Hospital, Los Angeles, 

California 

Good afternoon, Madam Chairman. I am Dr. William Warren Brien, director of 

orthopedic surgery and the clinical chief of the department of surgery at CedarsSinai Medical Center in Los Angeles. I also serve as a state commissioner on the 

California Health Policy and Data Advisory Commission. I appreciate the opportunity to testify today on the issue of limited-service hospitals. 

In many communities, certain physicians are exploiting a loophole in federal law, 

and own limited-service hospitals to which they refer their own patients. This activity raises serious concerns about conflict of interest, fair competition, and whether 

the best interests of both patients and communities are being served. 

To protect patients and the health care safety net, Congress should close the loophole in the federal Stark law by continuing the ban on the ability of physicians to 

self-refer to limited-service hospitals. 

As an orthopedic surgeon, I may bring a unique perspective to this debate. Many 

of the physician-owned limited service hospitals operating today were opened by orthopedic surgeons. I would like to be clear. Many physicians do not agree with the 

practices of some of our colleagues. Physicians who own these limited services hospitals and refer their patients there have potential conflicts of interest—their own 

financial interests with the interest of the best care for patients. And government 

data shows this to be the case. Of equal concern, is the impact on our broader 

health care system. 

My testimony will focus on concerns related to patient access to essential health 

care services and the adverse consequences that would surely result if the current 

moratorium on physician self-referral of Medicare patients to new limited-service 

hospitals were permitted to sunset in June. If the continued growth of these limited 

service hospitals is allowed, it will have a profound impact on overall patient access 

to life-saving hospital care. 

The Situation in Los Angeles 

Cedars-Sinai Medical Center is a 900-bed, not-for-profit, full-service hospital that 

serves as a local community hospital, a tertiary regional referral center for complex 

patient care, a Level I Trauma Center for the County of Los Angeles, as well as 

a major research, education and training hospital. Our mission has always centered 

on providing quality patient care and community service. 

The medical center annually provides about $100 million of charity care. We deliver primary health care services directly to inner-city children and adults through 

mobile units. We offer community clinics to uninsured patients and those covered 

52 

by Medi-Cal—the state’s Medicaid program—with more than 29,000 clinic visits annually. In fact, Cedars-Sinai is one of the top five Medi-Cal providers among private 

hospitals in L.A. County and is one of the largest Medi-Cal providers in the state 

of California. 

As a Level I Trauma Center, we are required to have physicians on call 24-hours 

a day, seven days a week in all of our departments. In a major urban area like Los 

Angeles, trauma injuries affect everyone from the wealthy, the poor and the insured 

to the uninsured. Last year, we treated more than 75,000 people in our emergency 

department and we handled an additional 1,500 trauma cases. Approximately half 

of those trauma cases involved uninsured patients. 

In sharp contrast, the physician-owned limited-service hospitals currently operating in Los Angeles offer no trauma care and only severely limited emergency services if anything at all. In my opinion, they should not even be called hospitals—but 

rather limited-access facilities. The physicians who own these limited-access facilities carefully select only patients with the right type of health insurance coverage— 

private or commercial insurance or Medicare—and then refer them to those facilities 

that they own. Poor patients covered by Medi-Cal or those without insurance at all 

are not welcome. These limited-access facilities also offer only high-revenue-producing surgical procedures. They do not offer the many services that we and other 

full-service community hospitals do that are seldom self-supporting, such as pediatric and obstetrical care, mental health programs, or services specifically targeting 

care for the poor and the elderly. 

Meanwhile, the full-service community hospitals provide those services and 

more—emergency services for all of the area’s patients, including the poor, the uninsured and those in need of costly, intensive care. 

The Effects of limited-access Facilities 

During the last two years, nine community hospitals in the Los Angeles area 

closed their doors forever. In 2004, the County of Los Angeles closed the Level I 

Trauma Center at Martin Luther King Jr. Medical Center. The loss of those nine 

hospitals and their emergency departments combined with the closure of the Martin 

Luther King Trauma Center has created a significant strain on the Cedars-Sinai 

trauma system and raises a serious access-to-care issue for the people of Los Angeles. 

Our already fragile health care system in Los Angeles will only be made worse 

if physician-owned, limited-access facilities are allowed to proliferate. Some existing 

community hospitals will certainly close their high-cost emergency rooms. Other, 

smaller community hospitals will likely not be able to maintain their financial solvency and will fold. Both scenarios would inevitably lead to a complete collapse of 

our area’s trauma system as fewer remaining hospitals are left to handle an increased number of emergency cases. 

Imagine being involved in a serious traffic accident at 5 p.m. on a Friday in Los 

Angeles’ notoriously bad rush hour traffic. Rather than arriving at a trauma center 

within 10 to 20 minutes, the trip now takes 30 minutes to an hour because the closest emergency rooms have since closed up shop for good. I am not an alarmist, but 

in trauma cases where every second counts, that scenario means that patients will 

die unnecessarily. That is a risk that we cannot afford to take. 

limited-access facilities also jeopardize general emergency care available to everyone in Los Angeles. Physicians who own limited-access facilities often refuse to participate in emergency ‘‘on call’’ duty at other community hospitals, leaving the fullservice hospitals struggling to maintain specialty coverage in their emergency departments. This means that a patient who needs emergency surgery in the middle 

of the night, may not get it because the needed specialists will not care for the 

broader needs of the people of Los Angeles. It could also mean that emergency patients must be transported much farther away to get access to care. 

And this isn’t just happening in L.A. Struggles to maintain specialty coverage in 

the emergency department are jeopardizing care across America. In Oklahoma City, 

for example, specialty physicians practicing in limited-access facilities reduced or 

eliminated their participation in emergency on call duty at Oklahoma University 

Medical Center, bringing their trauma center—the state’s only Level 1 Trauma Center—to the brink of closure. And in Rapid City, South Dakota, the neurosurgeon 

owners of the limited-access facility in the community stopped providing emergency 

coverage at the full-service hospital, causing significant access problems for the region for emergency neurosurgery. 

Because limited-access facilities often treat only a single condition, I worry as a 

physician about the safety of some patients treated there. Patients are placed at an 

increased risk when they suffer complications following surgeries at limited-access 

facilities, such as blood clots and heart attacks, and must be transferred to the fullVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00056 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
53 

service hospitals for treatment. Care for those patients cannot be well-managed and 

coordinated. 

If limited-access facilities are permitted to expand in number, they will certainly 

have significant adverse consequences for the ability of Cedars-Sinai and other community hospitals to continue to provide the high quality of patient care that we provide today to the Los Angeles community. Patient access will inevitably suffer. 

Government Concerns 

Both the Government Accountability Office (GAO) and the Medicare Payment Advisory Commission (MedPAC) in separate studies revealed disturbing patterns in 

the operation of physician-owned, limited-access facilities. Specifically, they found 

that physician owners do exactly what Congress feared—they selectively refer only 

healthier patients with good health insurance coverage to those limited-access facilities they own, refusing to treat others. As a result, full-service hospitals are left to 

treat a greater number of poor and uninsured patients with more serious health 

conditions. Further, the GAO and MedPAC also found that the limited-access facilities were much less likely to offer emergency services and tend to offer only highly 

profitable services. And MedPAC found that limited-access facilities are not less expensive. 

Based on its concerns over the rapid growth of physician-owned, limited-access facilities and potential conflicts of interest posed by physician-ownership of the facilities, Congress implemented in 2003 a moratorium prohibiting physicians from referring Medicare patients to new, physician-owned limited-service hospitals as part of 

the Medicare Modernization Act. That moratorium is set to expire in June, but 

based on their findings, MedPAC has recommended that the moratorium be extended to Jan. 1, 2007. 

This Is Not About Competition—It’s about Conflict of Interest 

Our opponents have argued that full-service hospitals do not want limited-access 

facilities to exist in our market-driven health care system. Let me set the record 

straight. Full-service hospitals do not take any issue with the formation of limitedaccess facilities, where supported by community need. Nor do they take issue with 

physician ownership in a hospital that the physician does not refer to. Rather, fullservice community hospitals strongly oppose the conflict of interest that results 

when a physician is an owner and controls patient referrals. Those two elements— 

ownership and patient referral—lead to very serious concerns about the health and 

economic interests of a community, including higher health care costs, duplication 

of services, patient cherry-picking, reduced emergency care coverage, inappropriate 

use of procedures, patient selection, and more. 

Conclusion 

In closing, Madam Chairman, I respectfully urge Congress to extend the moratorium until the permanent solution of banning physician-self-referral to physicianowned limited-access facilities is in place. I firmly believe that these limited-access 

facilities have significant adverse consequences on the health care that patients expect and deserve. And their negative impact will be felt by everyone. 

f 

Chairman JOHNSON. Thank you, Dr. Brien. Mr. Harris? 

STATEMENT OF JAMIE HARRIS, EXECUTIVE VICE PRESIDENT 

AND CHIEF FINANCIAL OFFICER, MEDCATH CORPORATION, 

CHARLOTTE, NORTH CAROLINA 

Mr. HARRIS. Madam Chairwoman, Mr. Stark, and Committee 

members, my name is Jamie Harris. Thank you for the opportunity 

to testify today. I am Executive Vice President and CFO for 

MedCath. We operate fully licensed acute-care hospitals that focus 

on cardiovascular care. All of our hospitals are owned in partnership with physicians, and in two cases a local community hospital 

system. 

Each of our hospitals operates a staffed emergency Department 

which is open 24 hours per day, 7 days per week. Our hospitals include approximately 175 to 300 physicians who are not cardioVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00057 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
54 

vascular doctors and who are not owners of the hospital. As a result, we are capable of treating a broad range of patients, regardless of their ability to pay or their condition. 

In fact, in the last year alone, we treated more than 60,000 patients in our emergency departments; 63 percent of these patients 

were not cardiovascular patients. We do not believe the evidence 

suggests a conclusion that any financial incentive associated with 

physician ownership determines patient or payer mix. Our internal 

data shows a small amount of our patients come to our hospitals 

from physician owners. As the chart that we have put up illustrates, in 2002, our internal statistics show that approximately 69 

percent of our patients came to our hospitals through sources that 

were not directly from a physician referral: 31 percent came from 

the emergency departments at our hospitals; 24 percent came from 

transfers from other hospitals, many of which were from rural communities; and 14 percent came from non-owner physicians. Only 

approximately 30 percent came directly from physician owners. 

We believe that patients and physicians use MedCath hospitals 

because we achieve better outcomes, with fewer complications, and 

have earned the confidence of our communities. In fact, the Lewin 

Group found that our hospitals, when compared to peer hospitals, 

have a 16-percent lower in-house mortality rate for Medicare cardiac cases and approximately 25 percent more of our patients are 

discharged directly to their home versus a skilled or other care facility. The Lewin Group estimates this saves Medicare approximately $1.5 million per facility per year. Imagine the billions of 

dollars that we could save Medicare if these results were the standard of care across the country. 

We believe physician ownership is the key contributor to these 

quality outcomes. Physicians become owners because of dissatisfaction with the quality of care, the efficiency, and much of the bureaucracy of community hospitals. Ownership and their role in governance motivates them to help design and operate our hospitals 

in a manner which has a direct, positive impact on patient care 

and patient satisfaction. Community hospitals in our markets have 

improved services as a result of our competitive presence. MedPAC 

concluded that physician-owned specialty hospitals serve as a 

wake-up call for the community hospitals to improve services and 

efficiencies. They also concluded that specialty hospitals have little 

impact on the profitability of community hospitals. They found that 

community hospitals were able to make up lost cardiac revenue 

from other sources or by reducing their costs, and they also concluded there was no significant increase in utilization after the 

entry of a specialty heart hospital into a market. 

We do also provide care to the Medicaid and uninsured patients. 

We believe there are three important reasons, however, why our 

hospitals receive fewer Medicaid patients. First, 42 percent of the 

Medicaid discharges are for obstetrics; only 9 percent are for cardiac care. Second, the volume of Medicaid patients is not uniformly 

distributed across all hospitals, regardless of whether they are community hospitals or specialty hospitals. In fact, in most communities only one or two hospitals primarily serve all the Medicaid— 

a primary amount of the Medicaid patients. And, third, several 

States that we operate in administer their Medicaid programs 

55 

through a capitated payer arrangement which we do not have access to. Further, the Lewin Group found that in all markets with 

comparable data, our hospitals ranked in the top half of volume for 

cardiac care provided to indigent patients. The MedPAC study 

found that our costs were not lower. However, we believe a more 

thorough analysis is required. The Lewin Group replicated and has 

expanded on this particular study and found the following factors: 

First, our hospitals are new facilities and, thus, our depreciation 

costs are substantially higher. Second, because we are new, they 

have higher interest costs in the early stages of development. And, 

third, our hospitals are not tax-exempt; therefore, we are required 

to pay significant levels of property, real estate, and income taxes. 

After accounting for these differences, this study found that our average operating cost per discharge was about 6 to 7 percent lower. 

A growing number of not-for-profit hospital systems are also embracing physician ownership as well. For example, our partner 

Avera McKennan in South Dakota and Carondelet in Tucson, Arizona, are good examples of not-for-profit systems that recognize the 

benefits of an innovative model with physician owners. 

In conclusion, the advantages of competition to the health care 

sector are essential to meet the growing demand for cardiovascular 

services. The moratorium merely endorses the failings of the status 

quo and should be allowed to expire in order to stimulate the much 

needed competition. We agree that CMS should focus on revising 

the DRG pricing system to be more aligned with actual costs of certain procedures and diagnoses, as long as it is done fairly and comprehensively. The public policy issue here is not about limiting specialty hospitals through a moratorium even if it is temporary. The 

public policy issue is about the need to meet the emerging health 

care requirements of our population. We believe our model is an innovative approach to meet those needs. I thank you for the time 

and welcome questions. 

[The prepared statement of Mr. Harris follows:] 

Statement of Jamie Harris, Executive Vice President and Chief Financial 

Officer, MedCath Corporation, Charlotte, North Carolina 

INTRODUCTION 

My name is Jamie Harris. I currently serve as Executive Vice President and Chief 

Financial Officer for MedCath Corporation (MedCath). Thank you for the opportunity to speak on behalf of our company, our physician partners, our nurses, our 

professional staff, and the patients who have utilized MedCath’s hospitals. Based in 

Charlotte, North Carolina, MedCath is a national provider of cardiovascular services. We build and operate fully licensed acute care hospitals, and other clinics and 

centers focusing on cardiovascular care. All of our 12 hospitals are owned in partnership with physicians and, in certain instances, a local community hospital. 

We have established an outstanding reputation for innovation and for our focus 

on providing high-quality cardiovascular care. We believe that patients with cardiovascular disease in the communities we serve receive better care as a direct result 

of the presence of our hospitals in those communities. 

As part of my written statement, I review the recent findings by the Medicare 

Payment Advisory Commission (MedPAC) concerning physician-owned specialty hospitals, and note where we agree and disagree with their analytic results. For the 

most part, MedCath-sponsored studies confirm MedPAC’s results. There are several 

important instances, however, where we disagree with their conclusions and study 

inferences. As an example, in assessing physician behavior, the MedPAC analysis 

fails to completely investigate and understand the source of referrals and the patient selection process at specialty hospitals. 

56 

1 Hospitals with Emergency Departments must comply with the regulations required by the 

Emergency Medical Treatment and Labor Act (EMTALA) and provide services to anyone coming 

to our hospitals seeking emergency medical care, regardless of their condition and their ability 

to pay. 2Trendstar discharge-based data October 1, 2003—September 30, 2004. 

3Trendstar admission source data October 1, 2003—September 30, 2004. 

THE NEED FOR HIGH-QUALITY CARDIOVASCULAR SERVICES 

According to the American Heart Association, cardiovascular disease is one of the 

leading killers in America, especially among women. While the current health care 

system is already feeling the stress from this demand, the aging baby boomer population is expected to place increased pressure on the system. Yet, of the more than 

6,000 hospitals that exist across the United States, only approximately 18 percent 

have an open-heart surgical program. 

Furthermore, according to the American College of Cardiology, by 2010, the shortage of cardiologists could become a serious public health problem if the supply of 

high-quality cardiology care cannot meet the demands of the population—particularly from the aging baby boomers. It is imperative that we make the current population of cardiologists more productive in their professional lives if we are to meet 

this demand; something MedCath hospitals are designed to do. 

WE ARE FULL SERVICE HOSPITALS THAT PROVIDE EMERGENCY CARE 

Each of our hospitals operates a staffed emergency department that is open 24 

hours a day, 7 days a week, equipped with an average of eight Intensive Care Unit 

beds, in addition to the inpatient beds to which patients can be transferred. As a 

result, MedCath heart hospitals are capable of treating nearly every patient regardless of their condition or ability to pay.1 We are capable of doing this because each 

of our hospitals includes a medical staff of 175–300 specialists, sub-specialists, and 

primary care physicians (most of whom are not owners of the hospital) who are 

available to care for patients that walk through our doors, whether they are a patient with a heart problem or not. 

In fact, in the most recent 12-month period ending September 30, 2004, morethan 

60,000 patients were treated in the emergency departments of MedCath’s hospitals. 

Approximately 63 percent of those treated were non-cardiac patients. Only 2.84 percent of these non-cardiac patients were transferred to another hospital—a common 

practice among hospitals across the United States as not every acute care hospital, 

not even the large systems, offers specialized services such as trauma, burn, or psychiatric care. Our hospitals admitted, treated, and/or released the remaining 97.16 

percent of these patients.2

PATIENT SEVERITY AND PATIENT MIX ARE A RESULT OF APPROPRIATE 

COMMUNITY REFERRAL PATTERNS 

The MedPAC report found that specialty hospitals treat less severe patients than 

community hospitals. Our own internal data shows similar patient severity results, 

but the differences in patient severity across hospitals are not due, as MedPAC suggests, to the intentional selection of patients for financial gain. Rather, these differences are due to community referral patterns that place patients in the appropriate setting for their required treatment conditions. We do not believe the evidence supports a conclusion that any financial incentive associated with physician 

ownership is a key determinant of patient (and payor) mix. 

Ultimately, the MedPAC study fails to reflect a complete investigation and understanding of the source of our referrals and the patient selection process at our hospitals. While the critics of our model would have you believe that a significant majority of the referrals to our hospitals are from physician-owners, our internal data 

shows that these referrals actually represent a minority of the referrals to our hospitals. For the study year 2002, MedCath statistics show that: 

• Only approximately 30 percent of our referrals are from physician-owners. • Approximately 24 percent of MedCath’s in-patient admissions came as referrals 

from other hospitals, particularly those located in rural areas. These referrals 

were from hospitals that either did not have the capacity or the expertise to 

treat the patients.3

• Approximately 31 percent of MedCath’s hospital admissions arrived through our 

emergency departments. • Approximately 14 percent of MedCath’s referrals were from physicians who did 

not have an ownership interest in our hospitals, but who prefer to practice 

there. 

57 

• All totaled, approximately 69 percent of MedCath’s patient admissions 

arrive at the hospital through sources other than our physician partners. Patients come to our hospitals for the quality of care, our expertise, and 

our efficiency. 

What the MedPAC study overlooked is that non-investor physicians, largely primary care physicians, are typically the first point of contact that a patient has with 

the physician community. Not only is the primary care physician the primary source 

of many services, he or she also coordinates the logistics of many specialists (i.e., cardiologists) for the patient. While MedPAC has suggested that the hospital selection is made by physicians for financial reasons, it is clear that our country’s medical triage system is structured so that the first point of contact is with the primary 

care physician, and thus he or she becomes the most significant decision-maker in 

the hospital selection process. Ultimately, patients receive care from the provider or 

institution best suited for their medical needs. 

The most egregious cases of improper physician referrals and financial incentives 

are not occurring at hospitals with physician ownership, but from non-physician 

owners who are using ‘‘professional fees’’ and other questionable forms of remuneration as inducements to refer. We find it ironic that some of the for-profit hospitals 

who have been charged, in some cases criminally, with these practices are now leading a charge against physician ownership. 

PHYSICIAN OWNERSHIP IS A KEY CONTRIBUTOR TO HIGHER QUALITY 

OUTCOMES AND IMPROVED EFFICIENCY 

Despite assertions by MedPAC that physicians become owners in specialty hospitals for financial gain, the reality is that physicians become owners because of dissatisfaction with the quality of care, efficiency, and bureaucracy of their local hospitals, and to have an opportunity to make dramatic improvements in the delivery 

of health care. With ownership in the facility and a significant role in the governance and operation of the hospital, physicians are motivated to design and operate 

highly efficient care delivery systems that have a direct, positive impact on patient 

care. This increased control over clinical protocols and the quality of care process 

naturally motivates physicians to send their patients to these facilities—where they 

have confidence in the care provided. 

The involvement of our physician partners in the governance and operations of 

our hospitals is a critical factor that contributes to quality patient care and is a logical by-product of their status as owners and board members. MedCath partners 

with local physicians who have established reputations for clinical excellence. We 

believe this alignment of interest between the physicians and the hospital operator 

is a primary reason MedCath hospitals have been able to improve the quality of 

care, reduce the average length of stay, save money for government payors, and 

achieve high levels of patient satisfaction.[4] MedCath has found that the economic 

commitment of physicians, under a physician ownership model, is in the best interest of the communities served and has resulted in the provision of a higher level 

of care and cost efficiencies. 

In the case of MedCath’s partnerships, all investors must assume financial risk 

and accountability for the hospital and the care provided. As startup businesses, all 

of our hospitals experience significant early stage losses, and there is no assurance 

they will subsequently be able to turn profitable. For some of our doctors, this has 

led to a financial return on their investment. For others, it has led to no financial 

benefit and in the case of one of our hospitals, which we had to close due to the 

anti-competitive tactics of the surrounding general hospitals, a loss of almost all of 

their investment. Ownership also causes the physician to have a greater incentive 

to self-police their peers—ensuring their use of the facility is appropriate. 

The weight of the evidence contradicts any finding that our physicians become 

owners simply for financial gain. We find it hypocritical for community hospitals to 

criticize physicians for having ownership interests in hospitals because it may influence referrals, when it is commonplace for these same hospitals to own practices 

and employ physicians at least in significant part for the purpose of directing referrals to their facilities. We also find it ironic that the federal agency with responsibility for enforcing the anti-physician referral statute has issued several advisory 

opinions approving ‘‘gainsharing’’ arrangements, which permit physicians, with no 

capital at risk, to receive distributions based on their ‘‘personal cost-saving efforts.’’ 

A ‘‘WAKE-UP’’ CALL TO COMMUNITY HOSPITALS 

While competition, regardless of the industry, is not always welcomed, the communities where MedCath hospitals are located have benefited significantly from our 

58 

7 Impact of MedCath Heart Hospitals on MSA Cardiology Inpatient Utilization Rates, The 

Lewin Group, August 2001. 

competitive presence. As indicated by MedPAC’s findings, physician-owned specialty 

hospitals often serve as a ‘‘wake-up call’’ for the traditional acute care hospitals in 

a community to improve services and efficiencies. Specifically, MedPAC found that 

specialty hospitals focus community hospitals on the issues of hospital operations 

and physician relations. Community hospitals in these markets have made constructive improvements, including extended service hours, improved operating room 

scheduling, standardization of supplies in the operating room, and upgraded equipment. This is evidence that community hospitals are responding to the new competitive pressures from specialty hospitals in a way that benefits patients, doctors and 

the entire community. 

A recent report released by the Federal Trade Commission and the United States 

Justice Department’s antitrust division similarly calls for vigorous competition in 

the health-care marketplace and elimination of protectionist policies that are preventing consumers from gaining access to high quality health care. Hardly a rush 

to judgment, this report was put together over a two-year period from 6,000 pages 

of transcripts, over 27 days of joint hearings and workshops, from the testimony of 

more than 250 panelists—including many hospital and health system executives 

and association leaders. The report found that ‘‘[e]ntry by single specialty hospitals 

[into the marketplace] has had a number of beneficial consequences for consumers 

who receive care from these providers.’’ 

A recent editorial in the Wall Street Journal also supports the concept of ‘‘marketoriented health-care reform.’’[5] Discussing specialty hospitals in particular, the article notes that their focused mission allows these hospitals to limit costs, increase 

quality, and give consumers greater choice over health decisions. Noting the recent 

attempts at limiting specialty hospitals, the article argues that critics of these hospitals want to limit consumer choice and ‘‘forc[e] patients into treatment at less-optimal facilities for no reason other than to prop up the current system.’’ 

Furthermore, the independent Lewin Group reported that MedCath’s eight hospitals that were open in 2002 on average saved Medicare between $12.2 million and 

$15.2 million per year. This is an average of $1.5 million to $1.9 million per hospital 

and resulted from our hospitals’ ability to discharge more patients to their homes 

versus to sub-acute care facilities or skilled nursing facilities.[6] Imagine the billions 

of dollars that the national healthcare system could save if the higher quality of 

care and lower cost structure that our hospitals have achieved could be replicated 

by other hospitals. Yet some of the large hospital systems are insisting that Congress enact barriers to this type of innovation and competition. 

MEDCATH’S HOSPITALS DO NOT ADVERSELY IMPACT PROFITABILITY AND 

UTILIZATION 

Our own independent studies confirm MedPAC’s significant finding that specialty 

hospitals have ‘‘little impact’’ on the profitability of community hospitals. In fact, 

MedPAC found that community hospitals were able to ‘‘make up’’ lost cardiac revenue from other sources or reduce their costs. MedPAC found, for instance, that 

community hospitals with a heart hospital in their market actually have a higher 

profit margin (3.4 percent) in 2002 than community hospitals without a heart hospital (2.7 percent) in their market. This is a critical point that we think is important 

for Congress to recognize. 

Our independent studies also confirm the MedPAC finding that there was no statistically significant increase in utilization after the entry of a specialty heart hospital into a market.7 In our opinion many of the markets where we have hospitals 

were significantly under served prior to our entry into the community and that we 

met a much-needed demand, thus bringing the market up to parity with other markets. We believe that this unfulfilled need that our hospitals have met has had a 

very positive impact in the communities where we are located. 

ANTI-COMPETITIVE TACTICS IN RESPONSE TO COMPETITION FROM OUR 

HOSPITALS 

Even though MedCath has experienced improvements in the level of cardiac care 

in communities served, this competition clearly draws many anti-competitive tactics 

by the community hospitals which obviously do not appreciate the entrance of a new 

competitor into their market. In many markets across the country, community hospitals are retaliating against physician-owners. Often, once a physician decides to 

invest in a hospital, he or she may be removed from reading panels and certain call 

59 

8See note 1 supra. 9 A Comparative Study of Patient Severity, Quality of Care between MedCath Heart Hospitals 

and Peer Hospitals in The MedCath Market Area, The Lewin Group, March 2004. 

rotations, fired from a medical director position, or given the least desirable times 

in the catheterization lab or surgery suite. 

Another example is the community hospitals engaging in economic credentialing 

or granting privileges based on financial reasons rather than qualifications. In Little 

Rock, Arkansas, six cardiologists filed suit against Baptist Health System (Baptist) 

alleging that the hospital’s policy of economic credentialing violated state laws 

against Medicaid fraud and deceptive trade practices, and the federal anti-kickback 

law. All six cardiologists are shareholders in Little Rock Cardiology Clinic, which 

holds a 14.5 percent ownership interest in the Arkansas Heart Hospital, a competitor of Baptist. Two of the doctors were told their medical staff privileges at Baptist 

would be terminated because of their clinic’s stake in the Arkansas Heart Hospital, 

and the others are expecting similar notices. 

We believe this debate is clearly about competition. We believe the retaliatory actions in many of the markets demonstrate the anti-competitive strategy of our competitors—to totally dominate the market place, rather than to provide patients with 

the opportunity to seek quality care from the provider of their choice. 

MEDCATH HOSPITALS HAVE BETTER OUTCOMES AND FEWER 

COMPLICATIONS 

The Lewin Group has confirmed that: 

• MedCath hospitals provided better care on average (as measured by lower 

in-hospital mortality rates and lower rates of complications) in a shorter period of time than the peer community hospitals. 

• After adjusting for risk of mortality, MedCath heart hospitals on average exhibited a 16 percent lower in-hospital mortality rate for Medicare cardiac 

cases compared to the peer community hospitals, including major teaching facilities. 

• MedCath heart hospitals also had shorter average lengths of stay for cardiac 

cases (3.81 days) than the peer community hospitals (4.88 days) after adjusting 

for severity. 

• Approximately 90% of our patients are discharged to their home instead of 

being discharged to a subacute care facility, home health agency, or skilled 

nursing facility. Not only is this better for the patient, the Lewin Group also 

estimates it saves Medicare approximately $1.5 million per facility per year. 

As evidence of our commitment to providing quality care, we advocate for a performance based payment system that provides incentives for delivering top quality 

health care. 

MEDCATH HOSPITALS CONTRIBUTE TO THE CARE OF THE UNINSURED 

AND OUR LEVELS OF MEDICAID PARTICIPATION ARE NOT ATYPICAL 

While the MedPAC report suggests that a financial motive drives patient selection, the reality is vastly different. Acute care licensed facilities, such as MedCath’s, 

are required by law to treat patients regardless of their ability to pay.8 While this 

may be the law, MedCath also believes it is a community responsibility to treat anyone who walks in our doors and needs medical care. 

In fact, a Lewin Group study found that in all four markets where comparable 

data was available, MedCath hospitals ranked in the top half of area hospitals for 

the volume of cardiac care provided to indigent patients.9 Approximately 75–85 percent of the self-pay/uninsured care is provided without compensation. Despite this 

large amount of uncompensated care, our hospitals and their services are available 

to all patients in need of quality cardiovascular care. 

Similarly, allegations that we do not provide services to the Medicaid and selfinsured populations are plainly incorrect. In fact, our payor mix for the 12-month 

period ending September 30, 2004 is as follows: 

Medicare 51.2 % 

Medicaid 4.0 % 

Self-pay/Uninsured 6.0 % 

Private insurance and other 38.8 % 

These percentages, especially the levels of Medicaid and self-insured/uninsured, 

are very similar to the typical general acute care hospital’s cardiovascular services. 

60 

In terms of Medicaid in particular, MedPAC’s findings are misleading for several 

reasons. First, the volume of Medicaid patients is not uniformly distributed across 

hospitals (including both general and specialty hospitals). In most communities, only 

one or two hospitals serve the vast majority of Medicaid patients with the other hospitals in the community serving the remainder. Based upon 2002 Medicare hospital 

cost report data, only 10 percent of hospitals provided nearly 60 percent of inpatient 

care for Medicaid patients. 

Second, heart hospitals are inherently less likely to draw Medicaid patients because these patients, comprised primarily of younger women and children, do not 

typically require cardiac care. In fact, only about 9 percent of total Medicaid discharges nationally are for cardiac care while 42 percent of Medicaid inpatient care 

is for obstetrics. 

Lastly, Medicaid programs in certain states in which we operate provide care for 

their beneficiaries through capitated arrangements with managed care plans. Because we are often blocked from participating by our competitors, we do not have 

contractual arrangements with these managed care plans in some of the areas that 

we operate. For example, in Arizona we have been involuntarily excluded from participation with these plans and, as such, our Medicaid levels are naturally comparatively lower. 

As MedPAC Chairman Hackbarth noted at the January 12, 2005 public meeting 

of the commission, ‘‘. . . I think all of us would agree that right now the burden 

of providing care to Medicaid recipients or uncompensated care is not evenly distributed. That’s an issue that long predates specialty hospitals and it’s an issue that 

has very important implications for the system. And to say that stopping specialty 

hospitals is going to materially alter that problem, fix that problem, I don’t think 

that’s the case. Among community hospitals, some do a lot of uncompensated care, 

have a lot of Medicaid patients. Others do a few. So that’s an important issue. But 

to address it you need measures that are appropriate to its scope. And it’s huge.’’ 

START-UP COSTS AT MEDCATH’S HOSPITALS EXPLAIN COST DIFFERENCES 

The MedPAC study found costs at our hospitals to be higher than those of other 

community hospitals, although it was not statistically significant. The MedPAC 

study, however, fell short of investigating and presenting the factors that account 

for these differences. In a draft report, the Lewin Group has replicated and expanded on the MedPAC analyses, and found the following factors that account for 

cost differences between our hospitals and other community hospitals: 

• Because most of our hospitals are relatively new facilities with most beds being 

intensive care beds and equipped with state-of-the-art medical equipment, our 

depreciation costs are substantially higher than that of the average community 

hospital. As our hospitals age, however, we believe depreciation expenses will 

become more aligned to those of community hospitals. • Our newly-built hospitals require financing of working capital until they can become fully operational, which we refer to as ‘‘startup’’ or ‘‘ramp up’’ costs. The 

interest cost on this debt and construction debt is very significant and substantially higher than the average community hospital. As our hospitals ramp up 

operations, repay this debt and become fully operational, however, these interest costs will become more aligned to those of community hospitals. • MedCath hospitals are required to pay property and income taxes, which is not 

required of not-for-profit hospitals due to their tax exempt status, thus our cost 

per discharge is inherently higher. 

After accounting for differences in depreciation, interest, and taxes (i.e., capital 

costs) between our hospitals and other community hospitals in our market areas, 

the Lewin Group found that our average adjusted Medicare operating cost per discharge was 6–7 percent lower than community hospitals in our market areas. Finally, most of our hospitals are relatively new and have not yet reached their optimum occupancy rates. Once occupancy rates increase for our hospitals, average 

costs per discharge will decline. 

As a final point, we note that our diagnosis related group (DRG) payments from 

Medicare are the same irrespective of our costs. 

PHYSICIAN OWNERSHIP IS BEING EMBRACED BY NOT-FOR-PROFIT 

SYSTEMS AND COMMUNITY HOSPITALS 

A growing number of not-for-profit healthcare systems around the country have 

embraced the concept of physician ownership—seeing the opportunity for improving 

the quality of care and cost effectiveness within their own healthcare systems. For 

example, Baylor Health Care System (Baylor), located in Texas, is one of our naVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00064 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
61 

tion’s largest and most respected not-for-profit, faith-based systems. While not a 

MedCath partner, Baylor (along with other not-for-profit systems around the country) understands the importance of aligning physicians and their hospitals. As such, 

systems such as Baylor’s are partnering with physicians who have ownership in 

order to provide higher quality healthcare services to their communities. Clearly, 

physicians must be an integral part of solving the nation’s health care crisis. 

Indeed, two of MedCath’s most successful hospitals are three-way partnerships between a community hospital, MedCath and the local physicians. Avera McKennan, 

MedCath, and local physicians in Sioux Falls, South Dakota, built and opened the 

Avera Heart Hospital of South Dakota in March 2001, which is currently delivering 

high quality cardiovascular care to the patients of South Dakota and surrounding 

states. Carondelet Health Network, MedCath and local physicians in Tucson, Arizona are partners in the Tucson Heart Hospital. 

Both of these partnerships embrace the collective expertise of each group and 

align all interests to deliver high-quality care to the community and to patients. We 

believe partnerships like these are critical to the future of delivering high-quality 

health care to a rapidly aging population. 

CONCLUSION 

In conclusion, the advantages of competition to the health care sector provided by 

specialty hospitals are both undeniable and essential to meeting the growing demand for cardiovascular services as a result of the aging baby boomer population. 

The moratorium should be allowed to expire in order to further spur much needed 

competition and to address this growing demand. To ensure reimbursement rates 

are appropriate, CMS should focus on revising the DRG pricing system to be more 

aligned with the actual costs of certain procedures and diagnoses. 

While the community hospital providers are aggressively attempting to frame this 

debate about conflict of interest and ‘‘limited service’’ providers, we believe their real 

motive is about limiting competition from facilities that have spurred innovation 

while delivering high quality health care with significantly better quality results. 

In our view, the public policy issue here is not the necessity of curtailing specialty 

hospitals through a moratorium which effectively endorses the failings of the status 

quo, but rather the need to efficiently meet the emerging health care requirements 

of our aging population. We believe the MedCath hospital model is an innovative 

model that meets those needs. 

f 

Chairman JOHNSON. Thank you. Mr. Brock? 

STATEMENT OF GARY D. BROCK, CHIEF OPERATING OFFICER, 

BAYLOR HEALTH CARE SYSTEM, DALLAS-FORT WORTH, TEXAS 

Mr. BROCK. Thank you, Madam Chairman, Members of the 

Committee. My name is Gary Brock, and I am the chief operating 

officer of the Baylor Health Care System based in the Dallas-Fort 

Worth region in Texas. I have been a hospital executive for 28 

years, have a master’s degree in public health from the University 

of Oklahoma. Baylor is a 101-year-old faith-based institution with 

strong ties to the Baptist General Convention of Texas. 

It is an honor for me to address you today on behalf of the Baylor 

Health Care System and to ask you to allow the moratorium on the 

development and growth of physician-owned specialty hospitals to 

end June 8th, without renewal. 

Baylor Health Care System is the corporate sponsor of 13 notfor-profit hospitals, with its flagship, Baylor University Medical 

Center, located in downtown Dallas, Texas. Baylor University Medical Center is a 1,000-bed quaternary teaching hospital, with a 

Level I trauma center that provides care to more penetrating trauma victims than Dallas County’s tax-supported Parkland Hospital. 

Baylor University Medical Center has the largest neonatal ICU in 

the Southwest and one of the five largest solid organ transplant 

62 

programs in the United States. Baylor Health Care System is deeply committed to its mission as a not-for-profit hospital. Last year, 

we provided more than $240 million in community benefits, at cost, 

and this does not include bad debt. Charity care is provided under 

the most generous charity care/financial assistance policy among 

all Dallas-Fort Worth hospitals. 

At the same time, Baylor has a long history of innovation. In the 

early 1900s, Baylor developed the pre-paid hospital plan, which 

today operates as the Blue Cross/Blue Shield Association. With the 

changes in medical practice, Baylor has sought and continues to 

seek new and innovative ways to lower the cost of the delivery of 

care, while at the same time improving quality, safety, and patient 

satisfaction. One of the most recent effective strategies Baylor has 

implemented is partnering with physicians economically and, more 

importantly, clinically in the design, development, governance, and 

operation of ambulatory surgery centers, surgical hospitals, and 

heart hospitals. Today, Baylor has an ownership interest in 25 facilities partnered with physicians. 

Five of these facilities are affected by the moratorium. Three are 

surgical hospitals. Two are heart hospitals. Each is critically important to the mission of the Baylor Health Care System, and in each 

case we have followed the guidelines developed by IRS in Revenue 

Ruling 98–15 for partnerships between tax-exempt organizations 

like Baylor and for-profit organizations. The IRS requires the taxexempt entity to have certain governance controls with respect to 

the partnership and for the partners to agree that charitable interests will prevail over for-profit interests. With respect to each of 

our surgical hospitals, a Baylor-controlled entity owns at least 50.1 

percent of the equity in a partnership that owns and operates the 

licensed hospital. For our two heart hospitals, the Baylor-controlled 

entity is actually the adjacent Baylor hospital. 

Thus, our flagship hospital, Baylor University Medical Center, 

owns 51 percent of the Baylor Jack and Jane Hamilton Heart and 

Vascular Hospital, located adjacent to and physically attached to 

Baylor University Medical Center. Cardiologists and vascular surgeons own the remaining 49 percent of equity in the facility. In 

north Dallas, the Baylor Regional medical Center at Plano owns 51 

percent of Texas Heart Hospital of the Southwest, and 83 cardiologists and cardio-thoracic surgeons owns the 49-percent interest. 

The governing board of each partnership has a majority of Baylorappointed representatives, who are lay volunteers from the community, and if ever a conflict arises between the for-profit interests of 

the partners and Baylor’s charitable mission, the board and partnership must defer to the charitable mission. 

The three surgical hospitals have a similar ownership structure, 

and all five facilities have adopted the charity care and financial 

assistance policy of Baylor. They all participate in Medicare and 

Texas Medicaid, and they all agree to take all patients regardless 

of their ability to pay. In our newest partnership, the Texas Heart 

Hospital of the Southwest, the physician partners agreed the hospital would be committed to the Texas State law requirement for 

charity care for tax-exempt hospitals. The physicians made this 

commitment to the community, despite the fact that as a for-profit 

facility it is not subject to the law, which requires tax-exempt hosVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00066 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
63 

pitals to provide charity care equal to 4 percent of net patient revenue. 

Madam Chairman, our model of partnering with physicians has 

now been in operation for over 6 years, with Baylor’s downtown 

Dallas Heart Hospital open the last 3 years. The results have far 

exceeded expectations. By partnering with our physicians, Baylor 

delivers on its mission, and delivers to the patient better, safer care 

at a lower cost. Baylor’s vision is to become the most trusted source 

of comprehensive health care services by the end of this decade. We 

urge you to allow the moratorium on physician ownership and development of specialty hospitals to end June 8th. This moratorium 

has affected our ability to meet our mission and vision due to the 

need to grow these services to meet the demands of the fast-growing population in the Dallas-Fort Worth region. Thank you. 

[The prepared statement of Mr. Brock follows:] 

Statement of Gary Brock, Chief Operating Officer, Baylor Healthcare 

System, Dallas, Texas 

Mr. Chairman, Members of the Committee, my name is Gary Brock, and I am the 

Chief Operating Officer of Baylor Health Care System, based in Dallas-Fort Worth, 

Texas. I have been a hospital administrator for more than 28 years and have a Masters in Public Health from Oklahoma University. 

Baylor is a 101 year old, faith based institution, with strong ties to the Baptist 

General Convention of Texas. 

It is an honor for me to address you today on behalf of the Baylor Health Care 

System and to ask you to allow the moratorium on the development and growth of 

physician-owned specialty hospitals to end June 8, without renewal. 

Baylor Health Care System is the corporate sponsor of 13 non-profit hospitals, 

with its flagship—BaylorUniversityMedicalCenter—located in downtown Dallas. 

BUMC is a 1,000 bed quadenary teaching hospital, with a Level I trauma center 

that provides care to more penetrating trauma victims than DallasCounty’s tax-supported Parkland hospital. BUMC has the largest Neonatal ICU in the Southwest, 

and one of the five largest organ transplant programs in the Country. Baylor Health 

Care System is deeply committed to its mission as a non-profit hospital. Last year, 

we provided more than $240 million in Community Benefits, at cost and not including bad debt. Charity care is provided under the most generous Charity Care/Financial Assistance policy among all Dallas-Fort Worth hospitals, including Parkland. 

At the same time, Baylor has a long history of innovation. In the early 1900s, 

Baylor developed the ‘‘pre-paid hospital plan,’’ which today operates as the Blue 

Cross Blue Shield Association. With the changes in medical practice, Baylor has 

sought, and continues to seek, new and innovative ways to lower the cost of the delivery of care, while improving quality, safety and satisfaction. 

One of the most effective strategies Baylor has implemented is partnering with 

physicians economically and, more importantly, clinically, in the design, development and operation of ambulatory surgery centers, surgical hospitals, and heart 

hospitals. Today, Baylor has an ownership interest in 25 facilities partnered with 

physicians. 

Five of these facilities are affected by the Moratorium. Three are surgical hospitals. Two are heart hospitals. Each is critically important to the mission of Baylor 

Health Care System, and in each case, we have followed the guidelines developed 

by the IRS in Revenue Ruling 98–15 for partnerships between tax-exempt organizations like Baylor and for-profit organizations. The IRS requires the tax-exempt entity to have certain governance controls with respect to the partnership and for the 

partners to agree that ‘‘charitable interests’’ will prevail over for-profit interests. 

With respect to each of our surgical hospitals, a Baylor controlled entity owns at 

least 50.1% of the equity in a partnership that owns and operates a licensed hospital. For our two heart hospitals, the Baylor controlled entity is actually the adjacent Baylor hospital. 

Thus, our flagship hospital, BaylorUniversityMedicalCenter, owns 51% of the 

Baylor Jack and Jane Hamilton Heart and VascularHospital, located adjacent to 

and physically attached to BUMC. Cardiologists and vascular surgeons own the remaining 49% of the equity in the facility. 

64 

In north Dallas the BaylorRegionalMedicalCenter at Plano owns 51% of the 

TexasHeartHospital of the Southwest, LLP, and 83 cardiologists, cardio-thoracic 

surgeons and vascular surgeons own the 49% interest. The governing board of each 

partnership has a majority of Baylor appointed representatives (lay-volunteers from 

the community), and if ever a conflict arises between the for profit interests of the 

partners and Baylor’s charitable mission, the board and partnership must defer to 

Baylor’s charitable mission. 

The three surgical hospitals have a similar ownership structure, and all five facilities have adopted the Baylor Charity Care/Financial Assistance Policy. They all participate in Medicare and Texas Medicaid and they all agree to take all patients regardless of their ability to pay. In our newest partnership, the TexasHeartHospital 

of the Southwest, the physician partners agreed the hospital would be committed 

to the Texas state law requirement for Charity Care for tax-exempt hospitals. The 

physicians made this commitment to the community, despite the fact that as a forprofit facility it is not subject to the law, which requires tax-exempt hospitals to provide charity care equal to 4% of net patient revenue. 

Mr. Chairman, our model of partnering with physicians has now been in operation 

for over six years, with Baylor’s downtown DallasHeartHospital open for almost 

three years. The results have far exceeded expectations. By partnering with physicians, Baylor delivers on its mission. The fact is, we cannot deliver on all aspects 

of that mission without aligning with physicians. That alignment takes several 

forms, but in the end, each has delivered to the patient better, safer, care—at a 

lower cost. 

Baylor’s Vision is to become the most trusted source of comprehensive health care 

services by 2010. We urge you to allow the Moratorium on physician ownership and 

development of specialty hospitals to end June 8. This moratorium has affected our 

ability to meet our Mission and Vision, due to the need to grow these services to 

meet the demands of the fast growing population of Dallas-Fort Worth. 

Thank you. 

f 

Chairman JOHNSON. Is the physician ownership in your facilities public information? Both of you. 

Mr. HARRIS. No. It is private. 

Mr. BROCK. We are a Medicare participating hospital, and to 

the extent of what is consolidated, this controlled interest would be 

part of our Medicare cost report. 

Chairman JOHNSON. But I do not think that the investors’ 

names are included as part of your cost report. 

Mr. BROCK. No. 

Chairman JOHNSON. I am asking are the investors’ names public information. 

Mr. BROCK. No. 

Chairman JOHNSON. Then you referred to the cardiologists and 

vascular surgeons who own the remaining 49 percent. Are any of 

the other doctors of your large medical complex or doctors in the 

greater Dallas area allowed to invest? 

Mr. BROCK. We have, as I mentioned, surgical centers, and we 

have over 500 different investors in those facilities. So, we have 

surgeons of all types that invest. 

Chairman JOHNSON. Are any of your investors doctors who do 

not practice at your facilities? 

Mr. BROCK. Yes. Well, actually about half the cases done in the 

facilities are not physician investors. 

Chairman JOHNSON. And are they doing the specialized cases? 

In other words, are they doing surgical cases, or you are such—— 

Mr. BROCK. Yes, they are doing—— 

Chairman JOHNSON.—a big organization you could be doing 

other kinds of cases, like some of the heart hospitals do a great vaVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00068 Fmt 6633 Sfmt 6602 E:\HR\OC\26371.XXX 26371
65 

riety of cases. And in the heart hospital where you do a great variety of cases, have you offered physician ownership opportunities to 

all of the doctors in your organization or just the heart doctors? 

Mr. HARRIS. Typically our ownership structure is primarily 

around cardiovascular-focused physicians because we feel that they 

have the most expertise to be able to set up the care model. Many 

of our cases that are done outside of cardiovascular are patients 

who are received through the emergency Department. Many of 

those specialists are not owners. 

Chairman JOHNSON. So, the specialists that own and help operate get a return on their investment as well as their Medicare fee, 

correct? 

Mr. HARRIS. If there is profitability in the facility, yes, ma’am. 

Chairman JOHNSON. And the facility fee that Medicare pays, do 

you also split that with them? Or is there some broader use of that 

amongst all of the collaborative entities? 

Mr. HARRIS. In our case, the money that would come to the hospital from Medicare would come in—obviously all the costs would 

be incurred, and then at the end of a year or any given period of 

time, if there were a profit, there might be a distribution that is 

made. 

Chairman JOHNSON. I see. So, the facility fee would just go into 

the general pot, and if the costs of operating were less, then that 

would be distributed, along with any other profit. 

Mr. HARRIS. Possibly, yes, ma’am. 

Chairman JOHNSON. And do you know whether the opportunity 

was made available to the non-cardiac physicians to invest since 

they also practice there? 

Mr. HARRIS. Typically that is not the case. Again, in our case, 

at MedCath we are focused on cardiovascular care. And the care 

model is structured around those type of patients with cath labs or 

operating rooms specifically designed for a cardiac patient. So, the 

ownership and the governance in the hospital is really focused on 

that type of care. So, typically the ownership is not distributed outside of the group who gives input. 

Chairman JOHNSON. I appreciate the greater control that physicians have, but given all of the physician advantages to practicing 

in these circumstances, why wouldn’t they just come without investing? I mean, if this is such a tremendous thing to do, why 

wouldn’t they come without investing? 

Mr. BROCK. In our case, they are. We have physicians—as I 

mentioned, about half of the cases being done in our surgical centers are being done by physicians who are not investors because we 

are able to accommodate their schedules better, give them better 

block time. We exceed the patient satisfaction scores that we have 

set up. And so, I mean, it is the service that is driving a lot of physicians to work with us. 

Chairman JOHNSON. In this context, you know, the patient satisfaction surveys are a little difficult to evaluate in terms of their 

value to us in health care, because many patients would prefer to 

go to a brand-new facility. I mean, it is much nicer and they are 

often smaller, and you can drive up and park. So, you know, I am 

looking at—what interests me and what I am responsible for is access to care for everyone, and particularly for those facilities that 

66 

have to provide services that cannot pay for themselves. It is nice 

to say, if you are interested in competition, have everything carry 

its weight and pay its own way. But you know and I know that just 

does not work in the real world. And nobody would be able to afford certain kinds of coverage if there was not an ability to crosssubsidize. Of course, the ability to cross-subsidize is primarily because of the up and down demand of an OB or pediatric ward. 

So, there is a bigger picture here that I am concerned about. I 

would like to have anyone else who wants to comment on this issue 

of what happens to a community hospital, and whether or not these 

hospitals are lifting a Department or whether they are attracting 

physicians from outside. Are you taking your physicians from the 

existing Baylor cardiac capability or from the existing hospitals? Or 

are you bringing in new physicians? And if you are not bringing in 

new physicians, if you are hiring local physicians who are already 

in practice, then is the hospital from which you attracted those 

physicians hiring new physicians to create ultimately a higher capacity? 

Mr. FOSTER. Thank you, Madam Chairman. 

Chairman JOHNSON. This is my last question, so say what you 

want. 

Mr. FOSTER. I would be happy to address that. A lot of questions within the statement there that I would like to pick up on 

a little bit. Clearly, the model of physician ownership in specialty 

hospitals, if it were, in fact, that dynamic and that fantastic, you 

would see non-physician investors using the facility. Our experience in Austin is that, to the extent that there are physicians that 

are not investors that might use the facility, it is for outpatient 

surgery centers, not inpatient hospitals like we are discussing 

today. 

You tend to see in outpatient surgery centers a little bit more use 

of maybe some non-investing physicians, but not, at least in Austin, Texas, non-investors using the specialty-owned hospitals. Also, 

you know, we think that it is important to point out that, again, 

if this model was so powerful, then we would see more of them in 

development even during the moratorium. Currently there is no 

moratorium on the development, of course, of specialty hospitals. 

There is a moratorium on the development of physician-owned specialty hospitals, which I think underscores further this notion that 

the entire economic architecture of physician-owned specialty hospitals it dependent upon the physician ownership position and the 

self-referral of cases to those hospitals. 

And so we have seen in Austin, Texas, dramatically so, that as 

these specialty hospitals develop, there is a large transfer of patients from the full-service hospitals to the specialty hospitals. And 

the response typically is that we either have to cut our costs or we 

have to raise our prices to continue to cross-subsidize the unprofitable services. Obviously there is a fair amount of physician recruitment that occurs to try to back-fill for the physicians that left because we are obligated to provide 24/7 emergency Department services and have those specialists on call. And so there are a lot of 

unique variables that go on. 

The other thing that we have seen in Austin is that of some noninvestor physicians that might see patients on a very infrequent 

67 

basis in specialty-owned hospitals—physician-owned specialty hospitals, it might even be those specialists that really are available 

to consult in the hospital, that they have to chase after those patients to new venues or risk losing the business themselves. And 

so to the extent that there is practice that is occurring by non-owning physicians in hospitals, it is largely sometimes because they 

feel pressured to, either by the physicians that are investors that 

are in a position to refer to them, or consult them, or just because 

they feel that they have to chase the business all over town. These 

are some of the observations that are occurring in Austin, Texas, 

that I think touch on some of the issues that you raised, Madam 

Chairman. 

Dr. PLESTED. In response to similar questions, Madam Chairman, it is interesting how semantics plays into some of the things 

that we are talking about. Most general hospitals are interested in 

this thing that they call centers of excellence, which is essentially 

a specialty service in the hospital. It is interesting that for a community hospital that is a center of excellence, if it outside the community hospital and a competitor, it is a boutique specialty hospital. But it is really the same thing trying to localize service and 

provide the service better to patients. 

The other thing that we have a tendency to do here is to ascribe 

an awful lot of very complex problems to a very small portion of 

our whole health care milieu. All of these problems are not caused 

by specialty hospitals. The problems with emergency room care certainly aren’t caused by specialty hospitals. I doubt if we could find 

an area where the closure of a community hospital or a community 

ER had anything to do with a specialty hospital. This has to do 

with community hospitals closing their services because they are 

not profitable. And I think the recurring theme that you mentioned 

that must be stressed is that we certainly must look at the payment of disproportional share hospitals and make sure that these 

payments go to the hospitals that are actually providing these services. 

Dr. BRIEN. Madam Chairman, in Los Angeles we face in and 

around the area of Cedars-Sinai Medical Center a little bit different issue. We, in fact, have specialty hospitals developing now. 

I am sure they are—in fact, they are waiting to see what happens 

with this moratorium, whether it is extended or not. 

The issue that we face is that the same doctors that are claiming 

they can provide better care at the specialty center are still practicing and on staff at our hospital. Also, as they move their practices over, they do not and they have refused to participate in our 

emergency room trauma panels. So, they have walked away from 

that, what I believe is a responsibility to the community in participation. 

The only difference in terms of the quality that seems to arise 

between our institution and these new institutions that are developing, it is the fact that the location is different, that the payer mix 

is different. They are looking for the better-paying patients. They 

are not signing Medicaid contracts. They do not want to take care 

of the uninsured. And the only other difference is that they are 

physician-owned and physician-run, and it is the conflict of interest 

that exists with regard to the physician referrals that is at issue. 

68 

I do not think that we would be sitting here talking about physician ownership if they were not self-referring to the facilities that 

they own. And I think that that is really the crux of the issue. An 

example, although it is not a hospital, it was a surgery center, combined by two major Los Angeles hospitals, went in together, started 

a surgery center to serve the physicians’ and the community’s 

needs. It failed in a couple years. That facility then turned over 

and became a physician-owned, self-referred surgery center, and 

the profits from that simple—I think it was a $25,000 investment 

in 1995 produces $20,000 to $25,000 a month in profit for the physicians. 

So, this is not about physician control or cost containment. This 

is about profiting, and the problem is it is at the expense of the 

major facilities, communities hospitals that have to provide the remaining care to those patients that do not have access to those facilities. 

Chairman JOHNSON. Thank you. Mr. Stark? 

Mr. STARK. Thank you, Madam Chair, and I thank all of you 

for taking the time to come and enlighten us. Mr. Harris, the Chair 

nibbled around the edge of this, but do your partnerships or joint 

ventures with physicians have an investment agreement the physician signs and you sign? 

Mr. HARRIS. Yes. 

Mr. STARK. Are they the same, basically the same for all your 

joint venture hospitals? 

Mr. HARRIS. Roughly. 

Mr. STARK. Okay. And you do not disclose who the physician 

owners are. 

Mr. HARRIS. Correct. 

Mr. STARK. Are the physician owners allowed to disclose to the 

public who they are? 

Mr. HARRIS. At their own choice. 

Mr. STARK. I beg your pardon? 

Mr. HARRIS. At their own choice. 

Mr. STARK. And are other individuals given an opportunity to 

invest in these joint ventures? 

Mr. HARRIS. We have a couple situations where we do have 

other individuals who have invested, but it is not normal. 

Mr. STARK. Is it allowed? Is it possible? Could I buy an interest 

in any one of your ventures? 

Mr. HARRIS. In certain cases, yes. 

Mr. STARK. What would be the—— 

Mr. HARRIS. Our focus of the partnership is on physicians, in 

our case cardiologists, who can bring a real expertise to the clinical 

care and the clinical protocol. 

Mr. STARK. But they do not have anything to do with the clinical care. You say in your annual report that you run them. You 

are in substantive—the company exercises substantive control over 

the hospital. So, you guys are exercising control. What difference 

does it make who you sell the joint venture to? 

Mr. HARRIS. It actually is very important because our boards at 

an individual hospital is shared governance between the MedCath 

representatives and physicians. 

Mr. STARK. But you will not disclose who they are. 

69 

Mr. HARRIS. According to the partnership agreement, that is 

correct. 

Mr. STARK. Okay. And they are at liberty to disclose it. Do you 

lend or cover the partners against loss over a certain amount? 

Mr. HARRIS. No, economically, the way that works is they invest 

a certain amount of money, we invest a certain amount of money. 

It is invested pro rata. If they lose that money, they lose it. We provide working capital. 

Mr. STARK. What if the loss exceeds their investment? 

Mr. HARRIS. If the loss exceeds their investment—— 

Mr. STARK. You cover it? 

Mr. HARRIS. That is correct. 

Mr. STARK. That is a loan, isn’t it? 

Mr. HARRIS. We loan it—— 

Mr. STARK. You get it back, don’t you? 

Mr. HARRIS. We do get it back. 

Mr. STARK. I just want to ask Dr. Plested, in your principles of 

medical ethics, just to cut to the chase here, you say that physicians should disclose their investment interest to their patients 

when making a referral. You also say that individuals not in a position to refer patients to a facility should be given bona fide opportunity to invest in the facility, which obviously Mr. Harris’ facilities 

do not meet. So, therefore, a doctor ethically should not be investing. Is that correct? Did you say that? 

Dr. PLESTED. That is correct, and I was trying to point that 

out. 

Mr. STARK. So, we have got all these unethical guys in his facilities. You ought to punish them. I don’t know what you could do 

to them. And then you also say the entity should not loan funds 

or guarantee a loan for physicians in a position to refer to the entity. That is them, isn’t it? And I don’t know what you and I would 

call a loan. I am not a chief financial officer. But what I am getting 

at is when you cut below zero—we just did a bankruptcy thing on 

this. If somebody covers your losses below zero and you are going 

to pay them back later, that kind of smells like a loan to me. 

Doesn’t it to you? Wouldn’t you call that—an advance, maybe? 

Dr. PLESTED. Let me comment. You said that they are dealing 

with a bunch of unethical physicians. He said that he—— 

Mr. STARK. You said they are unethical. I didn’t. 

Dr. PLESTED. He said that he does not disclose their ownership 

interest. The AMA Code of Ethics suggests that the physician—— 

Mr. STARK. But nobody else—— 

Dr. PLESTED.—their patient. 

Mr. STARK. It says here individuals not in a position to refer 

should be given a bona fide opportunity to invest in the facility. 

Dr. PLESTED. That is our opinion, yes. 

Mr. STARK. And they cannot. In his facilities they cannot. So, 

that makes them unethical, right. According to your—— 

Dr. PLESTED. They are not complying—— 

Mr. STARK. I would like to make your ethics a part of the record 

here. But I guess that we did this many years ago, and I am not 

unfamiliar with all these physician agreements. And as a practical 

matter, they do not work very well if you let the general public in 

because you brought the physicians there to refer patients and 

70 

make a lot of money from it. And whether or not your hospitals are 

any good and hurt the other hospitals, as Mr. Foster and Dr. Brien 

would suggest they do, there is a real problem, it seems to me, in 

physician ownership. And that is about as close as the AMA and 

I ever get to agreeing in over 30 years, but that is not bad. So, I 

guess that on those issue, Madam Chair, I think there are some 

problems of ownership and referral and separating them, and I 

think as our witnesses have presented to us today, there are some 

problems brought up. And I guess I would just conclude from 

that—and my time is up—that perhaps before we allow this to 

mushroom and become a problem that we or the Administration 

cannot change with regulation, we ought to come to a conclusion 

what our long-range plan should be. And I don’t think we disadvantage anybody by waiting another 12 months to work this out, 

because I think there are some real problems that could arise, and 

I don’t know if there are—certainly hospitals are not overcrowded 

these days, I don’t believe. Mr. Foster, Dr. Brien, you guys are not 

running 110 percent occupancy. 

Mr. FOSTER. There are seasons of time where we run high. 

Mr. STARK. Okay. So, I thank the witnesses, and I think the 

case has been made for some further study, and I appreciate the 

Chair’s having this hearing. 

Chairman JOHNSON. Mr. McCrery? 

Mr. MCCRERY. Mr. Brock, do you disagree with Mr. Stark’s 

statement that another 12 months or so moratorium wouldn’t hurt 

anybody? 

Mr. BROCK. Well, we are actually moving forward with the development of a heart hospital today with the moratorium in place. 

So—— 

Mr. MCCRERY. You are doing that without physician ownership? 

Mr. BROCK. No. Physicians will be an owner in that if the moratorium is lifted. 

Mr. MCCRERY. Oh, if it is lifted. Well, my point is: Do you disagree with Mr. Stark’s statement that no one will be hurt? Will you 

be hurt if the moratorium stays in place? 

Mr. BROCK. We are asking that the moratorium be lifted, be 

done away with, yes. 

Mr. MCCRERY. Okay. 

Mr. BROCK. We are in a very growing market in the Dallas-Fort 

Worth region, so we are moving toward 9 million population in a 

10-county area over the next 15 years. So, these are very cost-effective access models for us to use to serve a growing population. We 

did not get into this as a defensive measure. We got into it as an 

offensive strategy to give access, greater access to the public, and 

we bring additional capital partners to the table with us, with physicians bringing their dollars in, which reduces our capital burden, 

and it also puts—the physicians have upside but they also have 

downside risks. So, it really makes them get real focused around 

helping us operate these facilities and to pay attention to the costs 

that we are incurring within the facility, both in our operating supplies, our labor, as well as our capital costs. But Baylor and all of 

the competitors in the Dallas-Fort Worth area cannot generate 

71 

enough capital to provide access to the growing population that we 

have today. 

Mr. MCCRERY. So, you are not asking physicians to be investors 

in your new facilities so that they will feed you patients through 

self-referral? 

Mr. BROCK. No. I mean, we are looking for physicians to be 

there to be a partner with us, to develop quality, competitive programming for the community. 

Mr. MCCRERY. Well, it does kind of make sense, doesn’t it, that 

if a physician has an ownership in a facility, he is going to want 

to refer patients to that facility. That is human nature, isn’t it? 

Mr. BROCK. Well, definitely they would because they are going 

to have more involvement, more operating knowledge about that 

facility. All of these facilities that we operate in partnership with 

our physicians, they also retain active staff privileges on our other 

hospitals. So, they are extensions of their practice. They are extensions of our hospitals. 

Mr. MCCRERY. Dr. Brien or Mr. Foster, what is wrong with 

that? What is wrong with physicians referring patients to a facility 

in which they have an ownership interest? 

Mr. FOSTER. Well, I have seen situations with people I know 

where you might be a patient that needs surgery, you might even 

be in one of the St. David’s hospitals. And a surgeon might be consulted to come see you to decide whether you need surgery or not. 

And what we have seen happen—and not just on one occasion— 

where a surgeon who is consulted is an investor in a hospital that 

they own will say to the patient, ‘‘You know, you need surgery, but 

I am just not completely comfortable with doing the surgery here. 

I am a little bit more comfortable with the staff and the equipment,’’ you know, and all that at this other hospital. ‘‘So, what I 

work to do is discharge you and let’s schedule that surgery for another time.’’ 

The problem with that is that it in essence leverages or plays 

upon the implicit relationship of trust that exists between the patient and the physician, because the patient cannot judge whether 

or not the facility has all the right technical equipment and all the 

right staff and all that. But they trust their physician. And you 

sure, if you are having surgery, do not want your physician uncomfortable. Right? So, what do you do? You, of course, go to where the 

physician is directing you to go. And we are seeing that happen. 

And we think it is an exploitation of the relationship that is implicit, that trust relationship between the patient and their physician. We have some big concerns about that. We really do. 

Also, this whole issue of the unlevel playingfield, because I believe that we have physicians that can be fully aware of the services that we offer, fully familiar with the surgery centers and the 

operating rooms and all the things that we offer, without having 

to be an owner. At the St. David’s Healthcare Partnership, our 

board is made up of 35 percent physicians. We have physician involvement and governance. And there are 2,000 doctors on our 

medical staff that are fully familiar and fully aware and participated in the process, you know, within our facilities, and do not 

have to be a physician owner to get that. So, you know, I think it 

is a little bit disingenuous to say that you have to be a physician 

72 

owner to be familiar with the facility or comfortable with it or anything like that. That would be my response. 

Dr. BRIEN. I would agree. I think that the issue again, is physician ownership. I do not see an issue with physicians being partners in design of a complex, being partners in the development of 

a program, being partners in marketing the program, as long as 

they are not receiving money for referring their patients there. Because in the end, they do—I mean, the patients are coming from 

somewhere, and they are taking the healthy patients, they are taking the Medicare patient who needs a total hip replacement who 

doesn’t have any co-morbidities, and taking them to their specialty 

facility. 

Mr. MCCRERY. But the change in the DRG system, at least for 

Medicare, would solve that problem, wouldn’t it? 

Dr. BRIEN. To some degree for the inpatient. It obviously doesn’t 

deal with the outpatient, which in orthopedics in particular and 

some of the surgical centers are also trying to bring in their outpatient patients because they actually get a better return from 

Medicare if they are doing them in a hospital-based facility than 

in an outpatient surgery center. So, those are still issues. The issue 

is the conflict of interest. The issue is the physician ownership and 

the self-referral. 

And I just want to say, you know, it makes it sound like the existing community hospitals are not doing anything to improve the 

quality of patient care. And, in fact, compared—I mean, I look at 

this from my role in peer review, which is assessing quality and 

performance by the physicians. The focus truly is to educate physicians when errors have been made, to educate the system that we 

then try to fix to prevent those errors from occurring in the future, 

whether it is medication errors, wrong-side surgery errors. We 

work hard to fix those problems. 

I look at a facility, though, where the physicians have ownership 

interests, and if I am now peer reviewing somebody who does more 

cases, brings in more volume, and more revenue for the hospital, 

for themselves, and for me, it makes it very hard for me to critically look at them on an independent basis and peer review them, 

and currently that peer review process does go on, at least in our 

facility at this point. 

And just to go back on what we do at Cedars, we are reinvesting. 

We are reinvesting our moneys in building a brand-new, six-story 

critical care tower to bring in state-of-the-art critical care equipment and refurbish, all brand-new ICUs. We are refurbishing all 

of our operating rooms over the course of the next several years. 

We are building more operating rooms because our goal is not 

about the money that I make because I make it for my professional 

component only. It is about providing care for patients. These ICUs 

are for everybody, whether they are uninsured or they are Medicaid or they are insured or Medicare. We are providing the service 

to everyone, but there is a cost. And if we lose our best-paying patients, it makes it very difficult obviously to maintain and continue 

to refurbish and modernize our institutions to provide the bestquality care and access for everybody. 

Mr. MCCRERY. Is your concern that physicians are referring patients to their hospital, so to speak, their physician-owned hospital, 

73 

and that takes a patient away from you? Or is your concern that 

physicians are referring patients to their hospitals that do not really need the treatment? 

Dr. BRIEN. No, I don’t think it is a matter of referring for unnecessary treatment. 

Mr. MCCRERY. Okay. 

Dr. BRIEN. I think it is a matter of cherry picking the patients 

that are best for them to make money and leaving the other patients that do not make money for their institution at the community hospital. If it does not make money for their institution, it is 

certainly not going to make money for the community hospital. And 

that jeopardizes all the other programs, including trauma services 

and community services that we provide for the community. 

Mr. MCCRERY. I understand that argument. 

Mr. Foster, I would like to get a copy, if you can provide us one, 

of that flyer that you saw from Austin Surgical Hospital saying if 

you invest $4 million, you can get $55 million in 6 years. That is 

very interesting. 

Mr. FOSTER. I will follow up on that. 

Mr. MCCRERY. If I had $4 million, I—— 

[Laughter.] 

Mr. FOSTER. Again, I don’t know whether it has actually done 

that or not, but that was the marketing pitch. 

Mr. MCCRERY. Yes, I would like to see that, Madam Chair, so 

we can maybe follow up on that and see what the experience has 

been. 

Chairman JOHNSON. I also think you need to clarify the answer 

to Mr. McCrery’s question. You talked about the doctor who comes 

in and consults and then has a way of moving the patient. Does 

that doctor also perform operations at your hospital? And do you 

see evidence that the patients he chooses to move are more complex and so on? 

Mr. FOSTER. Yes, I mean, we have situations where doctors 

practice—— 

Chairman JOHNSON. The same doctor. 

Mr. FOSTER. The same doctor would practice at both locations, 

one he owns, one he does not, where there is a proactive attempt 

to steer the more profitable patients away from our hospital. 

Chairman JOHNSON. Do you see that? 

Dr. BRIEN. Yes, I do, and I think the other point, in fact, is that 

the hospitals that are opening, you have heard cardiac hospitals, 

orthopedic hospitals, surgical hospitals. We do not see AIDS hospitals opening, Medicaid hospitals opening, managed care hospitals 

opening, seniors with pneumonia hospitals opening. These are very 

specialized procedures that have the highest reimbursement. 

Chairman JOHNSON. Thank you. 

Mr. Doggett. 

Mr. DOGGETT. Thank you, Madam Chairman. 

Mr. Brock, I want to be sure I understand. I got interrupted during part of your testimony. You have the Baylor University Medical 

Center and then attached to it is the physician-invested Hamilton 

Heart and Vascular Hospital. 

Mr. BROCK. That is correct. 

74 

Mr. DOGGETT. And your belief is that you can get better patient—I believe it is better, safer care at a lower cost in the physician-owned attachment. 

Mr. BROCK. I know that to be the fact. 

Mr. DOGGETT. Do you have data comparing the two? 

Mr. BROCK. Yes. 

Mr. DOGGETT. Do you treat any cardiac patients at the portion 

of the hospital that is the University Medical Center? 

Mr. BROCK. When we opened this hospital, we moved all of our 

cardiac programming into this hospital. 

Mr. DOGGETT. What portion of Medicaid patients do you have 

there? 

Mr. BROCK. I mean, all cardiac is done in that hospital. 

Mr. DOGGETT. Including Medicaid? 

Mr. BROCK. Yes, Medicaid, Medicare, uncompensated. 

Mr. DOGGETT. There has been no decline in the portion of Medicaid patients since you did that? 

Mr. BROCK. No. Our payer mix reflects the payer mix of the 

main hospital. That facility has the highest quality scores. We follow the CMS core measures. They rank 92 to 100 percent in all of 

those measures. So, they are higher than any of our facilities. Their 

patient satisfaction scores are higher than in any of our facilities. 

The first year that facility was in operation, the physicians reduced 

the cost of care $12 million for that service over the way we were 

running it before they were involved with us. And the way they did 

that was through development of teams and councils that worked 

on standardization of equipment, supplies, and plannables, capital, 

purchases that were being made, care paths working with each 

other on how they can most effectively treat the patients that were 

going through there. We have data before and data after, so we can 

look at it. And we have shared that with CMS, and we would be 

glad to share it with this Committee as well. 

Mr. DOGGETT. Mr. Foster, I hear a number of physicians saying 

we can get the very benefits that Mr. Brock just talked about, that 

Dr. Plested talked about, expressing concern about corporations 

that are not from the local area and do not understand it. Aren’t 

there some benefits to be had by having physicians involved in this 

manner in the hospital? 

Mr. FOSTER. I think very clearly, to the extent that you can involved physicians in helping you in trying to lower costs and other 

things, that is a very good thing to do. I think the question is what 

is the vehicle that he is to do that. And that is why we are intrigued with the notion of the gain-sharing idea that was mentioned earlier, where you can, in fact, share with physicians the 

benefits of their efforts to reduce costs, but not do so to the extent 

that you create a system that induces them to self-refer. And so 

that is where gain-sharing I think does good with respect to aligning some of the incentives between providers and physicians, but 

stops short of creating an inducement to self-refer to facilities that 

they own. 

Mr. DOGGETT. And what effect do you believe it will have if the 

moratorium is allowed to expire in 3 months? 

Mr. FOSTER. I would also echo what was said earlier. We know 

that there are many of them in the queue, and Texas is sort of 

75 

ground zero for these things, as you know. And there are many of 

them in the queue, and whether or not facilities decide to proceed 

or not will be dependent upon how they read the tea leaves about 

whether there might be some subsequent action or regulation that 

would outlaw those. And so it is hard to predict, but my guess is 

that there would be a fair number of them that would roll the dice 

and go ahead and build on the hopes that they would be grandfathered in any kind of future or subsequent legislation. 

Mr. HARRIS. To that point, we have 12 heart hospitals, and I 

have heard this statement from Mr. Foster that there is a lot in 

the queue. We do not have any physician-owned heart hospitals in 

the queue. We are working with a number of community hospitals 

to do some joint ventures. That doesn’t include physician ownership, but we don’t see that queue being lined up that he is speaking of. And if I could comment just briefly on the physician ownership? 

Mr. DOGGETT. Sure. 

Mr. HARRIS. Because I think we actually have a hospital in 

your district. One of the things we believe strongly in physician 

ownership is that physicians, you know, care deeply about the community. The statistics that we gave in terms of a high number of 

the patients arriving at our hospital from the emergency Department, a high number of the patients coming from outlying central 

Texas, and if we go to South Dakota, we get folks from all over the 

eastern part of South Dakota. And those are areas that previously 

were underserved, and we have a program where a patient has a 

problem out 2 hours from the hospital in the middle of the night. 

They make one phone call, and they can be in our hospital immediately. And the physicians embrace the community aspect of that. 

And, Madam Chairman, to the point you asked me about disclosure, I want to make sure I clarify that correctly. Disclosure is not 

made publicly in terms of the physician as an investor like we 

would a public company. But we embrace very strongly disclosure 

to the patient that the physician is an owner in the facility. So, 

anytime there is a patient referral made, we embrace that very 

strongly. And we find that the patient likes that a lot because they 

feel that inside the hospital—we have probably all be in the hospital where we have complained to the doctor, and the doctor says, 

‘‘Go talk to the administrator about it.’’ The doctor is—he owns the 

hospital, he or she owns the hospital. They can do something about 

it immediately. So, the gain-sharing piece, while it has some advantages, it stops short of putting the physician at risk if things 

do not go right. 

Chairman JOHNSON. Mr. Harris, we have a vote coming up, so 

I want to be sure that Mr. Hulshof has a chance to question. 

Mr. HULSHOF. Thank you, Madam Chairman. You know, listening to the difference of opinion on this panel brings to mind the ancient conundrum where two women claim to be the mother of the 

same child. And, unfortunately, I don’t think anybody, with all due 

respect to my colleagues, I don’t think anybody on this side possesses the wisdom of Solomon. 

I would say, Mr. Foster, that, you know, reading the tea leaves, 

I am not sure that I would want to be one out there trying to do 

that, because as you know, the moratorium was a compromise. Our 

76 

counterparts over in the Senate had a very different point of view 

about what should happen with specialty hospitals. That is my editorial comment. Let me use the couple of minutes I have. 

Dr. Plested, let me ask you this, because I am going directly to 

your conclusion, the last paragraph of your testimony that says 

this: ‘‘Based on the MedPAC and [Federal Trade Commission/Department of Justice] recommendations and the limited data currently available’’—the limited data, my emphasis, but your words— 

currently available on physician ownership of specialty hospitals, 

the AMA believes that patients would be better served if we allowed the moratorium to expire and then come back and review 

what impact, if any, this has on communities. In other words, let 

me just—with the limited data available, would we not be better 

served allowing the moratorium to continue rather than let the 

genie out of the bottle and then trying to come back afterward, if, 

in fact, there is a dramatic impact on community hospitals, and 

then trying to undo what has already occurred if we allow the moratorium to expire. 

Dr. PLESTED. I believe that the testimony from CMS and 

MedPAC was that the moratorium went into effect on the 8th of 

December of 2003 and they have data through 2002, so that the 

amount of data that would be added to what they already have 

would be limited as well. So, we would still have limited data with 

a limited amount added to it, but the data that they do have 

doesn’t support a lot of these conclusions. 

Mr. HULSHOF. Well, let me ask you this, and again, just to kind 

of cut to the quick, as we have this vote pending, Mr. Hackbarth’s 

written this—and I am just going to sort of summarize in his testimony what MedPAC found. Does the AMA agree or disagree with 

this following conclusion of MedPAC: Physician-owned specialty 

hospitals treat patients who are generally less severe cases and 

concentrate on particular diagnosis-related groups, some of which 

are relatively more profitable? Do you agree or does your organization agree or disagree with that conclusion? 

Dr. PLESTED. I think that is the data that they had, and we 

would agree that that is what that data showed. 

Mr. HULSHOF. Do you agree or disagree with MedPAC’s conclusion that they, meaning specialty hospitals, tend to have lower 

shares of Medicaid patients than community hospitals? 

Dr. PLESTED. Absolutely, yes, sir. 

Mr. HULSHOF. And I presume you would most assuredly agree 

with the conclusion that the financial impact on community hospitals in the markets where physician-owned specialty hospitals— 

that that impact was limited in 2002? 

Dr. PLESTED. Yes, but these relationships do not really prove 

anything. They are interesting observations, but they do not prove 

that there is a problem with physician ownership of a specialty 

hospital because there are many, many other reasons why MediCAL patients go someplace else, Medicaid, MediCAL in my instance, that do not have anything to do with ownership of the hospital. 

Mr. HULSHOF. And I appreciate this hearing very much, and 

our vote is going on. Missouri is interesting in that we are a certificate-of-need State, and so we do not have specialty hospitals per 

77 

se. And yet the certificate of need is an interesting discussion to 

follow in our State legislature, as you know. But I do appreciate 

the diverse opinions that have been shared with us today. Madam 

Chairman, thank you very much. 

Chairman JOHNSON. Thank you very much, and I appreciate 

your pointing out the certificate-of-need issue. It is an interesting 

one. I think it is Dr. Brien that mentioned in your testimony that 

poor patients covered by MediCAL and those without insurance are 

all not welcome. Is that your testimony? Because if you can give 

us any backup on that statement about what is going on in Los Angeles, that would be very helpful. 

Dr. BRIEN. We will work to gather that information. 

Chairman JOHNSON. And then I am just interested in a very 

quick response. Was there a waiting list in your hospital before the 

new hospital was built? Was it a response to under-capacity demonstrated by a waiting list? 

Mr. FOSTER. There was no waiting list in Austin. 

Chairman JOHNSON. Okay. I am very interested in the Baylor 

experience. I do consider it a little different since the hospital continues to benefit from the surgeries that are done there. If any of 

you can shed light on this facility fee issue, it is interesting to me. 

And in Baylor’s sub-hospital, you would have the same facility fee 

as in your big hospital, but very many fewer costs. So, it seems to 

me it would add to the profitability of that sector and not be available to the bigger hospital to deal with, its responsibility to crosssubsidy and so on. So, I have only 3 minutes left until the vote, 

so now I do have to go. But the facility fee issue and how that 

works at all, this is important for us to understand better and also 

what the hospitals that are in the community, where boutique hospitals have been developed, what they are doing now in terms of 

recruiting. Because if they are recruiting, now you have an overall 

greater capacity in the town where there was not a waiting list, 

and capacity breeds usage. So, those are concerns that we did not 

get on the record earlier. Thank you very much for your testimony 

and your discussion of what is a difficult issue. Thank you. Members who have further questions may put them in the record. 

[Whereupon, at 6:48 p.m., the Subcommittee was adjourned.] 

[Submissions for the record follow:] 

Texas Hospital Association 

Austin, Texas 78761 

March 8, 2005 

The Honorable Nancy L. Johnson 

Chair, Subcommittee on Health 

House Committee on Ways and Means 

U.S. House of Representatives 

1136 Longworth House Office Building 

Washington, DC 20515 

Dear Congresswoman Johnson: 

On behalf of its 421 member hospitals, the Texas Hospital Association (THA) welcomes this opportunity to provide information and comments on the dramatic 

growth of physician-owned specialty hospitals in Texas, and the impact these specialty hospitals have had on full-service hospitals in effected markets. THA appreciates the subcommittee’s interest in this issue and urge you and your colleagues 

to take prompt action on the recommendations being presented by the Medicare 

Payment Advisory Commission (MedPAC). 

78 

Over the last year, THA has reviewed physician investment in specialty hospitals 

and other types of health care facilities in Texas and has assessed the impact this 

physician investment has had on the health care delivery system generally and on 

full-service hospitals specifically. Consistent with the reports previously issued by 

the General Accounting Office on specialty hospitals and confirmed by MedPAC in 

its review of this issue, the THA study found that physician-owned hospitals and 

other types of physician-owned facilities: (1) specialize in well-reimbursed services, 

such as cardiology, orthopedics and diagnostic imaging; (2) provide a lower acuity 

level of services; (3) serve relatively few uninsured and Medicaid patients; and (4) 

provide significantly less emergency care. THA’s study also revealed that physician 

investment in hospitals in Texas has grown dramatically over a very short period 

of time. Since 2000, the number of physician-owned hospitals has more than doubled, and Texas leads the nation with 47 such facilities. With an additional 29 physician-owned hospitals under development in Texas, the potential long-term impact 

on full-service hospitals and the delivery of health care in the state could be significant. 

While the long-term impact of physician investment and self-referral is uncertain, 

it is clear from the national studies as well as THA’s report that the development 

of physician-owned limited service facilities has been very detrimental to full-service 

hospitals, particularly in smaller urban or rural markets. Across Texas, the ability 

of full-service hospitals to continue to provide high cost, lower margin services (trauma, more complex medical or surgical cases) is jeopardized by the loss of revenues 

to physician-owned hospitals and other facilities that do not provide these essential 

services. This loss of revenues also makes it more difficult for full-service hospitals 

to cross-subsidize the costs of care to uninsured patients and other non-profitable 

services. Key findings from the THA study are attached for your information and 

review. 

THA supports the MedPAC recommendations being presented to the Subcommittee on Health at your hearing on March 8, 2005. The recommended changes 

to the Medicare hospital payment are appropriate and should help reduce the financial incentives that have prompted physician investment in hospitals and their referral of the more profitable cases to these facilities. THA also supports the recommendation that would allow the Secretary of Health and Human Services to regulate gain-sharing arrangements between physicians and hospitals. If properly 

structured, such arrangements can promote collaborative relationships between physicians and hospitals and can reduce health care costs without impacting the quality 

of care provided. 

While THA supports the MedPAC recommendation to extend the moratorium on 

physician-owned specialty hospitals, THA urges the subcommittee to deal with this 

issue in a more substantive manner by eliminating the ‘‘whole hospital’’ exception. 

As you know, the legislative intent of this exception was to allow for physician ownership in general hospitals that offer a full spectrum of health care services, where 

a single referral would produce little personal economic gain. In contrast, most of 

the newly developed physician-owned hospitals are much smaller in size, provide a 

more limited scope of services and the potential for personal financial gain to influence physician referral is more likely. This exception also allows physician investors 

to refer patients to their hospital for the performance of outpatient services, such 

as laboratory and diagnostic imaging, without violating the prohibition on self-referral applied to these types of health care services. 

THA also supports the elimination or narrowing of the ‘‘rural area’’ exception that 

allows self-referrals by physicians in a rural area if the physicians provide most of 

any designated services to patients who reside in such a rural area. This exception 

is extremely broad and provides little impediment to physician self-referrals in rural 

areas. There is a growing number of rural hospitals in Texas that have been negatively impacted by the establishment of a physician-owned ambulatory surgical center or outpatient imaging center in their community. Further, to address the ethical 

and financial issues associated with physician investment and referral of patients 

to ambulatory surgical centers, THA recommends that legislative action be undertaken to extend the prohibition on self-referral to ambulatory surgical centers. 

Thank you for the opportunity to provide comments on this important issue. 

Should you or your staff have questions concerning these comments or the THA 

study on physician ownership and self-referral of patients, please contact me or 

Gregg Knaupe on the THA staff at 512/465–1000. 

Sincerely, 

Richard A. Bettis, CAE 

President/CEO 

————— 

79 

1Texas Department of State Health Services, Facility Licensing Group (2004) 

2Texas Department of State Health Services, Facility Licensing Group (2004) 

3GAO–04–167 (Oct. 22, 2003), pg. 4 

4Publicly available financial and utilization data were obtained and reviewed on inpatient and 

outpatient hospital services; no public data are available on ambulatory surgical centers, diagnostic testing facilities or other types of outpatient health care facilities. 

Texas Hospital Association Report on Limited Service Providers 

FEBRUARY 2005 

Texas leads the nation in the number of physician-owned limited service hospitals 

with 47 such facilities, and there are an additional 29 limited service hospitals 

under development.1 Texas has 300 ambulatory surgical centers in operation and an 

additional 59 facilities are under development.2 Diagnostic testing facilities and 

other outpatient facilities are not required to be licensed or certified in Texas, and 

it is difficult to determine the actual number of these facilities. However, with 

changes in medical technology and the associated shift to outpatient settings, there 

is no question that there also has been a dramatic increase in the number of outpatient facilities in the state that provide diagnostic and therapeutic services. 

The proliferation of physician-owned limited service facilities in Texas in the last 

several years is a result of a number of factors. As noted in the 2003 GAO report, 

all of the specialty hospitals under development and 96 percent of those that opened 

since 1990 are located in states without a certificate of need process that requires 

state review and approval of additional hospital beds or new facilities.3 The Texas 

certificate of need review process was discontinued by action of the Legislature in 

1985. 

To assess the proliferation and impact of physician-owned specialty hospitals and 

other types of limited service providers on full-service hospitals, THA evaluated financial and utilization data that are available on these providers from the Texas 

Department of State Health Services and the Texas Health Care Information Council.4 THA also conducted a series of meetings with hospital representatives in various cities across the state, including: Abilene, Amarillo, Austin, Brownsville, Bryan, 

El Paso, Huntsville, Lubbock, Midland, Odessa, Plano, San Angelo, and San Antonio. 

An analysis of the health care facilities, utilization of services (admissions, births, 

emergency room visits, inpatient and outpatient surgeries), payer mix (percentage 

of Medicare, Medicaid, commercial and indigent patients) and amount of uncompensated care was compiled for those markets across the state for which data was available. This analysis also provides information on the financial and operational impact 

that physician-owned limited service hospitals have had on full-service hospitals. 

The following is a summary of the findings from the THA study: 

• The proliferation of limited service providers has occurred more frequently in 

urban markets and primarily in more affluent, high population growth markets. 

The highest concentration of physician-owned limited service hospitals is in 

Austin, the Dallas-Fort Worth area (Collin, Dallas and Tarrant counties), Houston and San Antonio. 

• In smaller urban markets and rural areas, limited service providers have focused on outpatient services, such as outpatient surgery and diagnostic imaging. Due to the high costs associated with the building of a hospital and the 

volume of services needed to make the hospital’s operations financially viable, 

there has been fewer physician-owned limited service hospitals developed in 

smaller urban or rural areas. However, physician-owned hospitals have been 

built in Amarillo, Brownsville, Bryan, Edinburg, Harlingen, Lubbock, Midland, 

Odessa, Tyler and Wichita Falls. 

80 

City Existing 

Hospitals 

Proposed 

Hospitals 

Abilene 1 

Amarillo 2 

Arlington 1 

Austin 3 1 

Baytown 1 

Beaumont 1 

Bellaire 1 

Bridgeport 1 

Brownsville 1 

Bryan 1 

Clear Lake 1 

Dallas 3 1 

Denton 1 

Edinburg 2 

El Paso 3 1 

Fort Worth 1 1 

Frisco 1 

Garland1 1 

Harlingen 1 

Houston 7 6 

Humble 1 

Hurst 1 

Irving 1 

81 

5Texas Health Care Information Council, Hospital Inpaient Discharges Public Use Data File 

2003, December 2004 

City Existing 

Hospitals 

Proposed 

Hospitals 

Jasper 1 

Keller 2 

Kingwood 1 

Lubbock 2 

Midland 1 

Nederland 1 

Odessa 2 

Paris 1 

Pasadena 1 

Pearlman 1 

Plano 2 

Port Author 1 

Red Rock 1 

Richardson 1 

Roanoke 1 

San Antonio 3 

Southlake 1 

SugarLand 1 

The Woodlands 1 1 

Trophy Club 1 

Tyler 1 

Webster 1 

Wichita Falls 1 

Total Hospitals 47 29 

• Physician-owned limited service providers tend to specialize in well-reimbursed 

services, such as cardiology, orthopedics and diagnostic imaging. While a limited service facility may specialize in cardiology or orthopedics, it typically does 

not provide the full range of cardiac services (e.g., heart transplant and pediatric cardiac procedures) or orthopedic services (e.g., bone marrow transplants, 

major joint replacements, trauma and patients requiring tracheotomy), but tend 

to provide services that do not require a longer length-of-stay or intensive care 

unit service. 

• Physician-owned limited service hospitals tend to provide a lower acuity level 

of services.5An analysis of hospital discharge data indicates that statewide 

82 

6Texas Department of State Health Services, Center for Health Statistics, Annual Servey of 

Hospitals (2003) 7Texas Department of State Health Services, Center for Health Statistics, Annual Survey of 

Hospitals (2003) 8 Covenant Health System Internal Utilization Data 

across all DRGs and conditions, the physician-owned hospitals treat a smaller 

percentage of patients in the higher severity levels (15.7 percent for physicianowned as compared to 21.5 percent for non-physician-owned hospitals). An analysis of diseases of the musculoskeletal system reveals that only 5.3 percent of 

patients treated at physician-owned hospitals fall into the higher severity levels, whereas 15.9 percent of the patients treated at non-physician-owned hospitals fall into those same categories. The trend is less marked in treatment of 

circulatory diseases. 

• Physician-owned limited service hospitals serve relatively few uninsured patients and, with the exception of a small number that provide a significant level 

of services to Medicaid recipients, physician-owned hospitals treat a lower percentage of Medicaid patients.An analysis of financial data submitted to the 

Texas Department of State Health Services by hospitals shows that full-service 

hospitals provide more than twice as much uncompensated care (charity and 

bad debt) as compared to physician-owned limited service hospitals.6

• Physician-owned limited service hospitals provide significantly less emergency 

care, and access to the emergency department and emergency personnel is more 

restrictive when compared to full-service hospitals. Full-service hospitals had 

14,760 emergency room visits per year as compared to 480 emergency room visits per year for physician-owned limited service hospitals.7 Heart hospitals typically provide more comprehensive emergency services and have 24/7 physician 

coverage of the emergency department. In contrast, limited service orthopedic 

or surgical hospitals tend to have very limited emergency capabilities and physician coverage of the emergency department is provided on an on-call basis. 

• With the proliferation of limited service hospitals, full-service hospitals have experienced more difficulty in securing physician on-call coverage of their emergency departments and in some instances, physicians with an investment interest in a limited service facility have resigned their privileges at the full-service 

hospital or have reduced significantly their on-call coverage. Full-service hospitals have been required to recruit new physicians or increase the compensation paid on-call physicians to assure coverage of the emergency department. 

• Physician investment in a health care facility poses a conflict of interest between physician investors and patients. Some patients are being strongly encouraged to use the facility in which the physician has an ownership interest, 

and it is uncertain whether the physicians are disclosing their ownership interest to patients. In some instances, these referrals to the physician-owned facility 

will result in a health insurer and patient paying more for the services rendered 

because the facility is not a participating provider in the health plan network. 

• Some referrals of patients to a physician-owned limited service facility raise 

quality of care concerns: 

o Patients stabilized at a full-service hospital and then transferred to a physician-owned limited service facility for surgical procedures; 

o Patients with cardiac problems stabilized at a full-service hospital and then 

transferred to a physician-owned heart hospital for pacemaker insertion; 

o Delays in treatment after patients have post-surgical complications or a 

limited service hospital does not have the appropriate medical staff, equipment or ICU beds available to meet patient needs and patients are transferred to full-service hospital; and 

o Delays in treatment when patients are admitted to limited service facilities 

that do not provide the required care (a patient with suspected cardiac condition is transported to a heart hospital by EMS and is discovered to have 

suffered a stroke, or a woman presents to a limited service hospital in active labor). 

• Physician investment in a limited service hospital often results in a significant 

and almost immediate movement of patients from the full-service hospital to 

which the physician previously admitted patients to the facility in which the 

physician has an ownership interest. For example, physician investors in the 

Lubbock Heart Hospital began moving patients to their facility as soon as it 

was opened and over a period of eight months reduced their performance of cardiac services at Covenant Health System hospitals by 71 percent.8

83 

9Texas Hospital Association, Patient Data System and St. David’s Medical Center Internal 

Data 

A similar movement of patients occurred with the opening of the Austin Heart 

Hospital in late 1998. There were significant reductions in the number of cardiac 

services performed at the St. David’s HealthCare Partnership hospitals by physician 

investors in the heart hospital after that hospital opened.9

Reductions in Inpatient/Outpatient Procedures at SDHC Partnership 

Hospitals 

• This movement of patients to a physician-owned limited service hospital soon 

after it opens does not appear to be based on any quality of care concerns the 

physicians may have had with the full-service hospitals in the community because the physician investors continue to admit patients into those facilities. 

However, the patients admitted into the full-service hospitals by the physician 

investors tend to have more complex medical conditions or are Medicaid or uninsured patients. • The financial impact of limited service providers has been detrimental to fullservice hospitals, particularly in smaller urban or rural markets where there 

has not been much population growth. Full-service hospitals have experienced 

significant reductions in revenues for outpatient surgery and diagnostic services. The impact on revenues for inpatient surgeries and other inpatient services has been less because limited service providers tend to provide more outpatient services and inpatient services with a lower acuity level. • The ability of full-service hospitals to continue to provide high cost, lower margin services (trauma, more complex medical or surgical cases) is jeopardized by 

the loss of revenues to limited service facilities. This loss of revenues also 

makes it more difficult for full-service hospitals to cross-subsidize the costs of 

care to uninsured patients and other non-profitable services. • Full-service hospitals have lost key physicians and other professional staff to 

limited service providers and have had to recruit new physician specialists and 

other personnel to replace them. 

f 

Statement of D.J. Calkins, Guadalupe Valley Hospital Board of Managers, 

Seguin, Texas 

My name is D.J. ‘‘Dave’’ Calkins, and I am a board member on the Guadalupe 

Valley Hospital, Board of Managers, in Seguin, Texas. Guadalupe Valley Hospital 

is a 117-bed full service medical facility and the sole full service medical facility in 

Guadalupe County, Texas with a population of approximately 90,000. The proliferation of physician-owned specialty hospitals and limited service facilities are having 

a devastating impact on the ability of full service hospitals, such as Guadalupe Valley Hospital, to remain fiscally-viable and to provide access to a broader range of 

services needed in the community, especially rural communities with limited fullservice healthcare options. 

The dramatic increase of physician-owned specialty hospitals and limited service 

medical facilities, coupled with the practice of physicians self-referring patients to 

their physician-owned facilities, raises serious public policy concerns. Left unchecked, the proliferation of these facilities will continue to drive up healthcare 

costs and will put many smaller, rural community hospitals at significant financial 

risk of closure and will undermine the ability of full-service urban hospitals to subsidize unprofitable, but essential services. 

Physicians with ownership interests have the ability and the financial incentive 

to shift well-reimbursed services and patients to their facilities and are exercising 

this practice. This practice drains essential resources from full-service hospitals, 

which rely on a cross-section of patients to subsidize unprofitable, but essential 

services. The loss of patients, and associated revenues, from physician-owned facilities has a dramatic impact. In addition, reimbursement rate structures make it 

more favorable for insurance companies to direct beneficiaries to these facilities hindering the ability of full-service hospitals to obtain needed provider contracts to enhance patient access to hospital services. 

In the case of Guadalupe Valley Hospital, a group of physicians with privileges 

at the hospital recently opened an Ambulatory Surgical Center (ASC) just down the 

street from the hospital. Since the ASC opened, the hospital’s outpatient surgical 

84 

1MedPAC, Report to Congress: Physician-Owned Specialty Hospitals, March, 2005 

2 CMS, House Ways and Means Health Subcommittee Testimony of Tom Gustafson, Deputy 

Director, March 8, 2005 

revenues have declined approximately 40%. This is a substantial loss for a rural 

hospital with limited population to garner market share. The hospital’s Chief Financial Officer projects an eventual loss of approximately $180,000 in revenue monthly 

due to patients being self-referred by physicians that own the ASC, yet practice out 

of the hospital. This is unfair competition and a blatant conflict of interest. In addition, a number of medical insurers recently restricted their beneficiaries from obtaining certain services at the hospital and began forcing the beneficiaries to travel 

to another community 15 miles away; in another county to obtain the same services 

they could receive in their own community. Insurers are doing this, because of the 

more favorable reimbursement rates received from stand alone facilities compared 

to full-service hospitals for the identical service; the only difference being location. 

This is absurd. 

I urge legislation to close loopholes allowing physician self-referrals to physicianowned specialty hospitals and limited service facilities, such as Ambulatory Surgical 

Centers. While I understand the desire by physicians to enhance their income, this 

should not come at the expense of full service medical facilities and the communities, which so dearly depend on them for access to the full spectrum of medical 

services. Physicians should be working in collaboration with hospitals to maintain 

the community’s health care infrastructure and to serve all patients, rather than 

contributing to the demise of the very institutions, which allow them privileges in 

which to practice medicine and only serving the well-insured few. Close the loopholes and adopt sound public policies, which allow physicians and hospitals to both 

benefit. 

Sincerely, 

f 

D.J. Calkins 

Ohio Hospital Association 

Columbus, Ohio 43215 

March 10, 2005 

The Honorable Nancy Johnson 

Chair, Subcommittee on Health 

U.S. House Ways and Means Committee 

Washington, DC 20515 

Dear Congresswoman Johnson: 

On behalf of the Ohio Hospital Association (OHA), we thank you for the opportunity to submit comments for the record regarding your hearing on limited-Service, 

Physician-Owned Hospitals, held on March 8, 2005. 

The OHA is the oldest state hospital association in the nation, representing the 

more than 170 acute-care hospitals and health systems across Ohio. Our governing 

Board of Trustees is comprised of representatives from the whole gamut of providers 

in Ohio; from large, urban teaching facilities to small, rural hospitals, and from 

every corner of the State. Each of our members is dedicated to providing their communities the highest-quality health care service all day, every day. But the emergence of limited-service, physician-owned hospitals threatens their ability to remain 

successful. 

According to a recent report by the Medicare Payment Advisory Commission 

(MedPAC) 1, limited-service, physician-owned hospitals (often nicknamed ‘‘specialty 

hospitals’’) harm their communities and local full-service, community hospitals by 

treating primarily cases that are relatively well-reimbursed by government and private insurance, and generally not treating patients with conditions that are poorlyreimbursed. Studies by the Centers for Medicare and Medicaid Services (CMS) 2 corroborate these findings. This anticompetitive cherry-picking allows limited-service 

facilities to make significant profits while expecting the community hospital to handle the most difficult and least profitable cases, as well as provide all of the community’s graduate medical education, emergency care, and other ancillary services. 

Under Section 507 of the Medicare Modernization Act of 2003, Congress enacted 

a moratorium that effectively froze the growth of new limited-service, physicianowned hospitals. The eighteen month moratorium, due to expire in early June of 

this year, was intended to give MedPAC and the Department of Health and Human 

Services time to study the practices and impact of limited-service hospitals. In reVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00088 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
85 

3 AAFP, ‘‘Extend Moratorium on Specialty Hospitals, Says Board,’’ online news story, February 17, 2005 

sponse, the subsequent report from MedPAC recommends various changes to the 

Medicare system. 

The report also recommends Congress extend the current moratorium until January, 2007, to allow Congress and the administration time to gather additional information and make the necessary changes to the payment system. Conversations with 

CMS staff, however, prove beyond doubt the federal government will need far more 

time to implement the broad scope of regulatory and legislative changes necessary 

to thoroughly and properly address the situation. Given the slow pace with 

which structural changes are made at the federal level, and rather than 

forcing the Congress in eighteen months to revisit the question of whether 

the needed policies have been implemented, it makes far more sense to 

continue the current moratorium permanently to allow adequate time to 

thoroughly address the issue. Therefore, OHA urges Congress to enact a 

permanent extension to the moratorium before it expires on June 8. 

We are not alone in our position. The American Hospital Association has been a 

leader in this effort, along with the Federation of American Hospitals and numerous 

other State hospital associations. The American Academy of Family Physicians 

(AAFP) recently voted 3 to extend the moratorium until ‘‘the AAFP is convinced by 

evidence of their benefit on the health and well-being of our communities.’’ And in 

a February 16, 2005 editorial (attached), The Columbus Dispatch said: 

‘‘. . . Specialty hospitals will sprout. If the moratorium expires, experts say, the 

current number of 100 nationwide could double in just a few years. With each of 

them taking a bite out of the market, full-service hospitals’ bottom lines eventually 

will suffer; hospitals can do only so many things to become more efficient. And when 

a hospital goes under, the entire community suffers.’’ 

It is ironic that current federal law will sanction a physician for referring an inexpensive test to a laboratory in which she or he has a financial interest, but will 

allow another physician to refer a costly orthopedic surgical case to a ‘‘specialty’’ 

hospital. Beyond the enormous—but necessary—task of addressing the payment system as MedPAC recommends, Congress must take further action, such as revisiting 

the ‘‘whole hospital’’ exception to the physician self-referral law. Eighteen months 

will not likely be a sufficient span of time for all of the needed changes to happen. 

The time for legislative action is now. While much needs to be done to address 

the dangers to the health care delivery system posed limited-service, physicianowned hospitals, the first step Congress must take should be to make permanent 

the current moratorium. 

Sincerely, 

James R. Castle 

President and CEO 

————— 

Extend the moratorium 

Freeze on specialty hospitals necessary for further study of ill effects on 

communities 

WEDNESDAY, FEBRUARY 16, 2005 

The 18-month moratorium on the building of specialty hospitals is to expire in 

June, but the problems presented by such businesses are far from resolved. 

Congress should extend the moratorium. 

The Medicare Payment Advisory Commission was charged by Congress in 2003 

to study specialty hospitals, and its preliminary report has reaffirmed what The Dispatch has contended all along: Specialty hospitals cherry-pick the most lucrative patients, while leaving the expensive-to-treat patients to nonprofit, full-service hospitals. 

They do this through a loophole in the law that allows doctors to refer patients 

to hospitals in which they own an interest, even though they would be prohibited 

from referring patients to other facilities they own, such as labs, pharmacies and 

home health-care services. 

This shady self-referral is good for specialty hospitals. It provides them a steady 

stream of the kind of patients that will ensure high profits. But it is a drain on fullservice community hospitals, which are forced to take the complicated cases, the expensive cases and the uninsured and indigent cases, while at the same time losing 

an important source of revenue. That revenue from lucrative specialties, such as 

86 

cardiac care and orthopedics, helps to finance a community hospital’s money-losing 

services, such as emergency rooms, burn units and trauma re units. 

But when that revenue goes to specialty hospitals, those vital services suffer. This 

allows a few doctors to unjustly enrich themselves at the expense of the community. 

The commission found that the Medicare reimbursement system favors specialty 

hospitals. They get the same reimbursements as full-service community hospitals 

even though they have less overhead. 

In return for this sweet deal, the commission found, specialty hospitals treat 

fewer poor people, handle fewer complicated cases and transfer patients to other 

hospitals more frequently than do full-service community hospitals. Those patients 

transferred by the specialty hospitals were more severely ill and more costly to care 

for than patients transferred by community hospitals. 

And, in spite of handling less complicated cases for shorter stays, physician-owned 

specialty hospitals actually cost more per patient than full-service community hospitals and even other surgical hospitals. 

The commission says that specialty hospitals do, indeed, take market share from 

full-service community hospitals. Community hospitals have, for the most part, been 

able to weather the storm financially by becoming more efficient and more competitive. But as specialty hospitals sprout, that will become more and more difficult. 

And specialty hospitals will sprout. If the moratorium expires, experts say, the 

current number of 100 nationwide could double in just a few years. With each of 

them taking a bite out of the market, full-service hospitals’ bottom lines eventually 

will suffer; hospitals can do only so many things to become more efficient. 

And when a hospital goes under, the entire community suffers. 

The commission recommends that the Department of Health and Human Services 

revise the method of payment for Medicare services. 

It also recommends that full-service hospitals be allowed to share the savings 

from cost-cutting measures with doctors, to try to minimize doctors’ referrals of patients to their own specialty hospitals. 

Congress should go further. It should bar physicians from referring patients to 

hospitals in which the doctors own an interest. 

As the commission itself noted, when physicians can earn income on a patient 

twice, as a doctor and as a hospital owner, the incentive to recommend surgery is 

great. Such a situation casts even good doctors in a bad light. 

Next month, the commission will issue its final report to Congress. Unfortunately, 

a ban on self-referrals isn’t likely to be part of its recommendations. It is, however, 

expected to recommend an extension of the moratorium for another 18 months. Congress should grant that extension. 

Copyright  2005, The Columbus Dispatch 

(Reprinted with the permission of the newspaper by the Ohio Hospital Association) 

f 

Statement of Carmela Coyle, American Hospital Association 

On behalf of the American Hospital Association’s (AHA) 4,700 member hospitals 

and health care systems and our 31,000 individual members, we are pleased to 

present our views on the critically important issue of physician-owned limited-service hospitals, which is having a serious impact on health care access, use and cost 

across the country. 

Certain physicians are exploiting a loophole in federal law that allows doctors to 

own limited-service hospitals where they then refer their carefully selected patients 

to perform highly reimbursed procedures. This raises serious concerns about conflict 

of interest, fair competition, and whether the best interests of patients and communities are being served. 

In order to preserve care in communities, prevent conflict of interest and promote 

fair competition, AHA strongly urges Congress to act quickly to close the loophole 

in federal law by permanently banning physicians from referring patients to new 

limited-service hospitals they own. 

The History of Self-Referral 

‘‘Self-referral’’—the practice of physicians referring patients to a facility they 

own—has been of concern to the Congress for many years. Laws to regulate these 

referrals grew out of a rapidly changing health care environment, in which new 

technologies made it possible for physicians to perform a variety of services and procedures in settings outside the traditional hospital. As a result, it became increasVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00090 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
87 

ingly common for physicians to invest in and own a health care facility—a clinical 

laboratory, for example—and also refer their patients to that facility. 

Physicians’ ability to refer patients to facilities they owned raised questions about 

the potential for conflict of interest. Were physicians’ referral decisions in the best 

clinical interests of the patient, or the best economic interest of the physicianowner? Research in 1989 by the Department of Health and Human Services’ Office 

of the Inspector General found that physicians, in fact, ordered more services when 

they owned the facility that provided the service. 

• Medicare patients of physicians referring to entities in which they had an investment interest received 34% more laboratory services than the general 

Medicare population. (U.S. Department of Health and Human Services, Office 

of the Inspector General: Financial Arrangements Between Physicians and 

Health Care Businesses, 1989b.) 

As a result, this practice was limited by a new law, the Ethics in Patient Referrals 

Act of 1989, which created a strict prohibition on physician conflicts of interest and 

self-referral to clinical laboratories—the area studied in 1989. Research continued 

looking at other services, and since that time additional findings show that self-referral increases the use and cost of health care services. 

Patients of physicians referring to entities in which they had an investment interest: 

• Got imaging exams 4.0 to 4.5 times more often than patients of physicians 

referring to independent radiologists (Hillman et al, 1990) 

• Received physical therapy at rates 39% to 45% higher than patients referred 

to independent practitioners (Mitchell and Scott, 1992) 

• Had higher overall costs for medical care covered by workers’ compensation 

(Swedlow et al, 1992) 

• Were substantially more likely to receive referrals for imaging services 

(GAO, 1994). 

These studies led to an expansion of the 1989 law to apply to many other services, 

including: 

• inpatient and outpatient services; 

• physical therapy services; 

• occupational therapy services; 

• radiology, including magnetic resonance imaging, computerized axial tomography scans and ultrasound services; 

• radiation therapy services and supplies; 

• durable medical equipment and supplies; 

• parenteral and enteral nutrients, equipment and supplies; 

• prosthetics, orthotics and prosthetic devices; home health services and supplies; 

and 

• outpatient prescription drugs. 

However, exceptions were created in the law to allow what Congress thought, at 

the time, to be a narrow set of arrangements that would be free from conflict of interest. One is the so-called ‘‘whole hospital’’ exception for self-referrals for inpatient 

and outpatient hospital services when a physician has an ownership stake in a 

‘‘whole hospital.’’ This exception was created based on the reasoning that a single 

physician’s ownership in and referral to a whole hospital was diffused across so 

many different departments in the hospital that it would limit any financial gain 

that might result to the physician. And Congress expressly prohibited physician selfreferral to individual departments or subdivisions within a hospital to protect 

against conflicts of interest. 

But at the time the self-referral laws were passed, policy makers did not foresee 

that specific departments or specialties within a hospital (e.g., cardiac care, orthopedics, surgery) would become stand alone hospitals. Because of concerns with this 

practice, the Medicare Modernization Act of 2003 (MMA) imposed a temporary moratorium on physician self-referrals under Medicare to new limited-service providers. 

The moratorium is set to expire June 8, 2005. 

This is Not About Competition 

Some suggest that full service community hospitals are just afraid of competition 

from these limited-service hospitals. Some have also suggested that consumer choice 

might somehow be limited without these facilities. That is absolutely not the case. 

Full service hospitals are more than willing to compete based on cost, quality and 

efficiency. They compete with other providers in their market areas every day. But 

when physician owners of limited-service hospitals can pick and choose the services 

88 

they provide, and when they can pick and choose the patients—often the healthier, 

well-insured patients—they refer to the facilities they own, they have unfair advantages. And that’s anti-competitive. 

As to patient choice, most patients rely almost exclusively on the advice of their 

physicians when deciding where to have a surgical procedure performed. Real choice 

means not having to worry that the motivation for referring a patient to a limitedservice hospital is anything other than what is in the best interest of the patient. 

Full service community hospitals welcome competition and patient choice—as long 

as it is free from the physician ownership and self-referral that create an un-level 

competitive playing field. 

The Facts 

According to the Centers for Medicare and Medicaid Services (CMS), 59 physicianowned, limited-service cardiac, orthopedic and surgical hospitals were open and operating at the end of 2003 as a result of this federal loophole. Many more have 

opened since then and many more are waiting to open their doors. 

These physician-owned, limited-service hospitals raise concerns about conflict of 

interest and fair competition in the health care market place. In October of 2003, 

the Government Accountability Office found that, when compared to full service hospitals, physician-owned limited-service hospitals: 

• treated patients that tended to be less sick; 

• treated smaller percentages of Medicaid patients; 

• are much less likely to have emergency departments; 

• derive a smaller share of their revenue from inpatient services; 

• have higher margins; and 

• had physician ownership that averaged slightly more than 50 percent. 

In March 2005, the Medicare Payment Advisory Commission (MedPAC) issued its 

report to Congress on the topic. They found, when compared to full service hospitals, 

physician-owned limited-service hospitals: 

• Tend to treat lower shares of Medicaid patients; 

• concentrate on certain diagnoses (diagnostic related groups (DRGs)) 

• treat relatively low-severity patients within those DRGs; and 

• do not have lower Medicare costs per case. 

In March 2005, CMS shared with the Congress preliminary findings from their 

research on this topic. Their work showed that, when compared to full service hospitals, physician-owned limited service hospitals: 

• generally treat less severe cases; and 

• provide less uncompensated care. 

These findings, from all three sources, describe some of the ways in which physician ownership creates unfair competition in the health care market place. But all 

of these advantages accrue to physician-owned limited-service hospitals because of 

procedure, service and patient selection—all driven by self-referral. 

Why Physician Conflict of Interest is a Serious Problem 

Self-referral, and the conflict of interest it creates, is dangerous for patient care. 

When physicians own, even in part, the facilities to which they refer patients, their 

decisions are subject to competing interests—what’s in the best clinical interest of 

the patient and what’s in the best financial interest of the physician. Studies have 

shown that when physicians self-refer, these competing interests lead to increased 

use of services and higher spending. 

Self-referral allows physician-owners to reward themselves in several ways. 

Patient selection. Physician owners have at least three ways in which they can 

financially reward themselves by selectively referring or ‘‘cherry picking’’ patients. 

First, physician-owners can simply avoid treating uninsured, Medicaid and other patients for whom reimbursement is low. They can do this by opening facilities that 

have no emergency departments, by locating in upper income areas, and by not 

treating patients with certain insurance coverage in their daily practices. All of 

these activities create barriers for uninsured, underinsured and other patients. 

Second, physician-owners can selectively refer patients to different facilities. Because patients trust and follow the advice of their physician, most will seek care 

and treatment in the facility recommended by their physician. Physician-owners, 

through their referral practices, can refer well-insured patients to the facilities they 

own, and poorly insured or uninsured patients elsewhere, often to the local full service community hospital. 

89 

And third, as physician-owners selectively refer, they can refer healthier, lower 

cost, lower risk patients to facilities they own, leaving more severely ill patients to 

be treated by local full service community hospitals. 

Service selection. Physician-owned limited-service hospitals, by definition, limit 

the care they provide to a select group of services. As MedPAC research has shown, 

physician-owners reward themselves by opening facilities that target only profitable 

diagnoses and procedures—cardiac care, orthopedic surgery, and other surgical procedures. There are no limited-service burn hospitals, limited-service neonatal care 

hospitals, or limited-service pneumonia hospitals. 

Quality oversight concerns. Physician ownership and self-referral can also lead 

to serious conflict of interest in the area of quality oversight. Oversight for the quality of care in America is performed through a ‘‘peer review’’ process—groups of physicians who review, evaluate and oversee the quality of the care provided by their 

physician colleagues and specialists. Challenging as peer review is, quality oversight 

is fraught with conflict of interest when the physician doing the review is an owner/ 

partner with the physician being reviewed. The arrangement raises concerns about 

whether quality could be compromised because of financial interests. 

The Impact on Care 

These conflicts of interest that create patient selection, service selection and quality oversight concerns are jeopardizing our health care safety net. Community hospitals are committed to serving all patients, regardless of their health status or ability to pay. But the conflict-of-interest practices of physician-owned limited-service 

hospitals are robbing community hospitals of their ability to serve their communities and placing health care services in many communities at risk. 

As physician-owned limited-service hospitals pull out from the community hospitals profitable services and healthier elective patients, full service community hospitals are challenged to: 

• Continue providing essential services that are seldom self-supporting, such as 

emergency departments, burn units, trauma care, and care for the uninsured. 

• Maintain specialty ‘‘on-call’’ coverage in their emergency departments, as physician-owners of limited-service hospitals no longer want to participate in this 

broader community commitment. Lack of specialty coverage in our nation’s 

emergency departments can jeopardize a hospital’s trauma level status and 

cause emergency patients to be transported much farther to access needed specialty care. 

• Overcome growing inefficiencies, such as more downtime and less predictable 

staffing needs, that result from a higher proportion of emergency admissions at 

full service hospitals. These result as physician-owners move more and more 

elective admissions to their own limited-service hospitals. 

• Coordinate care for patients in their community when more and more are being 

treated for a single condition by a limited-service hospital. Also, complications 

unrelated to the condition being treated (for example, a heart attack or a blood 

clot during or following surgery) result in last-minute emergency transfers to 

full-service hospitals, increasing the risk to patients. 

In a recent study by McManis Consulting, researchers went in to four communities to assess the impact of physician-owned limited-service hospitals on the full 

service hospitals and the communities they serve. The findings show that the selfreferral that results from physician ownership creates an un-level competitive playing field for hospitals. 

The study shows that when physician-owned limited-service hospitals open in an 

area, the financial health of the full service hospitals decline. Because the patient 

selection tactics of the physician-owned limited-service hospitals were not available 

to the full service hospitals, revenues from the ‘‘best’’ services, payers, and elective 

cases plummeted and costs increased. Operating rooms and staffing at the full service hospital were now less efficient, recruiting costs rose to replace departing physicians and staff, higher salaries and other incentives were required to retain staff 

in services targeted by limited-service hospitals and lower bond ratings increased 

borrowing costs for full service hospitals. The net income from Wesley Medical Center’s Heart Program in Wichita, Kansas fell by $16 million after the opening of the 

limited-service Galichia Heart Hospital in 2001. In Rapid City, South Dakota, the 

Black Hills Surgery Center’s net income grew and the full service Rapid City Regional Hospital’s net income fell by the same amount—about $18 million. 

At the same time, self-referral creates an un-level playing field for the services 

offered and access to care provided by full service hospitals. The McManis study documents that in two communities, patient access to emergency and trauma care was 

put at risk. In the Black Hills, South Dakota region and in Oklahoma City, a critical 

90 

mass of physician-owners in key specialties opted out of community emergency call 

obligations. The lead organizers of the Black Hills Surgery Center, who were the 

most active neurosurgeons in the region, no longer provide emergency coverage at 

the full service hospital. And no emergency service is offered at the surgical hospital. 

Oklahoma faced a statewide crisis in trauma coverage as a result of so many physicians opting out of emergency call coverage. As neurosurgeons, anesthesiologists 

and other critical specialties removed themselves from call coverage, the Level II 

trauma hospitals could no longer meet state standards for coverage. And the withdrawal of specialists from on call coverage placed a greater burden on physicians 

at inner city hospitals with busy emergency departments. This has caused some of 

the surgeons remaining at the full service hospitals to leave, and has made it difficult to recruit replacements. 

The loss of net income from key services forced cutbacks in under-reimbursed 

services such as behavioral health, trauma and subsidized services for the poor in 

all four areas of the study: the Black Hills region of South Dakota, Lincoln, Nebraska, Oklahoma City, Oklahoma, and Wichita, Kansas. And in each case, the total 

resources (physicians, staff, facilities and equipment) devoted to providing the procedures targeted by the limited-service hospitals increased in the community overall. 

These are serious implications for all patients served—for everyone who relies on 

an emergency department when they are in need of urgent care or a hospital to be 

there to meet a wide range of health care community needs. 

The Solution—Ban Physician Self-Referral to Limited Service Hospitals 

This conflict of interest created by physician ownership and self-referral is easily 

addressed. To protect patients and the health care safety net in America, Congress 

should close the current loophole in federal law now—amend the Ethics in Patient 

Referrals Act of 1989 to permanently ban physician self-referral to new limited-service hospitals. Nothing short of banning self-referral will do. 

Why is this a federal concern? Some have suggested that the growth in limited-service hospitals might be stemmed through state laws. But this approach 

misses the heart of the problem. The problem is not limited-service hospitals. There 

may be a role for ‘‘focused factories’’ within our health care system. The problem 

is not physician ownership. If a physician in California wants to invest in a limitedservice hospital in Kentucky, conflict of interest wouldn’t exist. The problem is selfreferral—physician-owners who refer patients to facilities they own. Self-referral is 

a federal issue, and Congress has acted, beginning in 1989 and in years since, to 

limit self-referral at the federal level. 

Payment changes alone are not enough. MedPAC has recommended a number of changes to the Medicare hospital inpatient payment system designed to rebalance payments and remove financial incentives for physicians to target certain, 

more-financially-rewarding Medicare services. While this may appear to be a viable 

option for addressing the issue, these changes alone won’t solve the problem. Even 

if Medicare inpatient payments were revised, it would do nothing to address incentives for physician-owners of limited-service hospitals to increase use of outpatient 

care and ancillary services (e.g., lab and imaging services) for which self-referral 

under the whole hospital exception loophole is currently permitted. And changing 

Medicare inpatient payments does nothing to change physician-owners’ incentives to 

select the most well-insured patients, avoid Medicaid patients, and avoid uninsured 

patients. 

Many Others are Concerned 

Full service community hospitals are concerned about the impact of physician 

ownership and self-referral on health care. But hospitals are not alone. The American Academy of Family Physicians, representing more than 94,000 physicians and 

medical students specializing in primary care, and the National Rural Health Association, representing practitioners and organizations that share a common interest 

in rural health, are among those supportive of continuing the moratorium on selfreferral to limited-service hospitals. 

And the U.S. Chamber of Commerce, also concerned about physician self-referral, 

supports extension of the current moratorium. In their recent letter to Congressman 

Bill Thomas, the U.S. Chamber stated that the ‘‘business community is concerned 

about the potential for physician owners to refer the most profitable patient cases 

to entities in which they have a financial interest, while referring more complicated 

and poorly reimbursed cases to general hospitals serving the community at large.’’ 

Their letter goes on to say that the Chamber ‘‘believes further evaluation of this 

topic is warranted, and thus urges an extension of the current moratorium.’’ 

91 

In conclusion, physician ownership and patient referral lead to very serious concerns about the health and economic interests of a community, including higher 

health care costs, duplication of services, patient and service selection, reduced 

emergency room coverage, inappropriate use of procedures, and more. We strongly 

urge Congress to close the loophole in federal law by permanently banning physician 

self-referral to new limited service hospitals. By doing so, Congress can help to prevent conflict of interest between physicians and patients, preserve care for everyone’s emergent and urgent health care needs, and promote fair competition in today’s market place. 

f 

North Texas Hospital 

Lewisville, Texas 75067 

March 7, 2005 

Ways and Means Committee 

My name is Dr. Damien Dauphine ́. I am a reconstructive foot and ankle surgeon 

with North Texas Hospital which is a surgical hospital in Denton, Texas. I am 

writing in reference to the Ways & Means Committee meeting tomorrow. As you 

know, the percentage of the national budget devoted to healthcare continues to rise. 

We believe that increasing competition in the healthcare arena while providing superb patient care is a win-win situation for Americans. 

I’m sure you have heard from the American Hospital Association and their stance 

on specialty or surgical hospitals. The fact remains, that the AHA is determined to 

squelch competition to preserve their monopolies all over America. The bureaucratic 

corporate hospital companies are the reason physicians like me have created these 

new facilities for healthcare delivery. 

The surgical hospital industry must continue to exist. Employees of nearly 100 facilities would be in danger of losing jobs. Whole communities are at risk. But most 

importantly, the citizens of our communities are at risk. Please do not allow the 

moratorium on specialty hospitals to continue. Patients must be allowed to 

have a choice in health care. We feel our opponents have misrepresented our industry. The facts are: 

• The so-called ‘‘cherry picking’’ of profitable patients can be eliminated more appropriately by DRG reform 

• The American Surgical Hospital Association (ASHA) is not aware of any facilities that are planning to open within a year of the expiration of the moratorium 

this June 

• Surgical hospitals serve both Medicare and Medicaid patients 

• Truth! There are currently 40 specialty hospitals that do not have ER’s. Also 

True! There are 400 general hospitals that do not have ER’s 

• Physician investment averages 2% in specialty hospitals, according to the Government Accounting Office—hardly a conflict of interest 

• Studies done in the 80’s show no inappropriate referrals by surgeons and over 

85% of our cases are outpatient Take a look at the general hospitals in your 

area, more than likely they are expanding, not closing departments or closing 

their doors altogether 

• The Wall Street Journal and The Washington Times have both supported the 

industry with opinion pieces. 

To further the argument that competition is a necessary component of price control, the Federal Trade Commission and the Department of Justice have examined 

the ‘‘Certificate of Need’’ programs in various states. The FTC and the DOJ’s aim 

was to determine if they (state’s CON’s) were effective in protecting the healthcare 

needs of their citizens. The following is a brief synopsis of their conclusions regarding certificate of need programs: 

‘‘States should consider the following steps to decrease barriers to entry into provider markets: 

a. Reconsider whether Certificate of Need Programs best serve their citizens’ health-care needs. On balance, the FTC and DOJ believe that such 

programs are not successful in containing health care costs, and they pose 

serious anticompetitive risks that usually outweigh their purported economic benefits.’’ 

At North Texas Hospital we offer expertise in emergency medicine, hyperbaric 

medicine, general surgery, vascular surgery, podiatric surgery and peripheral nerve 

reconstruction, orthopedic surgery, plastic surgery, gastroenterology, eye surgery, 

pain management, ear-nose-throat surgery, spine surgery, breast reconstruction, 

92 

and gynecologic surgery. We can compete in the Denton marketplace because we 

provide efficient and high quality care and our patient satisfaction response has 

been overwhelmingly positive. We offer services and procedures that many of the 

surrounding hospitals do not offer. We treat patients regardless of ability to pay and 

will be treating Medicare and Medicaid patients for many years to come. 

Please consider these factors as you debate the issues before you. 

Sincerely, 

Damien M. Dauphine ́, DPM 

f 

Fellow 

Statement of Trevor Fetter, Tenet Healthcare Corporation, Dallas, Texas 

I am Trevor Fetter, CEO of Tenet Healthcare Corporation. Through its subsidiaries, the company owns and operates acute care hospitals and related health care 

services. Tenet’s 83,259 employees proudly provide high quality, compassionate care 

at 74 full-service acute-care hospitals in 13 states. Recognizing the importance of 

our role in the community, not only do we provide a vital charity care program 

through our industry-leading Compact With Uninsured Patients, but we also make 

significant investments in essential state-of-the-art health care services, such as 

transplant, open heart, neurosurgery, pediatrics, and neonatal intensive care. In addition, as an investor-owned health care company, our hospitals contribute to the 

economic development of each of the communities in which they operate through 

payment of state and local taxes. 

I am pleased to offer comments to the House Ways and Means Subcommittee on 

Health about the unique problems created by physician ownership of and self-referral to specialty hospitals. I view this as one of the most critical issues facing fullservice community hospitals today. Physician-owned specialty hospitals, sometimes 

called limited service providers, undermine and complicate the delivery of responsible, effective health care decisions by injecting self-referral into the clinical process. Within the past several years, physician-owned specialty hospitals have emerged 

to capitalize on an unintended loophole in the anti-referral laws. The success of a 

physician-owned specialty hospital depends upon referrals by its physician owners. 

Succinctly, these arrangements tilt the competitive playing field by providing physician owners with strong monetary incentives for referring carefully selected patients 

to the facilities in which the physicians have ownership interests, while leaving less 

profitable cases to be handled by the local community hospitals. 

Physicians owning a financial interest in a specialty hospital tend to direct to 

their facilities only the most attractive patients—those with private health insurance and those who are less sick. However, those same specialists tend to refer 

underinsured or uninsured patients, as well as those with higher acuity, to full-service community hospitals for treatment, which is administered with little to no reimbursement of costs. Full-service hospitals then are left with inadequate resources to 

treat the sickest of patients. The practice of patient selection does not serve the 

American health care system, it does not serve community hospitals, and most importantly, it does not serve the best interests of the patients in our care. 

The only way to solve this problem is to close the loophole in federal law to permanently ban physician ownership of and self-referral to specialty hospitals. The relationships required by such ownership/referral patterns are exactly what the antireferral laws are designed to prevent. 

I certainly understand the pressures faced by both hospitals and physicians. We 

all must overcome numerous obstacles just to keep open the doors to quality patient 

care—the constraints of often unpredictable and inadequate Medicare and Medicaid 

reimbursement, increasing insurance premiums, pressures of managed care, demanding regulatory burdens, and on-call requirements, just to name a few. Within 

this demanding environment, it is understandable that some physician specialists 

would be intrigued by a specialty hospital’s promise of incomparable personal financial gain. However, I believe that each of these challenges requires a comprehensive 

solution aiming to reform a fractured health care system, not an anti-competitive 

solution in the form of self-referral to specialty hospitals, which ultimately impacts 

patient access to health care. 

As the CEO of multi-state hospital operating company, I support free and fair 

competition. True competition, however, requires a level playing field. Tenet hospitals, and other full-service community hospitals nationwide, routinely compete for 

patients on the basis of quality of care, physician recruitment, and provision of the 

93 

latest medical technologies. Yet the recent proliferation of physician-owned specialty 

hospitals across the country has dramatically altered the delivery of health care 

services by stifling fair competition and even threatening the viability of certain 

vital health care services nationwide. 

The existence of specialty hospitals is not the problem. Instead, it is the physician 

ownership of and self-referral to these facilities that creates an uneven playing field 

and directly harms full-service community hospitals. In recent years, physicianowned specialty hospitals built across the country are distorting the marketplace 

wherever they appear. These facilities limit their care to just one type of service— 

often cardiac, orthopedic, or surgical care—which guarantees high profit margins, 

while avoiding essential but unprofitable community services, such as emergency 

services. 

Ownership interest in these facilities is typically granted only to physicians who 

are able to refer patients, not to any investors from the general public. Referring 

physicians are often given sweetheart equity arrangements at bargain basement 

rates. By contrast, full-service hospitals, like those owned and operated by Tenet 

Healthcare, are prohibited by federal laws from offering physicians an ownership interest in the specialty wings or subdivisions of our hospitals. In fact, offering a physician any ‘‘inducement’’ for referrals is expressly against federal laws. These laws 

prohibit Tenet from giving specialists at our hospitals more than $300 in gifts per 

year, none of which can be given in exchange for a referral. Fair competition under 

the interpretation of existing rules simply would be impossible. 

The ‘‘whole hospital’’ loophole in the anti-referral laws permits specialty hospitals 

to cherry pick only the most profitable patients, leaving high-cost patients, individuals on Medicaid, and the uninsured to community hospitals. The Government Accountability Office (‘‘GAO’’) and the Medicare Payment Advisory Commission 

(‘‘MedPAC’’) have found clear evidence of this behavior, concluding that physician 

ownership and self-referral result in favorable patient selection. Because of their adverse financial impact, self-referrals to physician-owned specialty hospitals threaten 

the long-term viability of our full-service community hospitals. 

Commitment to Community 

In this anti-competitive environment, full-service community hospitals struggle to 

achieve the level of care that they desire to provide and that their communities expect. When specialty hospitals drain essential resources from full-service community 

hospitals, they particularly harm our capacity to provide emergency care and other 

vital health services over time. 

As the Members of this Committee are well aware, America’s hospital emergency 

rooms are quickly becoming the de facto public health care system, the primary 

point of access to quality health care services for the nation’s uninsured. Hospitals 

equipped with emergency rooms must provide medical evaluation and required 

treatment to everyone, regardless of their ability to pay, as required by federal law. 

Since the advent in recent years of these physician-owned specialty hospitals, which 

skim profitable service areas for low-risk patients, this burden has grown even 

heavier. While specialty hospitals treat the most profitable patients, full-service hospitals are left with the task of handling uninsured and high-risk patients within 

their community. 

A 2003 study by the GAO sheds considerable light on the attitude of specialty hospitals toward emergency services. According to the GAO, a majority of specialty hospitals do not have fully functioning, fully staffed, 24-hour emergency rooms. The 

GAO study reveals that while nine in 10 of all full-service community hospitals 

maintain an emergency department to address any medical concern that comes 

through its doors, half of specialty hospitals do not provide emergency services. 

Even among those specialty hospitals that do have emergency departments, GAO 

found that the care provided was almost entirely within the specialty hospital’s 

field. 

By opting not to operate fully functioning emergency departments, specialty hospitals enjoy a high degree of self-selection, which allows them to treat a healthier 

and better paying patient population with fewer complications and shorter lengths 

of stay. 

Moreover, GAO and MedPAC separately found that specialty hospitals treat a 

much smaller share of Medicaid patients than do community hospitals within the 

same market area. In its results, MedPAC found that physician-owned specialty 

hospitals treat far fewer Medicaid recipients than do community hospitals in the 

same market—75 percent fewer for heart hospitals and 94 percent fewer for orthopedic hospitals. 

The departure of specialists who relocate their practices from full-service community hospitals to physician-owned specialty facilities causes an additional strain on 

94 

specialty coverage for full-service hospitals. Communities expect full-service hospital 

emergency departments to maintain a complete state of readiness around the clock, 

every day of the year. On-call requirements for specialists ensure adequate staffing 

outside normal work hours, as well as on holidays and weekends for hospital emergency departments. The lack of physician specialists to provide coverage at full-service community hospitals has compromised the ability of those hospitals to provide 

24-hour emergency services. 

Full-service community hospitals long have used funds generated by profitable 

services to subsidize the losses suffered by unprofitable services. Only by maintaining the successful product lines are full-service hospitals able to subsidize other critical but less profitable services, such as trauma and burn centers, as well as fund 

special programs for delivering care to uninsured and underinsured patients. By removing the most profitable services from full-service community hospitals, physician-owned specialty facilities have a monetary incentive to refer only those betterfunded and less severely ill patients. This leaves the uninsured, underinsured and 

more severely ill patients to be treated by community hospitals, often without adequate (or any) compensation. While paying and less severely ill patients are diverted 

to physician-owned specialty facilities, community hospitals are left with the burden 

of caring for a higher percentage of the uninsured, underinsured, and the sickest 

patients, yet with fewer resources to cover the vast and unreimbursed costs involved. 

In Slidell, Louisiana, Tenet operates North Shore Regional Medical Center. In 

2002 North Shore had 723 cardiac admissions. After a physician-owned limited access facility specializing in cardiac care opened in 2003, the North Shore cardiac admissions had dropped to 359 in 2004. However, North Shore continues its community service of providing a full complement of critical emergency department services to all patients in need. In 2003, NorthShore received 23,570 visits to its emergency department, and 30 percent of those patients were self-pay and Medicaid. 

From what Tenet has witnessed in Slidell, and from what we have seen nationwide, 

physician-owned specialty hospitals simply do not share in the full complement of 

critical ED services to all patients, which full-service hospitals consider as a responsibility and commitment to their communities. 

Solution: Self-Referral Loophole Closure 

Allowing for the continuation of these financial arrangements between referring 

physicians and specialty hospitals is tantamount to purchasing admissions. I understand that Congress is weighing recommendations by MedPAC that would seek to 

level the playing field through Medicare payment adjustments. While I would certainly advocate for more accurate and appropriate Medicare reimbursement, I think 

it is important to recognize that Medicare payment adjustments alone will not level 

the playing field and will not solve the exploitation of this loophole. 

MedPAC was correct in recognizing the problems inherent in physician ownership 

of specialty hospitals, and the need to prevent such conflicts of interest; however, 

its policy response, which focused on refinements of Medicare’s DRG payment system, is inadequate. As an operator of acute care hospitals, Tenet operators can assure the Committee that simply adjusting the DRG’s will only marginally reduce the 

profitability of self-referral. It is the owner and referral relationship that creates patient selection. The underlying economics of these facilities, which relies upon referrals from physician owners, would not change materially. Furthermore, while some 

modifications may be warranted, we have to be careful that the wholesale refinement of the DRG system, which MedPAC proposes, could threaten the original reasons for and subsequent achievements of the Prospective Payment System we have 

in place today—that is, rewarding efficient providers. While payment refinements 

will not solve the self-referral problem, I can tell you that the massive redistribution 

of funds nationwide would have the unintended consequence of hurting some full 

service community hospitals, even in markets where there are now no physicianowned specialty hospitals. We have to be extremely careful about a solution this 

broad in scope that, in my opinion, does not address the central problem of physician self-referral. 

Conclusion 

Ultimately, the only effective solution is an amendment to the anti-referral laws. 

These laws generally prohibit physician referrals for services to entities in which the 

physician has an ownership interest. The intent of this prohibition was to establish 

and maintain a thriving marketplace for health care, free of conflicts of interest and 

protecting the integrity of the Medicare program. Under current law, physicians are 

permitted to have an ownership interest in an entire inpatient hospital, but not a 

subdivision of a hospital. Any referral by a physician who has a stake in an entire 

95 

1 Herzlinger RE. MedCath Corporation. Harvard Business School case 9–303–041. Cambridge, 

Mass.: Harvard University, 2003 

hospital would produce little personal economic gain because hospitals tend to provide a diverse and large group of services. However, a physician’s ownership in a 

subdivision of a hospital would not sufficiently dilute the potential conflict of interest. 

The ‘‘whole hospital’’ exception was intended to allow physician ownership in a 

comprehensive health facility, as long as that ownership interest is in the entire facility, not merely a subdivision. Congress never contemplated the emergence of specialty hospitals, which essentially have turned the entire concept of the ‘‘whole hospital’’ exception on its head. Specialty hospitals are not whole hospitals; rather they 

are subdivisions of hospitals—essentially cardiac, surgical, or orthopedic wings— 

that have been removed from the full-service hospital. As such, physician referral 

to specialty hospitals in which they have an ownership interest is as clear a violation of the anti-referral laws as would be physician ownership in a hospital subdivision. Simply put, under the present interpretation of the ‘‘whole hospital’’ exception, 

physician-owned specialty hospitals are exploiting an unintended loophole to engage 

in precisely the financial arrangement that Congress intended to prohibit. This situation must be changed. 

Not only must the current moratorium be extended, but also it is the hospital industry’s hope that Congress will close the loophole in anti-referral legislation that 

allows for self-referral to these facilities. The whole hospital exception loophole is 

not in the best interest of patients, and it will continue to undermine the vital 

health care services communities expect from their full-service community hospitals. 

Thank you for your attention to this critical issue negatively impacting access to 

care of all services to patients across the country. 

f 

Statement of Shawn Friesen, American College of Surgeons 

The American College of Surgeons is pleased to submit a statement for the record 

of the Subcommittee on Health’s hearing on physician ownership of specialty hospitals. This is a very important issue for the College and its members. As you know, 

surgeons provide patient care in all of America’s hospitals. The College strongly believes that maintaining care in all types of hospitals, including specialty hospitals, 

is necessary to sustain full patient access to the highest quality of surgical care. 

• Surgeons advocate the following policies for addressing the issue of specialty 

hospitals: • We oppose elimination of the whole hospital exception, either by legislation or 

regulation; 

• We oppose extension of the MMA moratorium temporarily or permanently; and 

• We support refining the hospital DRGs to ensure that Medicare payments properly reflect the cost of providing care. 

Specialty hospitals are an important marketplace innovation. Indeed, when the 

hospital prospective payment system was implemented in 1982, it was widely expected to lead to hospital specialization in order to increase efficiency and improve 

the quality of care. This is exactly what is happening today with the establishment 

of specialty hospitals. These hospitals provide more choices for patients and they 

provide high-quality care. Patients frequently choose these hospitals and they report 

high satisfaction with their care and experience. 

Physician-ownership of specialty hospitals is a positive trend. It is the joint ventures among physicians, hospitals, and other investors that are making possible the 

growth of specialty hospitals and the improvements they bring. Frequently, the initiative to create a specialty hospital comes from a physician group, often a group 

recognized in the community for its clinical excellence, as Regina Herzlinger notes 

in her case study of MedCath.1Physicians and hospitals working together, and with 

shared incentives, are able to make important changes in the delivery of health 

care. 

The College is concerned about the misplaced emphasis that some attach to financial gain as the prime motivator for physicians becoming involved in these ventures. 

Physicians are motivated to form specialty hospitals because they recognize the potential to increase productivity and efficiency while also improving quality of care 

and patient satisfaction. Sometimes physicians have been frustrated while trying to 

achieve these goals in existing community hospitals. At a MedPAC meeting last 

96 

2Transcript of public meeting: Medicare Payment Advisory Commission, September 10, 2004, 

Washington, D.C; available at www.MedPAC.gov 3Specialty hospital study meeting brief: prepared for meeting of Medicare Payment Advisory 

Commission, September 9–10, 2004, Washington, D.C. 

September, a MedPAC analyst reported on site visits, saying, ‘‘We repeatedly heard 

about the frustrations physicians had with community hospitals. Many community 

hospital administrators acknowledged they had been slow to react to the issues 

raised by their physicians.’’ 2

We want to emphasize that physicians have experienced very significant gains in 

productivity and efficiency through their involvement in specialty hospitals. According to a MedPAC staff report, ‘‘Physicians . . . told us that they can perform about 

twice as many cases in a given time period at specialty hospitals as at community 

hospitals. Physicians mentioned operating room turnaround times at specialty hospitals of 10–20 minutes, compared with over an hour at the community hospitals 

where they also practice. . . . At one specialty hospital, we were told that physician 

incomes had increased by 30 percent as a result of increased productivity.3

Finally, the entry of a specialty hospital into a community can be a powerful force 

for change and improvement. Efficiency and quality are the result of competition, 

which is healthy for the marketplace. In fact, the Federal Trade Commission recently reported that state certificate-of-need laws have an adverse impact on health 

care because they stifle competition. Further evidence comes from MedPAC, which 

reported that community hospitals in areas it visited responded to marketplace 

pressure created by specialty hospitals and improved their own performance. Specialty hospitals provide efficient, high-quality care, and patient satisfaction is high. 

They bring value to local health care systems. 

Indeed, quality and efficiency are the prime motivators for surgeons who choose 

to practice in these hospitals—including those who have no ownership interest. They 

can be more productive and have greater access to specialized equipment and staff 

than is possible in a general hospital. The end result is higher quality at lower cost. 

The criticisms of physician-owned specialty hospitals are not well founded. Critics 

say that they lead to increased utilization and unnecessary services, but there is no 

evidence to support this claim. Critics also say specialty hospitals do not serve lowincome patients or those who lack health insurance coverage. While it is true that 

specialty hospitals tend to treat relatively few Medicaid and uninsured patients, this 

is because of the markets where they are located. Investors tend to build specialty 

hospitals in financially stable suburban areas, where community hospitals also tend 

to treat fewer Medicaid and uninsured patients. Further, unlike most hospitals in 

these markets, specialty hospitals support their communities through the taxes they 

pay. 

Finally, critics say that specialty hospitals tend to treat less severely ill—and 

more profitable—patients, thus leaving the less profitable patients to community 

hospitals that provide a full range of services to all types of patients. Many of these 

services tend to be unprofitable. Unprofitable services, for example, include medical 

admissions rather than surgical ones, emergency and trauma care, and burn care. 

Thus, critics are concerned that specialty hospitals will drain resources from fullservice community hospitals and perhaps hurt them financially. 

The College would share this concern, but we do not believe that this will occur 

or that prohibiting specialty hospitals is the most appropriate way to address the 

issue. As you know, the College has long championed improvements to our nation’s 

emergency medical systems and trauma care systems, and we continue do so. We 

also support the DRG changes that will address this issue of unprofitable services, 

as recommended by MedPAC in its March 1 report to Congress and repeated today 

in its report on specialty hospitals. 

It is also important to recognize that, by their nature, specialty hospitals can only 

treat patients whose medical needs can be met by their resources. Patients with underlying conditions beyond a hospital’s capabilities must be referred to more comprehensive facilities. The same is true for ambulatory surgical centers (ASCs)—some 

patients cannot be cared for appropriately in these facilities and must be referred 

to general or tertiary care hospitals. We also note that some comprehensive hospitals have denied privileges to physicians who practice in competing hospitals or 

ASCs, a development that clearly should cause concern among patients. 

Like nearly all hospitals, specialty hospitals are paid based on DRG payments 

that vary according patient diagnosis, complications, procedures, and the average 

resources required to treat comparable cases. The recent MedPAC reports describe 

flaws in the Medicare DRG system that cause payments for some cases to be higher 

than would be dictated by the average cost of providing services and, conversely, to 

pay less than would be indicated for other cases. These discrepancies can provide 

97 

an opportunity for any hospital, whether specialty or comprehensive, to select patients that are more profitable and to provide fewer services—or even none at all— 

for less profitable patients. The College believes that these perverse incentives ought 

to be addressed and so we strongly support the recommendations advanced by 

MedPAC in its recent reports to Congress. 

We also are pleased that, as reported in the President’s budget for FY 2005, CMS 

plans to adopt MedPAC’s recommendation by initiating a DRG refinement process. 

Done properly, this process will ensure that Medicare payments accurately reflect 

the cost of providing care and that all hospitals are paid fairly and appropriately 

for their services to Medicare patients. We believe that these changes should resolve 

concerns that have been raised about the impact that specialty hospitals can have 

on community hospitals. In effect, the changes will create a level playing field in 

which healthy competition can operate, leading to enhanced quality and efficiency 

in the delivery of all healthcare services. The College believes that improvements 

like those recommended by MedPAC must be implemented in order to ensure the 

financial viability of providing emergency and trauma care as well as the broad 

range of care provided by tertiary care centers and other comprehensive hospitals. 

In closing, we want to emphasize that specialty hospitals are not new—physicians 

and others have been establishing them for 75 years. In fact, some of the nation’s 

finest hospitals are specialty specific. Also, it is worth noting that the average physician investor has a very small financial stake in specialty hospitals, and the majority of surgeons who work in physician-owned hospitals have no ownership interest. 

Further, a ban on physician ownership of specialty hospitals will not stop the trend. 

Corporations, including hospitals, are building them and they will continue to do so. 

Clearly, any action to prohibit specialty hospitals would be an action to limit the 

competition that is so vital to keep the healthcare system improving its efficiency, 

quality of care, and patient satisfaction. This is healthy competition and it is an example of the values that have been promoted by the Administration and by Congress. We must work together to preserve specialty hospitals, support healthy competition, and end distortions in our payment systems that can interfere with patient 

access and harm providers. 

Surgeons remain committed to community health care. Teaching hospitals, tertiary care centers, trauma and burn centers, and the network of community hospitals are all vital to the well-being of surgical patients. Considering this, the American College of Surgeons encourages all physician hospital owners to practice according to the following principles: 

• Specialty hospitals should accept all patients for which they can provide appropriate care, without regard to source of payment. 

• Patient selection should be based on medical criteria and facility capabilities. 

Those patients with needs that extend beyond a facility’s resources should be 

referred to a tertiary care center or other hospital that is appropriately 

equipped and staffed. Surgeons practicing in specialty hospitals should maintain their commitment to providing the emergency services needed in their communities and should take call in community hospital emergency departments, 

as necessary. 

• The issue of whether specialty hospitals should have their own emergency 

rooms is, and should remain, a matter of state law and community need. 

• Physician investors should disclose their financial interest to patients they propose to treat in a specialty hospital. 

Thank you for the opportunity to share the views of the College of Surgeons. 

Questions and comments may be directed to the College’s Washington Office. 

f 

Statement of James Grant, American Surgical Hospital Association, San 

Diego, California 

The American Surgical Hospital Association (ASHA) is pleased to have the opportunity to submit this statement for the record of the Subcommittee’s hearing on specialty hospitals and the reports and recommendations of the Medicare Payment Advisory Commission and the Centers for Medicare and Medicaid Services. ASHA is 

the national trade organization representing 75 physician owned hospitals that specialize in surgical care, the vast majority of such hospitals in the United States. 

98 

THE VALUE OF SPECIALTY HOSPITALS 

ASHA members provide cost effective, high quality surgical care in a very efficient 

manner. Specialty hospitals offer a choice of surgical site both for patients and physicians. Our patients are very satisfied with the care they receive, and far prefer 

the model we offer to that provided in the typical general hospital. We get high 

marks from our patients, our staff and our physicians, whether or not they are investors. The fact that patients have the option of choosing where their surgery is 

to be performed gives them a much greater sense of control, which is very important 

to maintaining patient well-being. Choice is a fundamental attribute of our society, 

and there is no reason it should not be an equal part of our healthcare system. The 

preliminary information from the report of the Centers for Medicare and Medicaid 

Services bears out both the quality of our services and the satisfaction of our patients. 

ASHA particularly wants to emphasize the excellent patient outcomes our members achieve. The average nurse to patient ratio in our hospitals is about 1:3.5 and 

it is well established that the nurse-patient ratio is a prime determinant of quality 

of care and medical outcome. In California hospitals generally the ratio is about 1:8 

and the state had mandated a standard of one nurse for every six patients. That 

standard is being challenged by California general hospitals. On all measures of 

quality, surgical hospitals excel, including lower infection rates, few medically related transfers to other hospitals, fewer medical errors and very low readmission 

rates. 

ASHA believes that two factors are primarily responsible for this excellent record 

that is replicated across its membership. The first is physician ownership and control of the hospital and its functions. The second is the very fact of specialization 

that allows physicians and staff to develop a high level of skill in all facets of surgical care. 

Physician investment in these facilities, whether alone or as part of a joint venture, is a key ingredient to our success. It means that the people whose names are 

on the door are responsible for setting the quality standards, the operational requirements and directing all facets of the hospital’s activities. It is this group of investors who are fundamentally responsible for the existence of the hospital and the 

maintenance of its standards. They create the environment that is so attractive to 

patients and other physicians. One important point about the specialty hospital concept is the number of surgeons who bring patients to the facility even though they 

have no investment interest. They know that their patients will be treated with skill 

and respect from the moment they enter until discharge. 

Because these hospitals provide a focused set of surgical services, the staff is able 

to develop a high degree of skill in these specialized areas. This skill makes possible 

the efficiency of operation and the high quality of patient outcome. We succeed because we are ‘‘focused factories’’ designed to provide elective surgical care to otherwise healthy patients. Cardiac hospitals may care for a different population, but 

their adoption of heart focused, best hospital practices under the guidance of their 

physician investors also allows them to provide an excellent level of care to patients 

with serious medical conditions. In addition to the information that CMS will provide to Congress on quality of care, ASHA also encourages the Committee to look 

at HealthGrades.com, an independent service that evaluates hospital quality for 

specific procedures. Using Medicare data and other resources, this service calculates 

an expected complication rate for each hospital. Actual performance is then measured and compared to the projected rates. Physician owned surgical hospitals score 

very well. 

The presence of a surgical hospital in a community is positive for patients and 

health plans. Competition forces general hospitals to improve their own services to 

patients and can lead to a reduction in overall costs, as health plans are able to 

negotiate for lower rates. In non-competitive environments, there is little incentive 

to improve services and cost effectiveness, whether to please patients or payers. 

MEDPAC’S REVIEW OF SPECIALTY HOSPITALS DOES NOT SUPPORT A 

CONTINUATION OF THE MORATORIUM 

For the past four years there has been a great deal of rhetoric about specialty 

hospitals, but little solid information. We now have complete reports from the Government Accountability Office (GAO) and the Medicare Payment Advisory Commission (MedPAC) that shed more light on the issues in the debate. The preliminary 

report of the Centers for Medicare and Medicaid Services (CMS) provides important 

information on quality of care, patient satisfaction and physician referral patterns. 

MedPAC has looked carefully at the fundamental issue raised by general hospitals at the beginning of this debate—are specialty hospitals harming general hospitals to the detriment of patients? The current moratorium was imposed because 

99 

of concern that such harm was occurring and the desire of Congress to obtain information that would let it answer this basic question. MedPAC’s bottom line is that 

general hospitals have not been harmed. They have effectively responded to the 

competition posed by specialty hospitals and remained as profitable as their peers 

in communities where no specialty hospitals exist. This is the experience of our 

members throughout the country. No proof of harm to general hospitals, risk to patients or abuse of the Medicare program because of excessive or unnecessary surgery 

has been found. Therefore, there is no justification to continue the moratorium beyond the legislated expiration date. 

ASHA wants to make an important observation about the current moratorium. 

There is a widespread view that the 18-month moratorium is benign, allowing existing specialty hospitals to proceed unhindered, while only limiting new development. 

This leads to the false conclusion that an extension of the moratorium as recommended by MedPAC would also not harm existing facilities. In fact the moratorium is not benign, but has hurt many well-established specialty hospitals. That is 

because it limits the expansion of facilities, the introduction of new services and the 

addition of new investors in response to changing needs and circumstances in our 

communities. Most of our members are located in areas experiencing rapid population growth, yet they have not been able to expand the number of beds or add 

new specialties to meet that increased patient demand. Our ability to serve our patients and our physicians has been eroded. Another moratorium would only exacerbate this situation. 

ASHA also believes that none of MedPAC’s findings would justify any change to 

the current law governing physician ownership of hospitals. We are pleased that 

MedPAC decided against including any recommendations on the whole hospital exemption to the Stark law. CMS’ analysis of referral patterns supports this conclusion, finding ‘‘no difference in referral patterns for physician owners and non-owners.’’ This finding indicates that financial gain is not the basis for a physician’s decision on where a patient will have surgery. 

MedPAC’s analysis of specialty hospitals did show that Medicare’s inpatient hospital payment system needs substantial revision. ASHA agrees with their recommendations and urges Congress and CMS to act on them this year. The Administration’s budget also supports these payment changes. We also urge adoption of 

MedPAC’s recommendations on gainsharing to encourage hospitals and physicians 

to work in concert to improve the quality and efficiency of healthcare. Finally, 

ASHA encourages the Committee to act on MedPAC’s recent proposals on pay for 

performance measures in the hospital setting. 

ASHA also supports full disclosure of ownership, consistent with the ethical 

standards of the American Medical Association. 

THE WHOLE HOSPITAL OWNERSHIP EXEMPTION IN STARK II 

The Federation of American Hospitals has called on the Department of Health 

and Human Services to restrict the whole-hospital exemption in the Stark law to 

hospitals that ‘‘provide a full range of services customarily offered by general general-based hospitals.’’ As previously noted, ASHA believes that no evidence exists 

that should cause Congress or the Department to modify the current hospital ownership exemption. 

Certainly no evidence supporting limits on physician ownership of hospitals was 

found in the original studies that led to the establishment of the Stark laws. In testimony before the House Ways and Means Committee in 1991, the individuals who 

conducted the original Florida studies on physician ownership and referral arrangements concluded that, ‘‘Joint venture ownership arrangements have no apparent 

negative effects on hospital and nursing home services.’’ 

The American Hospital Association also encouraged Congress to incorporate flexibility in the law governing referral arrangements. In testimony before the Ways and 

Means Committee in 1989, AHA noted, ‘‘Oftentimes, joint ventures which are the 

subject of H.R. 939 are well intended to provide the highest quality, most accessible 

and most reasonably priced medical care to the community.’’ AHA urged Congress 

to take a ‘‘more flexible or less proscriptive approach, allowing ventures consisting 

of referring physicians, if such ventures are for a legitimate business reason . . .’’ 

In 1995, testifying before the same Committee, AHA stated that ‘‘First there 

needs to be careful examination of the effects of the self-referral law on the development of new, more efficient delivery systems, and elements of the law that prevent 

new systems from evolving must be stricken or amended.’’ AHA went on to call for 

an expansion of the physician hospital ownership provisions in the Stark II law. It 

is important to note that the language that allows physicians to have ownership of 

hospitals is not a ‘‘loophole’’ in the Stark law, but a carefully reasoned provision designed to maintain flexibility in the evolution of healthcare delivery systems. 

100 

Regarding the FAH petition, if you examine the variation in services provided by 

general hospitals across the country, you quickly see that there are many differences among those facilities that we might think are ‘‘general community-based 

hospitals.’’ CMS could devote considerable energy to solving this puzzle. Does the 

Federation include a heart program among the obligatory ‘‘full range of services’’? 

Most hospitals don’t have one. Is Ob-gyn a requirement? There is great variation 

among general hospitals in how, or even whether, they provide those services. 

Maybe it should be based on revenue sources, but there’s a problem with that also. 

According to a number of hospital consultants, more than 60 percent of general hospital revenue comes from inpatient surgical services. Does that mean that most 

‘‘general community-based hospitals’’ are, in fact, surgical hospitals? 

As previously noted, MedPAC debated whether or not to include a recommendation on the whole hospital exemption but decided not to incorporate one in their report on specialty hospitals. Among the concerns expressed during discussion of this 

idea was the fact that no one could predict where elimination or modification of the 

exception might lead. For example, physicians have purchased rural hospitals in an 

effort to keep them open. Those acts of community concern could be outlawed if the 

exemption were to be amended or eliminated. The recent purchase of a Tenet hospital in California by the physicians who had a long-standing relationship with the 

hospital might not be allowed. It is obvious that there is no clear line that easily 

distinguishes physician ownership of one hospital versus another. HHS should not 

accept the recommendations of the FAH. 

SPECIALIZED HOSPITALS IN THE UNITED STATES 

Specialized hospitals are not a new phenomenon in medicine and have been in 

existence in this country for many years. There are many hospitals, both not-forprofit and for-profit, that provide a limited array of medical services. For example, 

psychiatric hospitals are very focused in the kinds of patients they treat. Often they 

will not admit a psychiatric patient with significant physical comorbidities because 

they do not have the medical services that patient requires. Such individuals are 

admitted to general hospitals with psychiatric units. However, ASHA has yet to 

hear the general hospitals accuse their psychiatric colleagues of ‘‘cherry picking.’’ 

Children’s hospitals and women’s hospitals have a long history in this country and 

their services are certainly focused on those appropriate to the populations they 

serve. Eye and ear hospitals are just one more example of the kinds of specialization 

that has developed in hospitals. Again, we are not aware that general hospitals have 

accused eye and ear hospitals of ‘‘skimming the cream’’. Cancer hospitals are also 

facilities with a focused mission. Clearly specialization is not the issue driving the 

opponents of ASHA’s members. Something else must be motivating their enmity. 

Perhaps that enmity stems from the fact that today’s physician owned specialty 

hospitals are not seeking out niche services of no interest to the general hospitals, 

but are competing directly with them across a number of valued service lines. In 

any other industry competition and the benefits it can bring to consumers is encouraged. Hospital services should be no different so that society can reap the benefits 

of innovation and cost effectiveness that accompanies competition. Yet our opponents ask Congress to protect them from that competition. ASHA urges you to resist 

their call for protection, since MedPAC found that general hospitals have responded 

effectively to the competition offered by ASHA members, even going so far as to 

make an effort to improve their own services to patients, physicians and hospital 

staff. We doubt if those enhancements would have occurred in the absence of effective competition. 

A careful examination of general hospitals in this country would show that they 

vary widely in the types of services they offer, consistent with their facilities, staffing and the kinds of physicians present in the community. For example, few hospitals have burn units and most do not have heart programs. Level 1 trauma centers are not common. The emergency services offered by most general hospitals are 

not of that caliber. Rural hospitals routinely send complex medical and surgical 

cases to their larger colleagues. The less difficult cases stay behind. Yet no one is 

accusing rural hospitals or critical access facilities of ‘‘unfair competition’’ or ‘‘skimming the cream’’ or ‘‘cherry picking.’’ 

The reality is that every hospital tries to do those things for which it is best suited and whenever possible sends other cases to a better equipped facility. Such behavior is appropriate and in the best interests of patients. ASHA is certain that the 

Members of this Subcommittee would be outraged if hospitals failed to ensure that 

patients were treated in the most suitable facility, whatever or wherever that might 

be. 

As noted, ASHA is the trade organization for specialty hospitals. We have 75 

member facilities, and all have some degree of physician ownership. All specialize 

101 

in surgical care. While our cardiovascular hospital members focus just on heart care, 

the typical ASHA member provides services in six surgical specialties. Urology, general surgery, orthopedics and ENT are commonly found in these facilities. Our members are located in eighteen different states. GAO found that 28 states had at least 

one specialty hospital, but approximately two thirds were located in seven states. 

In MedPAC’s sample, almost 60 percent were concentrated in four states. This concentration is primarily due to the presence of certificate of need (CON) laws governing hospital construction. Most specialty hospitals are in states that do not have 

hospital CON requirements. Since CON laws tend to protect existing facilities from 

new entrants into the market, it should come as no surprise that our members are 

usually found in states that do not have such barriers to market entry. It is worth 

noting that both the Department of Justice and the Federal Trade Commission have 

called for an end to CON because of its anticompetitive effects. 

WHY PHYSICIANS ESTABLISH SPECIALTY HOSPITALS 

It is important that the Subcommittee understand why physicians establish specialty hospitals. Those reasons will vary in each community, but the interest in a 

specialty hospital usually begins after physicians have failed to persuade the general hospitals at which they practice to make changes that will improve physician 

efficiency and patient care. For example, the StanislausSurgicalHospital in Modesto 

was established first as an ambulatory surgery center and later as a hospital by surgeons who could not get reasonable access to the operating rooms at the two other 

hospitals in town. These hospitals were profiting from their cardiovascular and neurosurgery services. Those cases had first call on the OR. Orthopedics, urology, ENT 

and other surgical disciplines took what was left, and even then were often bumped 

by trauma and other emergency cases. The result was that elective cases were delayed until 10:00 PM or later, to the great unhappiness of patients and surgeons 

alike. While no one disputes the need for hospitals to deal quickly and effectively 

with emergencies, many hospitals have figured out ways to keep the rest of the surgical schedule moving along. Stanislaus arose out of this unresolved conflict. 

Fresno Surgery Center is a similar case. Physicians in Fresno believed that they 

could provide a better model for elective surgical care. They could not persuade the 

hospitals to go along with their ideas, so they built their own facility. They continue 

to care for patients at the other hospitals in Fresno, as do their colleagues in Modesto. In fact, they require their physicians to maintain privileges at one of the 

other general hospitals in town. That means, of course, that they are all subject to 

the on call and other requirements of those hospitals. In California, like many 

states, insurance contracts are the dominant reason patients go to one hospital or 

another. Therefore, the physicians all must have privileges at multiple facilities if 

they are to meet the medical and financial needs of their patients. There may be 

rare examples of physicians moving their entire caseload to a surgical hospital, but 

those are truly the exceptions to the general rule. 

One of the most interesting facets of the national debate over physician owned 

specialty hospitals is the fact that the distribution of specialty hospitals varies widely according to state law and regulation. States historically have determined what 

kinds of facilities can be licensed as hospitals and have established various kinds 

of regulatory standards in this regard. For example, not all states require hospitals 

to have emergency departments as a condition of licensure. That is the case in California. The federal government has respected this state role and has focused its attention on quality standards for facilities participating in federal health benefit programs, for example Medicare’s conditions of participation. Yet now we are debating 

whether or not the federal government should usurp that state role and decide for 

itself what does and does not constitute a hospital for purposes of federal health 

programs. ASHA would argue that absent evidence of Medicare or Medicaid fraud 

or grave risk to the public health, there is no need for the federal government to 

infringe on these state determinations 

While physician ownership characterizes ASHA members, the nature of those arrangements varies widely. GAO found that about one third of their sample was 

independently owned by physicians; one third had corporate partners like MedCath 

or National Surgical Hospitals; and one third were joint ventures between physicians and local general hospitals. ASHA’s own survey of its members found similar 

characteristics. 

Clearly not all general hospitals are hostile to specialty hospitals or joint ventures 

with their physicians. For example, Baylor Medical Center in Dallas has a variety 

of joint ventures with physicians, including specialized hospitals and ambulatory 

surgery centers. Integris Health System in Oklahoma City has a joint venture with 

an ASHA member hospital specializing in orthopedic services. HCA partners with 

physicians in numerous ambulatory surgery centers and an orthopedic hospital in 

102 

Texas. Avera McKennan in Sioux Falls, SD, has a joint venture with MedCath and 

the cardiovascular physicians who practice there. Incidentally, Avera McKennan is 

across the street from the Sioux Falls Surgery Center, a physician owned surgical 

hospital. Both facilities have grown and prospered, and the physicians practice at 

both hospitals. In Fresno there is a specialty heart hospital, the Fresno Heart Hospital, that is a joint venture between the largest not for profit hospital and local 

physicians. 

RESPONSES TO CRITICS OF PHYSICIAN OWNED SPECIALTY HOSPITALS 

ASHA would like to turn to the main criticisms of physician owned specialty hospitals and address them. Fundamentally these are allegations that specialty hospitals hurt general hospitals financially and engage in unfair competition because 

they have physician owners. There are a number of arguments used to justify these 

criticisms. These are (1) ASHA members have a favorable payor mix and refuse to 

admit or otherwise limit the number of Medicare, Medicaid and charity cases; (2) 

they focus on the highest paying inpatient DRGs; (3) they only take the easier cases 

in those DRGs; (4) physician ownership is a conflict of interest and gives specialty 

hospitals an unfair competitive advantage in the market; and (5) physician ownership leads to increased, and unnecessary utilization of surgical services. 

We will start with the first fundamental accusation made by our opponents—specialty hospitals have hurt general hospitals. The facts do not support that allegation. No general hospital has closed because of competition from a specialty hospital. 

There is no evidence that general hospitals have eliminated a critical general service, like the emergency department, because of competition from a surgical hospital. 

MedPAC concluded based on its review of 2002 data that the financial impact on 

general hospitals in the markets where physician-owned specialty hospitals are located has been limited and those hospitals have managed to demonstrate financial 

performance comparable to other hospitals. Fresno has a 16 year history with specialty hospitals and that experience confirms the MedPAC conclusions. All Fresno 

hospitals have expanded since the debut of Fresno Surgery Center. This pattern is 

repeated in other communities where specialty hospitals operate. 

Although MedPAC tries to caveat this conclusion by noting the ‘‘small number’’ 

of specialty hospitals in its sample, the reality is that they looked at 48 hospitals, 

more than 50 percent of the entire complement of physician owned specialized facilities. By any statistical measure that is a more than adequate sample upon which 

to base sound conclusions. 

The Subcommittee needs only to look at the level of hospital expansion and construction in this country to determine that most general hospitals are financially 

healthy, with good access to capital. These are not the signs of an industry in distress. GAO found that ‘‘financially, specialty hospitals tended to perform about as 

well as general hospitals did on their Medicare inpatient business in fiscal year 

2001’’. According to GAO, specialty hospital Medicare inpatient margins averaged 

9.4 percent, while general hospitals averaged 8.9 percent. This is not a significant 

difference in performance. The highest margins were reserved for the for-profit general hospitals, such as those operated by Tenet and HCA. 

According to the Health Economics Consulting Group (HECG), ‘‘Based on a longitudinal study of general hospital profit margins in markets with and without specialty hospitals, we find that profit margins of general hospitals have not been affected by the entry of specialty hospitals. Consistent with economic theory, the models consistently showed that the most important predictor of general hospital profitability was the extent of competition from other general hospitals in the same market area—Contrary to the conjecture that entry by specialty hospitals erodes the 

overall operating profits of general hospitals, general hospitals residing in markets 

with at least one specialty hospital have higher profit margins than those that do 

not compete with specialty hospitals.’’ 

Let’s look at the unfair competition argument next. Our accusers say that specialty hospitals engage in unfair competition because they have physician owners. 

That ignores the reality identified by GAO that ‘‘approximately 73 percent of physicians with admitting privileges to specialty hospitals were not investors in their hospitals.’’ Clearly these physicians find something very attractive about the specialty 

hospital model, even without an investment interest. They have no motivation to engage in ‘‘unfair competition’’. Perhaps they are drawn to the high quality of hospital 

care, as evidenced by a nurse to patient ratio of one nurse for every 3.5 patients 

and an almost nonexistent infection rate. Possibly the ability to keep to a tight surgical schedule attracts them. Most surgeons see patients in their offices once they 

finish their surgical schedule. If that schedule is disrupted so are the lives of the 

patients waiting not so patiently for their surgeon to meet with them. 

103 

The percent of ownership is another important factor. According to GAO, ‘‘On average, individual physicians owned relatively small shares of their hospitals. At half 

the specialty hospitals with physician ownership, the average individual share was 

less than 2 percent; at the other half, it was greater than 2 percent.’’ MedPAC reported the range of ownership to be from 1 to 5 percent. While the return on investment can vary among physician owned facilities, the modest ownership shares and 

the large number of physicians who are using the facilities, but who have no investment, suggest that financial gain is a secondary consideration for most physicians. 

One cannot look only at a single side of a competitive market. Congress needs to 

consider the tools that general hospitals have to compete against specialty hospitals. 

According to the December 2004 report on specialty hospitals of the American Medical Association’s Board of Trustees, these include (1) revoking or limiting medical 

staff privileges to any physician who invests in a competitive facility; (2) hospitalowned managed care plans denying patients admission to competing specialty hospitals; (3) exclusive contracting with health plans to exclude specialty hospitals; (4) 

refusing to sign transfer agreements with specialty hospitals; (5) requiring primary 

care physicians employed by the hospital to refer patients to their facilities or to 

specialists closely affiliated with the hospital; (6) requiring subspecialists to utilize 

the hospital for all of their medical group’s referrals; (7) limiting access to operating 

rooms for those physicians who invest in competing facilities; and (8) offering physicians guaranteed salaries to direct or manage clinical services and departments in 

the general hospital. In addition, not-for-profit facilities have significant advantages 

because of their special tax status. Society has given not-for-profit hospitals special 

tax benefits in part to compensate them for the essential community services they 

offer. If they fail to hold up their end of the bargain, they should lose this special 

treatment. An analysis by Harvard professor Nancy Kane suggests that as many as 

75 percent of not-for-profit hospitals receive more in tax relief than they provide in 

charity care. 

Much has been made of the unfair burdens that weigh down general hospitals 

that are not shared by specialty hospitals. Often cited is the fact that specialty hospitals are less likely to have emergency departments. The burden of EMTALA is frequently raised. General hospitals often talk about the need to support burn units 

or other costly services and how competition from specialty hospitals affects their 

ability to do that. State law determines whether or not a hospital is required to 

have an emergency department. Surgical hospitals that are in states requiring 

emergency facilities have them and they are thus subject to EMTALA. If they are 

not required, surgical hospitals that treat only elective cases are not likely to have 

an ER, since it is an unnecessary expense and not consistent with the model of care 

provided. Heart hospitals, on the other hand, almost always have emergency departments because of the nature of the diseases they treat. 

To the extent that such disparities are widespread, the payment changes recommended by MedPAC would relieve them by moving Medicare dollars from high 

pay to low pay cases, evening out the differences. However, Congress needs to remember that most general hospitals do not have burn units, level 1 trauma centers 

or even heart programs. In fact, most hospitals must transfer burn patients or cardiac cases to another facility with the capacity to care for those individuals. No one 

challenges that practice as ‘‘cherry picking’’. It is widely regarded as appropriate 

medical practice because the facility is not designed to care for that particular individual or condition. 

The situation at most surgical hospitals is no different. They are designed to provide elective surgery to otherwise healthy patients. Patients needing such surgery 

who have multiple comorbidities would not be good candidates for a surgical hospital. Good medical judgement requires that the patient be admitted into the appropriate facility. Heart hospitals are different in that many of their cases will be emergent, so they are designed to accommodate them. Emergency departments and ICUs 

or CCUs are commonly part of these facilities. They are likely to offer a broader 

array of supporting medical services, consistent with the medical needs of their cardiovascular patients. 

Payor mix has been another contested area, with accusations lodged that specialty 

hospitals don’t take Medicare or Medicaid patients. This simply is not true. According to the HECG, the average specialty hospital earns 32.4 percent of its revenue 

from Medicare, 3.7 percent from Medicaid, 46.4 percent from commercial payors, 

18.1 percent from other sources, and provides charity care equal to 2.1 percent of 

total revenue. Cardiac hospitals have higher Medicare rates, while hospitals specializing in other kinds of surgery have lower levels of Medicare. In addition the average specialty hospital paid nearly $2 million in federal, state and local taxes. CMS 

has reported that the total of specialty hospital charity care and taxes exceeds the 

average amount of charity care provided by not for profit general hospitals. 

104 

According to MedPAC, there was wide variation in Medicaid admissions among 

specialty hospitals, although on average the rate of Medicaid was lower in such facilities when compared to general hospitals. Several factors may account for the difference. First, hospital location is a major determinant of the level of Medicaid and 

charity care. Second, because surgical hospitals tend to focus on elective surgeries 

and have fewer emergency admissions, they may not see the same level of Medicaid 

traffic as a general hospital with a busy emergency department, which often serves 

as the source of primary care for the uninsured or those on Medicaid. Third, many 

states have moved to managed care in Medicaid and have limited Medicaid patients’ 

access to certain facilities. If a hospital is not on the approved list, it will not see 

very many Medicaid patients, and those that do show up will have to be transferred 

to another hospital that is on the state’s list. 

The disparities in the distribution of Medicaid and uncompensated care were recognized at MedPAC when Chairman Hackbarth said on January 12 that ‘‘I think 

all of us would agree that right now the burden of providing care to Medicaid recipients or uncompensated care is not evenly distributed. That’s an issue that long predates specialty hospitals and it’s an issue that has very important implications for 

the system. And to say that stopping specialty hospitals is going to materially alter 

that problem, fix that problem, I don’t think that’s the case.’’ 

Specialty hospitals may indeed have a different payor mix than many general hospitals, but that does not mean that the general hospital is being harmed. Hospitals 

with higher levels of Medicare and Medicaid are eligible for DSH payments in compensation. If their Medicare caseload is more complex, another point of contention, 

then the outlier payments can offset the higher costs. Specialty hospitals have been 

challenged on the basis that they select only the highest paying DRGs. While 

MedPAC has demonstrated that some of the DRGs are more profitable than others, 

many of the cases treated in specialty hospitals are not drawn from the ‘‘rich’’ DRG 

pool. In fact many surgical DRGs are no more or less profitable than other services. 

To the extent that this is an issue, however, the payment recommendations of 

MedPAC would correct any disparities between rich and poor DRGs. Within DRGs, 

the case is made that surgical hospitals select the easiest cases, thus maximizing 

the profit that can be obtained in any DRG. There are some differences in patient 

acuity, but they are slight, and would be addressed by MedPAC’s payment recommendations. 

When GAO looked at this issue, its analysis revealed little real difference in acuity of admissions. For example, among admissions to surgical hospitals, two percent 

of the cases were in the highest acuity groups, while general hospitals had four percent of their admissions for the same surgery fall into the most severe classification. 

In other words, 98 percent of admissions to surgical hospitals were healthy and 96 

percent of admissions for the same services to general hospitals were in equally 

good health. In hospitals that specialized in orthopedic care, 95 percent of admissions were in the lesser acuity categories, while 92 percent of comparable admissions to general hospitals had the same severity classification. In heart hospitals 

GAO found only a five-percent difference in acuity between specialized facilities and 

general hospitals. 

These are not large differences. The only conclusion one can draw is that patients 

having elective procedures are generally healthy, no matter what kind of hospital 

they are in. If there are differences in the profitability of specialty hospitals versus 

general hospitals, it must be for reasons other than patient selection. 

ASHA will now turn to the allegation that physician ownership of surgical hospitals has generated additional surgical volume, some of it of dubious medical necessity. The facts do not support this accusation. 

MedPAC has determined that specialty hospitals take market share from other 

hospitals and do not add to the volume of surgery. The Commission could not find 

evidence that the increase in service volume experienced in communities with specialty hospitals was higher than that found in areas that had no specialty hospitals. 

No information has been provided that would contradict that finding. This outcome 

is exactly what one would expect in a competitive environment 

ASHA would like to conclude by examining the allegations that physician ownership of hospitals is a conflict of interest and gives specialty hospitals a competitive 

edge over the general hospitals in their communities. ASHA believes that there is 

no conflict of interest when a physician owns the facility in which he or she provides 

services to patients. That issue was thoroughly debated when Congress considered 

the Stark laws and Congress chose to allow physician ownership of hospitals, ambulatory surgery centers, lithotripsy facilities and a number of other sites where the 

physician provided the service in question. The AMA has also addressed the potential conflict of interest at length and concluded that no conflict exists in these circumstances. AMA also recommends additional safeguards to protect patients and 

105 

some of those have been incorporated in various safe harbors developed by the Inspector General. 

AMA also raises an issue that the Subcommittee must explore if it is going to consider whether physician ownership creates a conflict of interest that should be addressed in federal legislation. That is the conundrum of hospital ownership of physician practices, their employment of physicians (particularly specialists), and the 

ownership of health insurance plans by hospital systems. If one is to argue that 

physician ownership of hospitals is a conflict of interest, then one is surely bound 

to agree that hospital ownership of physician practices or employment of physicians 

raises the same concerns. If one arrangement is outlawed, then all should be dealt 

with in the same way. 

There is one other resource that ASHA urges the Subcommittee to look at as it 

considers the issue of physician owned specialty hospitals, and that is the more than 

20 years’ experience that Medicare has with ambulatory surgery centers (ASCs). 

There are now about 4,000 Medicare certified ASCs in this country, providing millions of surgical services every year. Virtually every ASC has some physician owners. Yet in the history of Medicare’s coverage of ASCs, there is virtually no evidence 

that physicians performed unnecessary services or engaged in behavior that placed 

patients at risk. Nor is there any evidence that an ASC forced a hospital to close 

or curtail essential community services. Specialty hospitals are the next logical step 

and Medicare’s ASC experience should be a strong predictor to Congress that physician owned specialty hospitals also pose no risk to Medicare, to patients or to general hospitals. 

In summary, after thorough study the allegations against specialty hospitals have 

not been proven. Therefore, ASHA urges the Committee to allow the moratorium 

to expire as scheduled in June. The reforms to Medicare’s inpatient payment system 

and the hospital pay for performance recommendations suggested by MedPAC 

would greatly benefit the Medicare program and should be adopted. However, there 

is no evidence to justify putting specialty hospitals under another moratorium or 

any other operational limitation during the period these needed changes are implemented. 

ASHA appreciates the opportunity to submit this statement for the record and 

looks forward to working with Congress as it addresses this issue. 

2004 MEMBERSHIP SURVEY RESULTS 

During the summer of 2004 the American Surgical Hospital Association (ASHA) 

distributed a questionnaire to the entire hospital membership. The purpose of the 

survey was twofold—to gather basic descriptive information about the nation’s surgical hospitals and to test the accuracy of some of the allegations made against surgical hospitals by their opponents. 

All 71 member hospitals received the questionnaire, distributed by email from 

ASHA headquarters. Forty four facilities provided usable data, for a response rate 

of 62%. Since a number of surgical hospitals are new, they had not completed the 

full year of operations needed to respond to all of the questions. The data are self 

reported, but are readily available in any hospital, so response accuracy should not 

be a factor. 

According to the survey results, the average ASHA member hospital had the following characteristics in 2003. The facility had 21 inpatient beds, with 8 operating 

and procedure rooms. Six surgical specialties (orthopedics, urology, ENT, plastic surgery and general surgery were frequently identified) were offered at the hospital 

and 5343 procedures were performed. Of these, outpatient procedures accounted for 

90 percent of the total, with the balance being inpatient surgical services. Hospitals 

also provide necessary ancillary services, like imaging and lab. Forty three percent 

of facilities reported having an emergency department. The balance did not, reflecting the fact that they only performed elective surgical procedures and were located 

in states that do not require hospitals to have emergency departments. 

While only a few ASHA members are cardiovascular hospitals, they are a breed 

apart from the typical surgical hospital. They focus on heart care and do not provide 

other surgical specialties. In addition, they tend to be much larger, usually over 50 

beds, and provide ICU and CCU services consistent with the needs of their patient 

population. These facilities are much more likely to have emergency departments, 

again a reflection of the type of patients they treat. 

All ASHA member hospitals have physician investors. The average number is 31. 

However, the business arrangements varied greatly, with joint ventures being the 

most common model at 68 percent. Thirty two percent of surgical hospitals are 

owned exclusively by physicians. 

The type of joint venture varied widely, with 46 percent of hospitals reporting 

that they had a corporate partner. One third of joint ventures were with local comVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00109 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
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munity not for profit hospitals, and 20 percent were a hybrid with both hospital and 

corporate partners. 

However, investors are not the only physicians to use ASHA member hospitals. 

The typical member has 92 physicians with admitting privileges, far in excess of the 

number of investors. This is consistent with the findings of the Government Accountability Office in its 2003 reports on surgical hospitals. 

The average ASHA member employs 119 full and part time staff. The nurse to 

patient ratio is 1:3.5, far better than the requirement of 1:6 mandated by California. 

It is well established that the ratio of nurses to patients is not only an indicator 

of hospital quality, but also a driver of high quality patient care. Other quality indicators were the low post operative infection rates, 0.57 percent; a low rate of emergency transfers to other facilities, 0.22 percent; and a low medication error rate of 

0.56 percent. 

One consistent accusation has been that surgical hospitals do not accept Medicare 

or Medicaid patients and fail to provide charity care. The ASHA survey refutes this 

allegation. Medicare revenue averaged 29 percent, with Medicaid making up 6.5 

percent of earnings. The level of charity and uncompensated care was reported as 

5.3 percent. According to the Medicare Payment Advisory Commission (MedPAC), 

in 2002 for all U.S. hospitals, Medicare was 32 percent of revenue. Medicaid accounted for 12 percent. MedPAC and other studies found that charity/uncompensated care averaged slightly more than 5 percent for all hospitals. Both the level 

of Medicaid and charity care depends largely on the location of the hospital. Inner 

city facilities usually have higher levels of both, while many suburban hospitals do 

not. Also, most Medicaid programs are based on managed care that limits the number of hospitals involved in the program. Unless a specialty hospital has a contract 

with Medicaid, it will not see those patients. 

The ASHA membership survey presents a very different view of surgical hospitals 

than the one popularized by their opponents. It establishes that surgical hospitals 

provide high quality care in a variety of specialties, not just a select few. They treat 

all kinds of patients, regardless of the type of health insurance they may, or may 

not, have. It also demonstrates that the surgical hospital model appeals to physicians, whether or not they have an investment interest. 

Economic and Policy Analysis of Specialty Hospitals * 

John E. Schneider, PhD 1,2

Robert L. Ohsfeldt, PhD 1,2

Michael A. Morrisey, PhD 3

Bennet A. Zelner, PhD 4

Thomas R. Miller, MBA 1

1Department of Health Management and Policy, University of Iowa 

2 Health Economics Consulting Group, LLC 

3Department of Health Care Organization and Policy, and ListerHillCenter for Health Policy, 

University of Alabama Birmingham 4McDonough School of Business, Georgetown University 

February 20, 2005 

Project Director: 

John E. Schneider, Ph.D. 

Health Economics Consulting Group, LLC 

*This project received support from the American Surgical Hospital Association and the South 

Dakota Association of Specialty Care Providers. The authors would like to thank Martin Gaynor 

(Carnegie Mellon University), James C. Robinson (University of California Berkeley), Regina 

Herzlinger (Harvard Business School) and Steve Culler (Emory University) for their helpful 

comments. The views expressed in this report are those of the authors and do not necessarily 

reflect the views of the manuscript reviewers or funding organizations. 

Economic and Policy Analysis 

EXCUTIVE SUMMARY 

This study examines the economic theory and published evidence related to specialty hospitals, including a review of evidence on efficiency, demand, case mix, and 

quality. We conduct a statistical analysis of profit margins of acute care general hospitals in markets with and without specialty hospitals. We also analyze the merits 

of two policy options: limiting specialty hospital entry and physician self-referral. 

The major findings of the study can be summarized as follows: 

Demand 

Demand for services provided at specialized inpatient and outpatient facilities has 

been growing rapidly in the past decade due to a combination of factors, including 

increased incidence of specific diseases, new treatment processes and technologies, 

107 

and changes in consumer preferences. An important factor contributing to the 

growth of specialty hospitals is that some procedures or specialized services are 

more profitable than others, given existing Medicare and private payment rates. Not 

surprisingly, there has been little or no entry by specialty hospitals targeted at unprofitable services. 

Efficiency 

There appear to be economic advantages associated with specialization, due mainly to process redesign, learning, avoidance of diseconomies of scope, and focus on 

core competencies. However, the literature does not consistently suggest that either 

form—specialized or diversified—is superior in terms of economic efficiency. In addition, specialty hospitals appear to have equal or better patient outcomes compared 

to their general hospital counterparts. Hence, there is no direct evidence to suggest 

that specialty hospitals should be barred from entering acute inpatient care markets 

on the basis of economic efficiency or quality of care. 

Quality 

There is comparatively little evidence on the quality of care delivered in specialty 

hospitals. The literature we have reviewed indicates that the care provided by specialty hospitals is, at the very least, equivalent to that provided by general hospitals. However, since specialty hospitals tend to exhibit high volumes of specific 

procedures usually performed by high volume surgeons, to the extent there is a relationship between higher volume and superior clinical outcomes, one might expect 

better outcomes at high volume specialty hospitals compared to lower volume general hospitals. More generally, our review of scores from HealthGrades data indicate 

that there are no significant differences in mortality rates between specialty hospitals and general hospitals in the same geographic area. Finally, our survey results 

suggest that the intensity and quality of services are likely to be higher in specialty 

hospitals. 

Effects on General Hospital’s Finanical Stability 

Specialty hospitals, like their ambulatory surgery center predecessors, compete 

with general hospitals in some product line markets, particularly in states without 

certificate of need (CON) regulation. There is no evidence, other than anecdotal, to 

suggest that general hospitals have been financially harmed by such competition, 

or that such competition is undesirable from a societal perspective. 

Based on a longitudinal study of general hospital profit margins in markets with 

and without specialty hospitals, we find that profit margins of general hospitals 

have not been affected by the entry of specialty hospitals. Consistent with economic 

theory, the models consistently showed that the most important predictor of general 

hospital profitability was the extent of competition from other general hospitals in 

the same market area. General hospitals in less competitive markets (i.e., those 

with fewer competitors) had higher profit rates than general hospitals in more competitive markets. Contrary to the conjecture that entry by specialty hospitals erodes 

the overall operating profits of general hospitals, general hospitals residing in markets with at least one specialty hospital have higher profit margins than those that 

do not compete with specialty hospitals. These findings are also consistent with economic theory, which suggests that firms will enter markets in which extant profit 

margins are comparatively higher. 

Effects on Access to Care 

One potential result of an increase in competition between specialty and general 

hospitals is the alleged attenuation of a general hospital’s ability to provide indigent 

care by internally cross-subsidizing loses from indigent care with profits from ‘‘high 

margin’’ procedures. Rather than limit market competition, the economically optimal 

public policy approach for reimbursing indigent care would be to directly subsidize 

any hospital for providing such care, to the extent that current subsidies (tax-exempt status, disproportionate share payments, etc.) are inadequate. Nonetheless, 

even in the absence of such reform in the financing of indigent care in the U.S. 

health care system, our analysis of Medicare cost reports fails to find any indication 

that entry by specialty hospitals has adversely affected the overall profitability of 

general hospitals in the same market area. Thus, some combination of current subsidies and profits on other ‘‘high margin’’ product lines appears to be sufficient to 

offset any possible adverse effect of specialty hospital competition on the ability of 

general hospitals to offer indigent care or other specific unprofitable services. 

Physicians Self Referral 

There is no evidence to support the contention that physician self-referral to specialty hospitals has any adverse effect on patient or societal welfare. The literature 

108 

1The moratorium was enacted by Congress as part of the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (MMA). It became effective when the law was signed 

on December 8, 2003, and will expire June 8, 2005. However, the Medicare Payment Assessment 

Commission (MedPAC) recently recommended that the moratorium be extended to December 

2006 in order to allow for more time to study the effects of specialty hospitals on general community hospitals. 2These states were chosen due to the relatively high proportion and maturity of specialty hospitals. Site visits generally involved question and answer sessions with all levels of the management team (including physician owners) at each facility, followed by tours. Also provided were 

documents on management strategy, quality assurance, consumer satisfaction, physician ownership, and cost management. 

on self-referral generally shows higher rates of service utilization associated with 

physician ownership of ancillary services. However, any inference of causality in 

this association is problematic at best, because those physicians most likely to use 

such ancillary services most intensively also have the most to gain from increased 

control over the availability of such services, independent of any incentive associated 

with a return on investment in the facility itself. Thus, it is extremely difficult to 

quantify the impact of the financial incentive associated with physician ownership 

per se on the volume of self-referrals. 

More importantly, the existence of an association between physician ownership of 

self-referral for ancillary services provides no evidence that ownership of acute care 

facilities would result in similar differences in utilization. The direct financial incentive for physician self-referral associated with physician investment in specialty hospitals is unlikely to play a major role in a physician’s use of a specialty hospital, 

for four reasons: (1) the extent of investment for the vast majority of physicians with 

ownership interests in specialty hospitals is small compared to the extent on physician ownership of ancillary services; (2) there is no direct evidence that physician 

self-referral is motivated primarily or disproportionately by financial incentives associated with physician ownership; (3) there is no evidence that self-referrals result 

in worse outcomes than other types of referral; and (4) in the case of physician ownership of acute care facilities, it is likely that the magnitude of financial incentives 

is small relative to the more direct financial incentive associated with fee-for-service 

payment for physician services. 

Economic and Policy Analysis of Specialty Hospitals 

1. INTRUCTION 

Hospital specialization has become a controversial topic in recent years, culminating in a moratorium issued in 2003 by Congress directing the Center for Medicare and Medicaid Services (CMS) to cease reimbursements to new physician-owned 

specialty hospitals for those Medicare and Medicaid patients referred by physicians 

with a financial interest in the facility.1The moratorium, which comes in addition 

to existing laws in many states prohibiting the operation of some types of specialty 

hospitals, is in part a response to the concern among incumbent general hospitals 

that specialized facilities may harm the community by undermining the ability of 

general hospitals to internally cross-subsidize unprofitable services, many of which 

may be considered essential to the community. 

This report focuses on two interesting and important economic questions raised 

by the moratorium. First, are there meaningful economic advantages associated 

with hospital specialization, such as lower costs or higher quality? Second, does the 

presence of specialty hospitals reduce the ability of general hospitals to provide necessary but unprofitable services, such as emergency care and other services disproportionately provided to low-income groups? Each of these questions has policy 

implications. If specialty hospitals are more efficient or higher quality or both, economic theory and prevailing competition policy in the U.S. generally support allowing free market entry. That is the argument made recently by a Federal Trade Commission report and an opinion essay in the Wall Street Journal (Federal Trade Commission and U.S. Department of Justice 2004; Wall Street Journal 2005). On the 

other hand, if specialty hospitals interfere with the ability of general hospitals to 

provide unprofitable services, separate policy concerns arise. 

This report is divided into five sections. Section 2.0 provides a brief overview of 

the structure of the specialty hospital industry. Section 3.0 examines the first question—whether there are meaningful economic advantages associated with hospital 

specialization, such as lower costs or higher quality. The primary methodologies for 

the analysis presented in Section 3.0 are (a) published studies and reports and (b) 

observations from our case studies of five surgical hospitals, two in central California and three in South Dakota.2 Section 4.0 reviews the evidence on the quality 

of care and case mix severity at specialty hospitals. The analysis presented in SecVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00112 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
109 

tion 4.0 relies on published studies, reports, and our own analysis of published quality data from HealthGrades. Section 5.0 offers guidance from economic theory on 

assessing the pros and cons of the current policy debates over specialty hospitals. 

Section 5.0 includes an in-depth statistical analysis of the effect of specialty hospital 

market entry on the average profit margins of general hospitals. The analysis combines data from several sources, including Medicare Cost Reports and the Bureau 

of Health Profession’s Area Resource File. Rather than make explicit policy recommendations, we discuss some of the salient economic issues relevant to the debate. Concluding remarks follow in Section 6.0. 

1.1 Methodology 

This report is based on data from four different sources. All sections rely on data 

drawn from published studies and reports. For some of the arguments and analyses 

we undertake, there is limited relevant published literature and reports, primarily 

because the debates over pros and cons of specialty hospitals are a relatively new 

occurrence. In cases where there is an insufficient supply of published data and 

analyses, we conducted analyses based on data collected from (1) site visits, (2) secondary data sources, and (3) our own survey of specialty hospitals. The secondary 

data sources used for this analysis include Medicare Cost Reports (HCRIS), quality 

data from Health Grades, and market area data from the Bureau of Health Profession’s Area Resource File (ARF). These datasets are described in greater detail in 

Section 5.1.1. 

Throughout the report, we describe some of the findings from case studies of five 

surgical hospitals, two in central California and three in South Dakota. These states 

were chosen due to the relatively high proportion and maturity of specialty hospitals. Site visits generally involved question and answer sessions with all levels of 

the management team (including physician owners) at each facility, followed by 

tours. Also provided were documents on management strategy, quality assurance, 

consumer satisfaction, physician ownership, and cost management. The main goal 

of the site visits was to improve our understanding of the layout and functioning 

of specialty hospitals. Thus, rather than focus this report on the findings from the 

site visits, we report the main findings relevant to each section of the report. For 

some of the discussions, the site visits did not directly provide any relevant insights. 

In addition to secondary data and site visits, we conducted a survey of the 70 specialty hospitals belonging to the American Surgical Hospital Association. The survey 

achieved a 50 percent response rate, but incorporating existing data from ASHA resulted in item-level response rates ranging from 50 to 90 percent. Descriptive statistics from the survey are provided in Table 2 and the survey instrument is provided 

in Appendix A. 

110 

Table 2 

Survey of ASHA Member Hospitals:1 Means for Selected Survey Items 

Variable Mean 

Q6–8: Accreditation (%) 67.0 

Q11: Bed capacity 24.6 

Q12: Staffed inpatient beds 19.3 

Q13: Operating rooms 5.2 

Q14: Intensive care beds 4.0 

Q15: Recovery beds 17.2 

Q16: Percent with ER (%) 42.1 

Q18: Number of owners 32.7 

Q19: MD owners 31.6 

Q20: MD owners admit • 5 patients/year 20.6 

Q21: Q20 with 0–1% ownership stake 13.0 

Q22: Q20 with 2–5% ownership stake 11.7 

Q23: Q20 with 6–9% ownership stake 1.4 

Q24: Q20 with • 10% ownership stake 0.8 

Q25: Inpatient discharges 835.1 

Q26: Inpatient days (overnight stay) 2,269.6 

Q27: Inpatient days (observation days) 884.2 

Q28: Surgeries (overnight stay) 717.7 

Q29: Outpatient surgeries (no overnight stay) 3,105.5 

Q30: Total gross patient care revenue2 $39,300,000 

Q32: Percent Medicare revenue (%) 32.4 

Q33: Percent Medicaid revenue (%) 3.7 

Q34: Percent Commercial revenue (%) 46.4 

Q35: Percent other revenue (%) 18.1 

Q38: Percent revenue as charity care (%) 2.1 

Q39: State income tax paid, previous tax year $830,661 

Q40: Federal income tax paid, previous tax year $994,082 

Q41: Property tax paid, previous tax year $221,463 

Q44: Full-time equivalent (FTE) RNs 52.1 

Q45: Patient to RN ratio 3.4 

Q48: Percent collect patient satisfaction data (%) 92.1 

Q50: Annual number of inpatients transferred 7.6 

Q51: Percent with transfer arrangement (%) 92.1 

2 Sources: Survey of ASHA membership; see section 1.1 for description and Appendix A for survey instrument. Notes: (1) based on responses from 35 specialty hospitals supplemented with data from the American Surgical Hospital Association; 

item-level response rates range from 50 to 90 percent; (2) includes inpatient and 

outpatient. 

2. OVERVIEW OF HOSPITAL MARKET 

During the latter half of the twentieth century, industries began exploring new 

ways to organize production. One of the most prominent of these changes was the 

adoption of lean production, flexible specialization, and focused factories (Skinner 

1974; Womack, Jones, and Roos 1990; Essletzbichler 2003), which resulted in many 

business establishments becoming less diverse and more focused (Gollop 1991). The 

hospital industry appears to be following a similar path with the growth of freestanding specialty hospitals and specialized units within general hospitals (Myers 

1998; Eastaugh 2001; Robinson 2005). 

Demand for specialized inpatient and outpatient services has been growing rapidly in the past decade (General Accounting Office 2003a). The increase in demand 

is most likely due to a combination of factors, including increased incidence of specific diseases, new treatment processes and technologies, and changes in consumer 

preferences. Analogous to non-health care industries, the hospital industry has been 

the subject of renewed emphasis on quality of care and customer satisfaction. In response, general and specialty hospitals alike have developed consumer-oriented centers of care focused on providing a limited range of services tailored to the specific 

needs of patients (Baum 1999; Romano and Kirchheimer 2001; Eastaugh 2001; 

Smith 2002; Urquhart and O’Dell 2004; Herzlinger 2004a; Lo Sasso et al. 2004). 

111 

3For example, focusing on core competencies has been associated with improved supply chain 

management (primarily through standardization), simplified human resource management, and 

streamlined production scheduling. 

Specialty hospitals are typically defined as those that treat patients with specific 

medical conditions or are in need of specific medical or surgical procedures.3 The 

former describes hospitals specializing in psychiatric care, cancer care, rehabilitation, women’s care, children’s care, and certain chronic diseases; the latter describes 

hospitals specializing in cardiac, orthopedic, and general surgery. As of 2002, there 

were a total of more than 1,000 specialty hospitals in the U.S. (Table 1). These estimates exclude specialized ‘‘distinct part’’ units of general hospitals, a large segment 

of the specialized facility market. For example, Schneider, Cromwell, and McGuire 

(1993) reported that there are more than 900 distinct psychiatric units and more 

than 500 distinct rehabilitation units within general acute care hospitals. 

The recent political controversies surrounding specialty hospitals have focused 

primarily on facilities specializing in cardiac, orthopedic surgery and general surgery, and to a lesser extent obstetrics and gynecology. There are approximately 100 

to 120 of these hospitals currently operating in the U.S. Growth in surgical hospitals ranged from 33 percent (orthopedic and general surgery) to 70 percent (cardiac surgery) during the seven-year period from 1995 to 2002. Most of these facilities are located in states without Certificate-of-Need (CON) programs, which regulate the construction and augmentation of health care facilities. States with the 

highest concentrations of surgical specialty hospitals are South Dakota, Kansas, 

Oklahoma, Texas, Louisiana, Arizona, and California. 

Table 1 

Trends in Numbers of Specialty Hospitals, 1990–2003 

Facility Type 1995 2002 

% 

Change, 

1995–2002 

Psychiatric 1,2 675 488 ¥27.7% 

Rehabilitation 1,2 NA 216 —— 

Extended Stay 1,2 NA 270 —— 

Obstetrics and Gynecology 1,5 12 18 +41.7% 

Orthopedic and General Surgery3,5 60 80 +33.3% 

Cardiac Surgery 4,5 10 17 +70.0% 

Other 6 96 100 +4.2% 

Notes and sources: (1) American Hospital Association Hospital Statistics (1996/97 

and 2004 editions); (2) Centers for Medicare and Medicaid Services; (3) American 

Surgical Hospital Association; (4) MedCath Corporation; (5) General Accounting Office (2003a); (6) includes hospitals specializing in children, cancer, respiratory diseases, and ear/nose/throat. 

The distinction between surgical specialty hospitals and all other specialty hospitals is an important one because the current debates and controversies refer exclusively to surgical hospitals. There are two likely reasons for the concentration on 

surgical hospitals. First, although reliable evidence is lacking, it is possible that the 

average operating margins associated with surgical procedures are higher than 

those associated with, for example, psychiatric and rehabilitation care. Second, 70 

percent of surgical hospitals have at least some level of physician ownership (General Accounting Office 2003a), which is a concern to some policy makers. Some additional discussion of these issues is provided in Section 5.0. 

Another important aspect of the specialty hospital industry is the motivation for 

market entry. Site visits and published literature identify several important motivating factors (Walker 1998; MedPAC 2003; Casalino, Pham, and Bazzoli 2004; 

Casey 2004; Rohack 2004; Iglehart 2005). Motivations include the ability of physicians to (1) directly control quality of care; (2) optimally schedule operating room 

time (e.g., allow more choice in operating room block time and minimize schedule 

disruptions caused by emergent cases); (3) select patients that are clinically appropriate for the specialized setting; (4) maintain greater decision-making authority 

over equipment and supply purchases; and (5) capture a portion of the facility fee 

as additional entrepreneurial earnings. An additional motivation for market entry 

is likely to be the existence of above-average profit margins on certain procedures. 

As is the case in any industry, it is the exception to observe market entry into products and services for which profit margins are unusually low or negative. 

112 

Some of the other factors identified relate to physicians freeing themselves from 

contract restrictions and other bureaucratic apparatus common to larger general 

hospitals. Interestingly, many of the comments recorded during the site visits mirror 

those expressed by physicians in single-specialty medical groups. Casalino, Pham, 

and Bazzoli (2004) report that one of the motivating factors for single-specialty 

groups was to ‘‘avoid the complicated governance and operational issues engendered 

by having primary care and specialty physicians in the same organization’’ (p.86). 

3 EFFICIENCY 

An important question concerning the efficiency of specialty hospitals is whether 

there are distinct economic advantages or disadvantages to specialization. Embedded in this question is whether there are advantages or disadvantages associated 

with the dominant hospital organizational structure, which consists primarily of 

full-service diversified general hospitals. This section reviews the theory and evidence on four aspects of efficiency that are relevant to specialization: (1) economies 

of scale, (2) economies of scope, (3) competencies and learning, and (4) volume-outcome effects. 

3.1 Economic of Scale 

Economies of scale exist if the average costs of producing a product or service decline as the volume of production increases. The evidence on economies of scale in 

the production of hospital services, while highly variable, indicates that U.S. general 

hospitals typically experience scale economies up to approximately 10,000 discharges per year (Cowing 1983; Vita 1990; Gaynor and Anderson 1995; Keeler and 

Ying 1996; Dranove 1998; Li and Rosenman 2001). However, the same evidence suggests that scale economies vary significantly by product and service line. In order 

to asses the potential role of scale economies in specialty hospital efficiency, scale 

economies for specific services (e.g., total knee replacement) in specialty hospitals 

versus general hospitals would need to be compared. We are not aware of any study 

that does so. However, for many specific surgical procedures, the volume of these 

specific services performed at specialty hospitals typically exceeds that performed at 

general hospitals within the same market area (Cram, Rosenthal, and Sarrazin 

2004). Thus, to the extent economies of scale exist in these specific procedures, they 

are likely to be realized to a greater degree in specialty hospitals compared to general hospitals. 

3.2 Economic of Scope 

In some cases the joint production of two or more products or services can be accomplished at lower cost than the combined costs of producing each individually. 

This is often the case when production relies on common resources, such as technology, workers, inputs, and general overhead. Cases where the costs of joint production are lower than the costs of separate production are said to exhibit economies 

of scope (Panzar and Willig 1981). The decision to specialize will depend in part on 

the extent to which firms’ existing scope of products and services exhibit 

diseconomies of scope (i.e., where joint production is more costly than separate production). Conversely, the decision to diversify will in part be based on the extent 

to which joint production costs are less than separate production costs. 

Evidence on economies of scope in the U.S. hospital industry is inconclusive. 

Menke (1997) found limited evidence of inpatient-outpatient scope economies in 

chain and non-chain hospitals. Similarly, Fournier and Mitchell (1992) found significant scope economies among select outpatient services and surgery services, but 

their study is based on 20-year old data from one state. Sinay and Campbell (1995) 

examined 262 merging acute care hospitals in the U.S. during the period 1987 to 

1990. Of the service pairings studied, evidence of economies of scope was found between acute care and sub-acute care (in merging hospitals) and between intensive 

care and outpatient visits (in control hospitals); all other pairings showed either 

diseconomies of scope (e.g., acute care and outpatient care; intensive care and subacute care) or were statistically insignificant. Rozek (1988) failed to observe scope 

economies in general hospital diversification into psychiatric services, and Li and 

Rosenman’s (2001) study of hospitals in the state of Washington reached inconclusive findings on scope economies. The lack of consistent findings on economies of 

scope suggests that it is probably not a significant source of production economies 

for general hospitals. Thus, it would be difficult to argue that specialty hospitals are 

less efficient than general hospitals due to the absence of scope economies. 

3.3 Learning and Competencies 

Skinner (1974) stressed that ‘‘simplicity, repetition, experience, and homogeneity 

of tasks breed competence.’’ Learning occurs as the experience of production in one 

time period influences the production in a later time period; that is, the production 

113 

4For example, focusing on core competencies has been associated with improved supply chain 

management (primarily through standardization), simplified human resource management, and 

streamlined production scheduling. 5The relationship between core competencies and hospital efficiency is relatively under-studied. General discussions are provided by Eastaugh (2001; 1992); Snail and Robinson (1998); 

Douglas and Ryman (2003); Coddington, Palmquist, and Trollinger (1985), Porter and Teisberg 

(2004), Herzlinger (2004c), Moore (1990), and Walker and Rosko (1988). 

process is assumed to have some degree of flexibility and can change over the relevant range of output (March 1996; Nooteboom 2000; Greve 2003). The implication 

is that the costs of producing the first batch of output are greater than the costs 

of the producing a subsequent batch due to the learning that occurred during the 

production of the first batch. Assuming that experiences of producing the first batch 

can be applied to the second batch (and other subsequent batches), the average costs 

of production are expected to decline as output cumulates over time. The learning 

effect will depend on the ability of the firm to process information during the production process and then apply that information appropriately. 

The learning process is critical to the formation and adaptation of organizational 

routines, which include rules of thumb, guidelines, templates, and protocols (Nelson 

and Winter 1982). Specialized routines are the subcomponents of organizational 

‘‘know how’’ and ‘‘core competencies,’’ and are often sources of comparative advantage and production economies (Chandler 1992; Wruck and Jensen 1994; Greve 

2003). Core competencies refer to firms’ existing stock of knowledge assets (including tacit knowledge and know-how), skills, and resources. By diversifying and expanding into activities that are related to core competencies, firms are typically able 

to take better advantage of the learning process and improve managerial efficiency 

(Teece et al. 1994; Teece and Pisano 1994; Hill 1994; Danneels 2002).4 In addition, 

limiting expansion into related business lines is likely to minimize some of the negative tradeoffs associated with growth in firm size, such as influence costs and other 

forms of incentive attenuation (Milgrom and Roberts 1990). Consistent with Skinner’s emphasis on the value of repetition, concentrating on core competencies is believed to enhance the learning process by assuring that decision-making situations 

are repeated in sufficiently large numbers. According to Teece et al. (1994, p.17), 

‘‘If too many parameters are changed simultaneously, the ability of firms to conduct 

meaningful quasi experiments is attenuated.’’ Given the complexities of the learning 

process, the costs of learning in some cases may be lower for smaller specialized 

firms. Smaller firms may have the advantage of being able to allocate the majority 

of the resources available for learning and adaptation to a relatively small set of 

related production process (Almeida, Dokko, and Rosenkopf 2003). 

Learning and core competencies have been shown to be important determinants 

of the performance of health care organizations. In health care setting the learning 

process is to some extent evident in the positive association between procedure volume and outcomes (discussed in greater detail in the next section). During our site 

visits, we consistently observed a culture supportive of coordination and cooperation 

aimed at achieving ongoing improvements in efficiency and quality. Specialty hospital managers generally attributed their success in process adaptation to three factors: (1) relatively small size, which enables more rapid and efficient decision making; (2) flat hierarchical structures, which allow decision making and process improvement to migrate to the most appropriate level; and (3) focused and consistent 

management goals, which make it easier for team members to learn and their roles. 

Managers also emphasized the importance of performance feedback, mainly through 

surveys of customer satisfaction. Again, managers indicated that their relatively 

small size allowed them to spend more time collecting, analyzing and acting on customer feedback. While it is possible that diversified general hospitals are able to 

achieve similar learning effects, the smaller scale of specialty hospitals may lower 

the costs associated with learning. 

In health care settings, there also appear to be distinct advantages to focusing 

production within core competencies.5 Shortell, Morrison, and Hughes (1989), in 

their three-year case study of eight large hospital systems, found that the best performing systems and hospitals were the ones that avoided diversification into unrelated activities, thereby minimizing diseconomies of scope and maximizing efficiencies associated with learning. Eastaugh (2001) examined a panel of 219 U.S. 

acute care hospitals from 1991 to 2000, finding that a 31 percent increase in specialization over the time period was associated with an eight percent decline in costs 

per admission. Douglas and Nyman (2003) review the theory of core competencies 

in hospitals and test the theory using data from the 32 largest hospital markets in 

114 

6MedCath’s description of their facilities is apposite: ‘‘Externally, MedCath’s heart hospitals 

appear typical; however, a step inside reveals important differences: Physicians empowered to 

make decisions about hospital operations; state-of-the-art operating rooms; cutting-edge equipment and technology; centrally located services such as radiology, pharmacy and laboratories; 

nursing stations strategically positioned to allow better patient monitoring; and large, singlepatient, fully equipped rooms that avoid unnecessary patient moves and permit family members 

to remain overnight. Above all, physicians and nurses freed from bureaucratic and administrative chores so they can devote a majority of their time and energy directly to caring for their 

patients.’’ (MedCath Corporation 2001) 7 Unpublished working paper: Seider H, M Gaynor, and WB Vogt (2004) ‘‘Volume-Outcome 

and Antitrust in U.S. Health Care Markets’’ Carnegie-Mellon University. 

the U.S. They found that the degree to which hospitals focused on core competencies 

was positively related to hospital financial performance. 

In terms of core competencies, our site visits reached similar conclusions. When 

asked why their facility performed one set of procedures or services and not another, 

managers consistently indicated that they had a strong desire to not venture too far 

from the core of their collective knowledge. Managers and owners emphasized that 

the key decision makers are typically physician owners, most of whom are likely to 

feel most comfortable focusing on the delivery of services in their specialty field. One 

chief executive officer and physician owner stressed that specialty hospitals often attract the most highly trained and skilled physicians in the community by allowing 

them to essentially redesign the care process based on the state of the art in their 

field. We found corroborating anecdotal evidence in the trade press (Walker 1998; 

Baum 1999; Daus 2000; Casey 2004; Wolski 2004; Zuckerman 2004).6

3.4 Volume-Outcome Effect 

Several studies have found a positive association between the volume of services 

a hospital performs and the quality of the outcomes (Hillner, Smith, and Desch 

2000; Halm, Lee, and Chassin 2002; Shahian and Normand 2003). One potential 

criticism of specialty hospitals is that the volume of cases may be too low to capture 

the positive effects of volume on patient outcomes. There are, however, five important limitations to these findings. First, the magnitude of the relationship is highly 

sensitive to case mix adjustment (Halm, Lee, and Chassin 2002). Second, there is 

considerable debate over how much volume is necessary to improve outcomes. For 

example, a common belief is that outcomes for percutaneous coronary interventions 

are better in hospitals that perform more than 400 such procedures per year. However, Epstein et al. (2004) found that there were no significant mortality differences 

between hospitals with medium volume (200–399 cases per year) and high volume 

(400–999 cases per year). Third, many studies do not differentiate between individual physician effects and hospital effects. It is possible that the volume-outcome 

relationship reflects differences in experience levels of individual physicians, most 

of whom maintain admitting privileges at multiple institutions (Robinson et al. 

2001). Fourth, volume-outcome relationships are likely to be procedure specific. 

Again, on average specialty hospitals have higher procedure-specific volumes than 

their general hospital counterparts (Cram, Rosenthal, and Sarrazin 2004). 

The fifth limitation is that the causal relationship between volume and outcome 

is unclear: do patients treated at high-volume hospitals achieve better outcomes because of learning and practice (the ‘‘practice makes perfect’’ hypothesis), or do hospitals with better quality reputations attract higher volumes of patients (the ‘‘selective referral’’ hypothesis) (Hughes et al. 1988)? Some recent studies have used instrumental variable techniques to disentangle these effects; one such paper found 

strong evidence of the ‘‘practice makes perfect’’ hypothesis for coronary artery bypass graft surgery.7 There is some evidence that both hypotheses explain differences 

in outcomes but, nonetheless, taken together these two hypotheses explain a relatively small proportion of the overall variation in patient outcomes (Luft 1980; 

Luft, Hunt, and Maerki 1987). 

3.5 Summary 

The preceding discussion suggests that there are several areas in which specialty 

hospitals achieve production economies. First, specialty hospitals are able to take 

advantage of economies of scale and scope by producing relatively high volumes of 

a limited scope of services, and by lowering fixed costs by reengineering the care 

delivery process. Second, the site visits consistently found evidence of learning and 

core competencies. Managerial and clinical staff indicated a strong desire to focus 

on a relatively narrow array of tasks, and indicated a commitment to perfecting 

those tasks. The evidence on scale and scope economies and core competencies suggests that there are efficiency reasons for some degree of diversification, but that 

expansion into unrelated activities can result in diminished financial performance. 

115 

8Kovner et al. (2002) found that the median number of RN hours per adjusted patient day 

was 6.43 for the study’s 534 general hospitals. For the five specialty hospitals we visited, RN 

hours per adjusted patient day ranged from 10 to 15 hours per patient day. Ideally, however, 

the appropriate comparison would be between cardiac and orthopedic units of specialty hospitals 

and cardiac and orthopedic units of general hospitals. We know of no such studies, and we were 

not able to identify a source of data on nurse staffing ratios within specific units of general hospitals. 9Dobson (2004), in a study conducted by Lewin Group for the MedCath Corporation, found 

case-mix results counter to the GAO study and Cram et al. (2004). The Lewin Group found that 

MedCath cardiac hospitals have a 21 percent higher case mix severity for cardiac patients compared to their community general hospital peers. The differences in findings are likely attributable to differences in the sample and the measurement of severity or complexity. For example, 

the Lewin Group study used DRG weights to measure severity, whereas Cram et al. used a predicted mortality model based on age and presence of seven comorbid conditions. However, the 

Lewin Group findings are consistent with anecdotal and empirical evidence that admitting physicians may perceive specialized facilities as being more appropriate for complicated cases, due 

in part to the positive volume-outcome relationship (Baum 1999; Magid et al. 2000). 

Specialty hospitals also may in some cases possess a technological advantage or resource that is unique in the market. This is likely to be the case for many entering 

specialty hospitals, as most have had the opportunity to redesign care delivery processes from the ground up. 

Perhaps as a result of these efficiencies, specialty hospitals appear to be capable 

of offering more intensive services for the same price. Specialty hospitals tend to 

have substantially higher nurse-patient ratios 8 and tend to place greater emphasis 

on ancillary services identified by patients as important, such as comfortable familyfriendly rooms, more attention from administrative and clinical staff, and the mitigation of common inconveniences (e.g., appropriately located elevators and convenient parking). Specialty hospitals also appeal to physicians by offering newer equipment, more staff assistance, and more flexible operating room scheduling. These are 

costly services, yet specialty hospitals must compete for contracts with the same 

managed care organizations that general hospitals do; similar to general hospitals, 

they must also accept the Medicare fee schedule as payment in full. 

4. CASE MIX AND QUALITY 

4.1 Case Mix 

There is some evidence that, on average, specialty hospitals treat patients with 

lower acuity compared to general hospitals (General Accounting Office 2003a, 2003b; 

Cram, Rosenthal, and Sarrazin 2004).9 These findings are consistent with the observed case mix differences between ambulatory surgery centers and general hospitals (Winter 2003). The focused nature of specialty facilities may be better suited 

to patients whose care involves relatively little uncertainty, or whose condition is 

reasonably well defined. General hospitals may be more efficient in treating complex 

cases, particularly cases that allow them to exploit scope economies across service 

lines. In sum, it is possible that the apparent cost advantage of specialty hospitals 

is in part attributable to a healthier average case mix. 

It should also be noted that prospective administered pricing mechanisms create 

incentives for general and specialty hospitals alike to focus on diagnosis categories 

and procedures where the administered price exceeds facilities’ average costs. Medicare’s administered pricing system (PPS) has been shown to affect the scope of services offered by acute care hospitals. The PPS system employs a fee schedule based 

on approximately 500 diagnosis related groups (DRGs); each DRG is mapped to a 

price, with some hospital-specific adjustments. Payment by DRG provides strong incentives to hospitals to specialize in those DRGs for which they have relatively low 

production costs (Dranove 1987). In the context of specialty hospitals, Robinson 

(2005) posits that ‘‘The success enjoyed by the specialized firms reflect astute selection of services and markets as much as efficiency in delivering care.’’ 

4.2 Quality 

Empirical evidence on the quality of care provided by specialty hospitals is limited 

to two studies, one by the Lewin Group (2004) and another by Cram et al. (2004) 

from the University of Iowa. The Lewin study used Medicare Part A (MedPAR) data 

to compare eight MedCath heart hospitals to 1,056 peer general hospitals that perform open-heart surgery in the U.S. After adjusting for risk of mortality, MedCath 

heart hospitals on average exhibited a 16 percent lower in-hospital mortality rate 

for Medicare cardiac cases compared to peer general hospitals. 

Cram, Rosenthal, and Vaughan-Sarrazin (2004) found no significant differences in 

mortality for cardiac patients treated at specialty hospitals and general hospitals, 

after adjusting for lower severity and higher procedure volume at specialty hosVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00119 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
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10 In this respect the Cram et al. study and the Lewin Group study found similar results, although the Lewin study found that risk-adjusted in-hospital mortality rates in cardiac hospitals 

were 16 percent lower on average than the mortality rates of community hospital peers. 11Kovner et al. (2002) found that the median number of RN hours per adjusted patient day 

was 6.43 for the 534 hospitals studied. For the five specialty hospitals we visited, RN hours per 

adjusted patient day ranged from 10 to 15 hours per patient day. However, these data comparisons are limited; ideally, nurse staffing ratios should be compared only within particular product 

and service lines (e.g., orthopedic). 12 Health Grades quality measures are based on data from Medicare Part A (hospital) discharge abstracts for the time period 2001–2003. For more information on methodology and analysis, refer to www.HealthGrades.com and the Health Grades report entitled ‘‘The Seventh Annual Health Grades Hospital Quality in America Study’’ Health Grades Inc. 2004) 

pitals.10 Similar results have been found when comparing ambulatory surgery centers and general hospitals (e.g., Warner, Shields, and Chute 1993; Mezei and Chung 

1999). Data gathered from our site visits mirror these findings. Managers of specialty hospitals consistently reported two factors they believed to have been critical 

to achieving high quality patient outcomes: high volume and high nursing intensity. 

Consistent with the Cram et al. findings of higher procedure volume, managers of 

specialty strongly believed that they were improving care through ongoing learning 

and improvement. Specialty hospitals also reported nurse-patient ratios higher than 

the national average,11 which suggests that they may be able to capture some of 

the positive quality and outcome effects associated with richer nurse staffing 

(Kovner et al. 2002; Lang et al. 2004; Stanton and Rutherford 2004; Mark et al. 

2004). 

Limited scope is also likely to increase accountability associated with the smaller 

set of procedures. For example, a specialty hospital leader at one of the visited hospitals remarked that ‘‘four procedures account for seventy percent of our business; 

if we develop any kind of quality problem in one or more of those procedures it’s 

a huge problem for our organization.’’ In addition, specialty hospitals typically engage in extensive collection of data on quality and patient satisfaction, and use 

these data to modify care processes (Walker 1998; Fine 2004; Iqbal and Taylor 

2001). Among the ASHA member hospitals surveyed, 92 percent reported that they 

engage in regular assessments of customer satisfaction. Finally, there is consistent 

anecdotal evidence that the kind of care delivered by the typical specialty hospital 

is consistent with the general trend toward ‘‘consumer-driven’’ health care (e.g., 

O’Donnell 1993; Baum 1999; Leung 2000; Urquhart and O’Dell 2004; Hoffer Gittell 

2004; Herzlinger 2004b). 

4.2.1 HealthGrades Analysis 

HealthGrades is a national organization that produces hospital quality reports for 

over 5,000 U.S. acute care hospitals.12 We merged membership data from ASHA 

and MedCath to publicly available quality data published on the HealthGrades 

website. There were 22 matched hospitals, representing approximately 31 percent 

of the ASHA hospital sample. For those hospitals, we examined the mean quality 

score (based on a 1–5 Likert scale) for the most common sets of procedures performed by the 22 hospitals. Consistent with the Lewin Group study and Cram et 

al., the results show that specialty hospitals typically performed at least as well as 

general hospitals in the same geographic region. Based on measures of in-hospital 

mortality (including 1 and 6 month post-discharge mortality rates), the mean score 

for the 22 specialty hospitals was a 3.86 out of 5, which was not statistically different from the mean scores for general hospitals in the same market areas. 

5. POLICY ISSUES 

The debate over specialty hospitals has raised several policy questions, two of 

which have received a high level of attention. First, do specialty hospitals harm the 

ability of general hospitals to provide indigent care? Some argue that specialty hospitals take profitable business away from general hospitals, and as general hospitals 

lose market share, particularly in high-margin product lines, they are hampered in 

their ability to provide low-margin services and meet their implied obligations to 

serve the community. Second, does having an ownership stake in the facility create 

financial incentives for physicians to provide inappropriate and unnecessary treatment? What are the optimal policy options to address these questions? Rather than 

make explicit policy recommendations, we discuss some of the salient economic 

issues concerning these two policy problems. 

In this section policies are discussed in terms of their effectiveness in accomplishing intended objectives. In order to assess the net effect of a policy, ideally it 

is necessary to take into account all direct and indirect effects attributable to the 

policy. The sum of these effects is analogous to what economists refer to as change 

117 

13 Acute care hospitals’ implicit obligation to serve the community is based on two policies: 

the Hospital Survey and Construction Act of 1946 and non-profit tax exemption. The nominal 

intent of the Hospital Survey and Construction Act of 1946 (commonly known as the Hill-Burton 

Act) was to bolster the relatively under-developed postwar hospital industry by requiring states 

‘‘to develop programs for the construction of such public and other non-profit hospitals as will, 

in conjunction with existing facilities, afford the necessary physical facilities for furnishing adequate hospital, clinic, and similar services to all their people’’ (Hospital Survey and Construction 

Act 1946). 14See generally Lewin and Altman (2000). 15 A summary of these issues can also be found in Nancy Kane’s recent testimony to the Subcommittee on Oversight of the U.S. House Committee on Ways and Means (Kane 2004). 16This is a common occurrence in most industries. In the language of the current debate, this 

would be considered cream skimming. An important question is whether it is optimal policy to 

discourage triaging of care across settings according to intensity, given the extensive literature 

on the cost and quality benefits associated with moving patients from inpatient to outpatient 

settings following the implementation of Medicare’s PPS. 

in net social welfare; that is, the extent to which the policy effects aggregate wellbeing. For example, the Federal Trade Commission recently emphasized that health 

care policies intended to mitigate some of the less desirable side effects of competition must be weighed against the losses normally resulting from restrictions on market entry and competition (Federal Trade Commission and U.S. Department of Justice 2003, 2004). 

5.1 Indigent Care and Cross-Subsidization 

The indigent care issue has several components. The first issue has to do with 

the practice on the part of general hospitals to meet their implicit obligation to serve 

the community13 by cross-subsidizing low-margin services with high-margin services 

combined with other government subsidies. Many of the former state rate regulation 

programs were explicitly designed to help acute care hospitals meet these obligations (Fournier and Campbell 1997; Schneider 2003); however, all but one of the 

state rate regulation programs were dismantled during the 1990s. In the absence 

of state rate regulation, hospitals have relied on six other mechanisms to pay for 

unprofitable services: (1) tax-deductible donations, (2) tax-exempt bond financing, (3) 

exemption from income and property taxes, (4) internal cross-subsidization, (5) Medicaid disproportionate share payments (additional payment for treating a disproportionate share of Medicaid patients), and (6) state-administered charity care risk 

pools14 (Figure 1). 

Figure 1 

Non-Profit General Hospital Methods for Funding Indigent Care 

Tax exemption is perhaps the most widespread subsidy provided to non-profit general hospitals. non-profit tax status allows hospitals to avoid property and income 

tax in exchange for an obligation to serve the community. However, Kane and 

Wubbenhorst (2000) found that the amount of charity care provided by hospitals is 

significantly less than the amount of tax benefit accrued through non-profit status.15

Thus, even if tax exemption were the only means for hospitals to fund indigent care, 

the amount of the benefit on average appears to be more than sufficient to fund prevailing levels of indigent care. Although specialty hospitals generally provide less 

charity care (approximately 2.1 percent of gross patient care revenues; Table 2), per 

facility they contribute on average approximately $2 million annually in state and 

federal taxes. This represents an additional 5.1 percent of gross patient care revenues. The combined 7.2 percent of gross patient care revenues exceeds the average 

charity care provision of tax-exempt general hospitals, which is approximately 5 to 

6 percent of revenues (American Hospital Association 2005). 

Hospital internal cross-subsidization is to be distinguished from the popular notion that hospitals shift costs between third-party payers; that is, ‘‘one group pays 

more because another pays less’’ (Morrisey 1994). In this case, hospitals cross-subsidize low-margin indigent services with the proceeds from high-margin services. 

Under normal circumstances, hospital internal cross-subsidization would not be sustainable, mainly because sustained high margins on some services would encourage 

market entry, and as firms entered the excess profits would be competed away.16

In order for cross-subsidization to work, government must restrict market entry, either through certificate of need (CON) or some other means. Indeed, that is how 

many states currently approach the problem, and an important reason why Congress has resorted to the specialty hospital moratorium. 

There at least two problems with policies encouraging cross-subsidization of this 

kind. First, the policy relies on CON to limit market entry, and there is a large volVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00121 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
118 

17 Currently, 14 states have no CON program and another six states maintain CON programs 

only for long-term care (Conover and Sloan 2003). 18The poor performance of CON is attributed to four factors: the administrative burden associated with determining appropriateness of new investments, the potential for CON laws to create and maintain hospital cartels by erecting barriers to new hospital entrants, the susceptibility of the CON process to industry influence (e.g., Payton and Powsner 1980), and the potentially sub-optimal input allocation induced by the CON constraint on the use of capital inputs. 19Some studies have found that CON programs can be used to enhance patient outcomes by 

concentrating services in high-volume facilities (e.g., Vaughan-Sarrazin et al. 2002). However, 

these studies are limited by the causality problem described in Section 3.4, and the lack of analysis of whether improvement in outcomes compensates for the net social welfare losses associated with barriers to market entry (Federal Trade Commission and U.S. Department of Justice 

2004). 20One of the criticisms of specialty hospitals is that many do not provide 24-hour emergency 

services. But it is not clear whether any current means of funding emergency room services are 

optimal. From a societal perspective, it may be more economically efficient to fund and operate 

emergency rooms no differently than police and fire departments. 

ume of research critical of CON.17 Studies of the impact of CON programs have consistently found the programs to be ineffective at controlling costs and enhancing access. Sloan and Steinwald (1980) found that mature CON programs had an insignificant effect on hospital costs, and immature CON programs actually increased hospital costs. Lanning, Morrisey and Ohsfeldt (1991) and Antel, Ohsfeldt, and Becker 

(1995) also conclude that CON is associated with higher inpatient costs and expenditures per capita. A possible explanation is that the CON constraint prevents hospitals from employing the least-cost combination of inputs to produce inpatient services, resulting in allocative inefficiency.18 Further, there is no evidence that the repeal of CON was associated with an increase in hospital expenditures (Conover and 

Sloan 1998).19 As a result of the apparent failure of CON to achieve its stated goals, 

many state CON programs have been either terminated or significantly reformed 

since the repeal of the Health Planning Act in 1986 (Conover and Sloan 1998). It 

would be more difficult in theory for hospitals located in competitive markets in 

non-CON states to engage in internal cross-subsidization; instead, such hospitals 

would have to rely on tax exemption, disproportionate share payments, and charity 

care risk pools to fund indigent care. 

Second, it is not clear whether the losses in net social welfare associated with restricting market entry exceed the costs of alternative means of assuring the provision of indigent care, such as direct subsidies. The Federal Trade Commission’s recent report on health care competition integrated this point into one of their policy 

recommendations, emphasizing that ‘‘[competition] does not work well when certain 

facilities are expected to cross-subsidize uncompensated care. In general, it is more 

efficient to provide subsidies directly to those who should receive them, rather than 

to obscure cross subsidies and indirect subsidies in transactions that are not transparent’’ (Federal Trade Commission and U.S. Department of Justice 2004 p.23). 

The U.S. experience with airline regulation provides an excellent example. In 

order to develop air travel infrastructure, airline regulation required carriers to 

cross-subsidize unprofitable routes with profitable ones. Cross-subsidization appeared to contribute to infrastructure development in the early years of regulation, 

but eventually led to extraordinarily high costs (Morrison and Winston 1986). Consumer welfare and producer surplus improved markedly following deregulation 

(Winston 1998; Peltzman and Winston 2000). If subsidizing indigent care is a policy 

objective, the economically optimal public policy would be to directly subsidize any 

hospital for providing indigent care.20 Protecting incumbent hospitals from competitive entry may be just as likely to allow incumbent firms to maintain higher prices 

and facilitate slack in organizational processes, rather than permit them to fund additional indigent care. 

A related concern is that specialty hospitals engage in unfair competition with 

general hospitals by treating only less severe and more profitable patients (i.e., 

cream skimming). As noted, there is some evidence that specialty hospitals, like 

their ambulatory surgery center predecessors, treat healthier patients with fewer comorbid conditions. However, from a policy perspective, treating healthier patients 

in less intensive settings is likely to improve patient welfare, given the extensive 

literature on the cost and quality benefits associated with triaging patients from inpatient to outpatient settings following the implementation of Medicare’s PPS. Thus, 

the cream skimming issue, as others have observed, is predominantly a function of 

(1) variation in operating margins within DRG and (2) crude case-mix adjustments 

in current reimbursement rates. Case-mix adjustment methodology has improved 

dramatically in recent years, and CMS maintains the administrative data necessary 

for such adjustments (FitzHenry and Shultz 2000; Iezzoni 2003). Again, according 

to economic theory, establishing administered prices that are more closely aligned 

119 

21Two recent law suits filed against large hospital chains have challenged the extent to which 

hospitals have been operating in accordance with the implicit contracts (Taylor 2004; Davies 

2004). The suits allege that acute care hospitals, particularly those granted non-profit status, 

have been failing in their implicit obligation to serve mostly through aggressive bad-debt collection processes and turning away consumers with outstanding balances due. 22Profit rates were calculated as the difference between gross patient care revenue and total 

patient care costs (i.e., net income from patient care activities), divided by gross patient care 

revenue. Mean profit margins reported here are somewhat lower than those reported elsewhere, 

for two reasons: (1) for the purposes of this study profit margins are based on patient care revenue rather than total revenue; and (2) profit margins are aggregated to the county or MSA 

level. 

with average costs together with improvements in case-mix adjustment would be superior policy mechanisms compared to restrictions on market entry. 

In sum, there are significant drawbacks to the current four-part strategy to encourage the provision of indigent care. Tax exemption should in theory be sufficient 

compensation for indigent care, particularly when combined with disproportionate 

share payments and charity care risk pools. However, there are no explicit mechanisms in place to control how hospitals allocate the proceeds from tax exemption.21

Internal cross-subsidization would not be sustainable in competitive markets; therefore, costly entry-barrier regulations must accompany cross-subsidization. Both of 

these policies are sub-optimal insofar as they result in net losses in social welfare. 

Losses in net social welfare are likely to exceed the value of indigent care delivered. 

Policies such as direct subsidies for indigent care and more accurate case mix adjustment of payments would likely result in overall gains in net social welfare. 

5.1.1 Effects on General Hospital Profit Margins 

Were it the case that specialty hospitals erode profits of general hospitals in the 

same market, we should observe lower or at least declining profit margins among 

general hospitals in markets where there is at least one specialty hospital. In order 

to further examine this issue, we statistically analyzed the extent to which profit 

margins of general hospitals are affected by the presence of one or more specialty 

hospitals in the market. We obtained Medicare Hospital Cost Report Data for 1997 

through 2003 for all U.S. acute care hospitals. For each hospital in the dataset, 

county and metropolitan statistical area (MSA) market areas were identified and 

additional market-level data from the Bureau of Health Profession’s Area Resource 

File were merged. Mean general hospital profit rates22 were calculated for all county 

and MSA market areas in the U.S. 

The analytic approach was to estimate what economists refer to as a profit function—a mathematical expression of the likely relationship between profit margin, 

the dependent variable, and the factors expected to affect profit margin, referred to 

as covariates. We estimate a standard ‘‘ad hoc’’ profit function of the following basic 

linear form: MARGINit = α0 + α1Dit + α2Sit + α3Pit + α4Zit + εit. In this expression, 

MARGINit refers to the mean of the operating margins (profit rates) of general hospitals within the ith county (or MSA) in year t. It is hypothesized that the mean 

area-level general hospital profit rate is a function of demand factors (Dit), supply 

factors (Sit), input prices (Pit), a vector of market area characteristics (Zit), and an 

error term (εit) representing unexplained or unmeasured factors. The demand factors 

included in this model are per capita income, population density, the percent of the 

population at or below the poverty level, and the area unemployment rate. The latter two measures are included to capture the likely indigent care burden faced by 

general hospitals. Supply factors include output measures (inpatient days per population and outpatient visits per population) and the number of physicians per capita. 

Price measures include the mean area wage for hospital workers (from the U.S. Bureau of Labor Statistics) and the Medicare Part A (hospital) average adjusted price 

per capita (AAPCC). 

The main variables of interest are the specialty hospital indicator variables and 

the measure of market competition. We constructed two variables to measure the 

presence of specialty hospitals, each of which was based on our survey of ASHA 

membership. The first is a simple indicator variable (SCP) that equals 1 if the market area has one or more specialty hospital (most markets have only one). For example, if specialty hospital X opened in 1999, than SCP equals zero in 1997 and 1998 

and equals one thereafter. The second specialty hospital indicator is the total number of physicians admitting patients to the specialty care provider in the market 

area. 

The other main variable of interest is a measure of market concentration. Although not an ideal measure of market concentration, a standard method of measuring market concentration is the Herfindahl-Hirschman Index (HHI). The HHI is 

calculated by summing the squares of each firm’s market share in the county; that 

120 

23 In addition, MSA-level year 2000 differences were significant at p ≤ 0.10. 24 Note that it is not uncommon in profit models for only a relatively small proportion of the 

variation in profit rates to be explained by the covariates; the best models often explain between 

5 and 20 percent of the variance in profit rates. Our models explain less of the variation because 

the unit of analysis is the market area rather than the hospital. 25The analysis included several variants of the linear equation. For each model tested, the 

coefficients did not differ significantly from what is reported here. 

is, HHI = Σi100*si

2, where s denotes the market share of firm i. This method allows 

for firms with relatively large market share (e.g., 60 percent) to be more heavily 

weighted in the index. The HHI index equals 10,000 when an industry or market 

consists of a single seller. For the multivariate models of mean area profit rates, 

we assume the county or the MSA to be the relevant geographic market. In addition, since we are primarily interested in the effects of competition, we excluded 

from the analysis any county or MSA with only one acute care hospital (i.e., counties 

or MSAs with HHI = 10,000). 

The model is specified as a fixed effects panel data regression, which is designed 

to estimate the impact of the covariates on profit rates both cross-sectionally (county 

or MSA) and over time (year). This allows for the effects of specialty hospital entry 

to accrue over time, effects that may not be observable looking only at a cross-sectional snapshot. The regression models are based on 933 counties and 299 MSAs. 

Descriptive trend comparisons of mean general hospital profit rates for counties 

and MSAs are shown in Figure 2 (counties) and Figure 3 (MSAs). The results for 

counties and MSAs are similar. Mean general hospital profit margins in counties 

with at least one specialty hospital were greater in all years of analysis. In the 

county-level analysis, the year 2001 and 2003 differences were statistically significant (p ≤ 0.05). In the MSA-level analysis, the year 2001, 2002, and 2003 differences 

were statistically significant (p ≤ 0.05).23

The regression results are consistent with the descriptive findings. The results of 

the regression model are shown on Table 3 (counties) and Table 4 (MSAs). For each 

geographic level of analysis, three models are reported: (1) specialty hospital variables are limited to the indicator variable SCP; (2) specialty hospital variables are 

limited to the total number of physicians admitting patients to the specialty care 

provider in the market area; and (3) including both specialty hospital indicator variables. 

The estimated coefficients of the key variables have the anticipated sign.24 The 

key variables of interest are (1) the HHI market concentration measure, (2) an indicator variable for the presence of a SCP, and (3) the number of MDs admitting patients to the specialty care provider. Consistent with economic theory, the models 

consistently showed that market concentration had a positive effect on profits; that 

is, as markets become more concentrated, profits increase. Interestingly, we also 

found that both of the specialty hospital variables were positive and significant in 

four of the six models, without regard to the geographic unit of analysis. This relationship was remarkably stable, evident in all model specifications tested.25

The interpretation of this finding is that, contrary to the conjecture that entry by 

specialty hospitals erodes the overall operating profits of general hospitals, general 

hospitals residing in markets with at least one specialty hospital have higher profit 

margins than those that do not compete with specialty hospitals. These findings are 

also consistent with economic theory, which suggests that firms will enter markets 

in which extant profit margins are comparatively higher. 

Table 3 

Multivariable Profit Function Regression Models, Dependent Variable is 

Market Area (County) General Hospital Profit Margin, 1997–2003 

121 

Independent variable 1 County 

(1) (2) (3) 

- - - 

Per capita income ¥0.00000143** ¥0.00000137** ¥0.00000143** 

Population density 0.00000218 0.00000203 0.00000219 

Inpatient beds per capita 3.47753300** 3.55058200** 3.46631100** 

MDs per 1000 pop. ¥0.00400460 ¥0.00421430 ¥0.00401000 

Inpatient days per 1000 pop. ¥0.00000524 ¥0.00000545 ¥0.00000522 

Outpatient visit per capita ¥0.00126660 ¥0.00136540 ¥0.00126630 

Medicare Part A AAPCC 0.00024970** 0.00024770** 0.00024970** 

Unemployment rate ¥0.00065720 ¥0.00067840 ¥0.00065280 

Poverty rate 0.00194070** 0.00193060** 0.00194040** 

Annual wage (hospital staff) 0.00000017 0.00000023 0.00000017 

HHI 0.00000336** 0.00000329** 0.00000338** 

1= SCP present 0.03676190** — 0.03464330** 

MDs admitting to SCP — 0.00032730** 0.00006750 

Constant ¥0.09486860 ¥0.09659210 ¥0.09488130 

Number of observations 6424 6424 6424 

F 5.34 4.64 4.94 

Prob. >F 0.0000 0.0000 0.0000 

Overall R-squared 0.0111 0.0125 0.0110 

Sources: Survey of ASHA membership, Medicare HCRIS Cost reports, 

Area Resource File, and Bureau of Labor Statistics; see section 5.1.1 for description. 

Notes: *Significant at p ≤ 0.10 (t-test); **Significant at p ≤ 0.05 (t-test) 

5.2 Physician Self Referral 

Multivariable Profit Function Regression Models, Dependent Variable is 

Market Area (MSA) General Hospital Profit Margin, 1997–2003 

Independent variable 1 MSA 

(4) (5) (6) 

Per capita income ¥0.00000073 ¥0.00000057 ¥0.00000072 

Population density ¥0.00002250 ¥0.00002380 ¥0.00002260 

Inpatient beds per capita 7.56830900* 7.51012900* 7.52111000* 

MDs per 1000 pop. ¥0.01176980 ¥0.01183570 ¥0.01174600 

Inpatient days per 1000 pop. 0.00000699 0.00000783 0.00000686 

Outpatient visit per capita ¥0.00283480 ¥0.00287550 ¥0.00286490 

Medicare Part A AAPCC 0.0003083** 0.00031420** 0.00030700** 

Unemployment rate ¥0.00269240 ¥0.00274240 ¥0.00261580 

Poverty rate ¥0.00127800 ¥0.00156110 ¥0.00131490 

Annual wage (hospital staff) ¥0.00000064 ¥0.00000061 ¥0.00000064 

HHI 0.00000395* 0.00000360 0.00000399* 

1= SCP present 0.0323107** — 0.02809040** 

MDs admitting to SCP — 0.00032330** 0.00013120 

Constant ¥0.01532120 ¥0.01553810 ¥0.01475440 

Number of observations 1465 1465 1465 

F 4.00 3.39 3.75 

Prob. >F 0.0000 0.0001 0.0000 

Overall R-squared 0.0454 0.0415 0.0462 

Sources: Survey of ASHA membership, Medicare HCRIS Cost reports, 

Area Resource File, and Bureau of Labor Statistics; see section 5.1.1 for description. 

Notes: *Significant at p ≤ 0.10 (t-test); **Significant at p 5≤ 0.05 (t-test) 

5.2 Physician Self Referral 

The remaining policy issue is the potential effects of physician self-referral. The 

costs and benefits of physician self-referral has been debated for many years, mainly 

122 

26 It should also be noted that high variation in utilization and referral patterns exist without 

respect to physician ownership. For example, Weinstein et al. (2004) recently observed significant variation in utilization patterns for major surgery for degenerative diseases of the hip, 

knee, and spine in several South Florida hospital referral regions where there are no physicianowned specialty hospitals. 27 Refer to section 3.4 

because the dominant physician payment mechanism in the U.S. has been and continues to be fee-for-service, which creates financial incentives for self-referral. In the 

case of specialty hospitals, the general argument against physician self-referral is 

that physician ownership may result in financial incentives to admit patients to the 

facilities in which they have an ownership stake. These arguments are to some extent based on research that has found that utilization of ancillary services is higher 

when an ownership relationship exists between referring physicians and ancillary 

services (Mitchell and Sass 1995; Lynk and Longley 2002; Kouri, Parsons, and 

Alpert 2002; Zientek 2003; O’Sullivan 2004). However, there are at least four important limitations to applying these arguments to acute care hospitals. 

First, the vast majority of studies of higher utilization resulting from self-referral 

are based on physician ownership of ancillary services, rather than acute care hospitals. Mitchell and Sass (1995), in their frequently cited study of physician referral, 

failed to find higher utilization rates associated with self-referral to acute care hospitals. This lack of association has been one of the main reasons that the two phases 

of Stark anti-kickback legislation have exempted physician ownership of acute care 

hospitals (Stout and Warner 2003; Rohack 2004; O’Sullivan 2004). In addition, there 

is no direct evidence that the observed higher utilization rates resulting from selfreferral to ancillary services represent inappropriate or unnecessary care (Kouri, 

Parsons, and Alpert 2002; Zientek 2003). 

Second, there is no direct evidence that physician self-referral is motivated disproportionately by financial incentives. Physician self-referral is motivated by four 

factors: appropriateness, quality, efficiency, and financial returns. The relative magnitude of each of these incentives has been the subject of debate, but there is no 

direct evidence to suggest how, on average, physicians assign weights to each factor. 

Consistent with the empirical findings, anecdotal evidence suggests that physicians 

may disproportionately weight financial incentives when the referral is for standardized products or services (e.g., lab or pharmacy), and disproportionately weight appropriateness and quality when the referral is for more intensive procedures, such 

as surgery (Moore 2003). 

Third, there is no evidence that self-referrals result in worse outcomes than other 

types of referral (Kouri, Parsons, and Alpert 2002; Zientek 2003). A likely reason 

for these findings is the endogeneity of three factors: physician quality, the likelihood of self-referral, and the quality of patient outcomes. In the case of specialty 

hospitals, site visits and trade press literature indicate that physician investors in 

specialty hospitals tend to be those who highly value efficiency in quality and cost 

dimensions. Thus, for many physician investors, self-referral is likely to represent 

the most optimal referral in terms of quality and cost. 

Fourth, in the case of physician ownership of acute care facilities, it is likely that 

the magnitude of financial incentives is limited. The General Accounting Office 

(2003a) found that 30 percent of specialty hospitals surveyed had no physician investors. For half of the facilities with physician investors, the average individual 

physician ownership share was less than two percent. In the ASHA survey, virtually 

all physician investors owned only five percent or less (Table 2). Moreover, the entrepreneurial returns (i.e., the fraction of the facility fee considered operating margin) for any single case are likely to be substantially less than the professional fee 

charged by physicians. Given the order of magnitude difference between these two 

revenue streams, physician incentives are likely to be driven more by professional 

fees, which do not vary significantly by practice setting.26 Indeed, in this context 

the potential for a surgeon to enhance his or her own productivity is a more likely 

source of financial incentive for self-referral to a specialty hospital. In other words, 

the primary financial motivation may be to enhance the return on investment for 

the surgeon’s investment in ‘‘human capital’’ (associated with the number of procedures performed) 27 rather than any effort to assure a return on investment in the 

form of financial assets (associated with the overall financial performance of the 

hospital). 

In terms of policy options, even if we were to assume that these limitations were 

not important, a more central question is whether creating barriers to market entry 

are the most appropriate means of addressing the issue. The net social welfare 

losses associated with barriers to market entry are likely to be greater than those 

123 

attributable to physician referral incentives, particularly in light of the weakness of 

these incentives. 

6. CONCLUDING REMARKS 

In this study we have reviewed the theory and evidence on some of the key characteristics of specialty hospitals, including efficiency, demand, case mix, and quality. 

These findings were supported by observations from five specialty hospital site visits. We also conducted statistical analyses of the effects of specialty hospitals on the 

profit margins of general hospitals. The main findings of the study can be briefly 

summarized in the following three points. 

First, there are economic advantages associated with specialization, due mainly 

to process redesign, learning, avoidance of diseconomies of scope, and focus on core 

competencies. Specialty hospitals appear to have equal or better patient outcomes 

compared to their general hospital counterparts. Hence, there is no evidence to suggest that specialty hospitals should be barred from entering acute inpatient care 

markets on the basis of efficiency or quality of care. 

Second, there is no evidence, other than anecdotal, to suggest that general hospitals have been financially harmed by competition from specialty hospitals, or that 

such competition is undesirable from a societal perspective. Specialty hospitals compete with general hospitals in the same manner in which general hospitals compete 

with each other. Based on a longitudinal study of general hospital profit margins 

in markets with and without specialty hospitals, we find that profit margins of general hospitals have not been affected by the entry of specialty hospitals. Consistent 

with economic theory, the models consistently showed that the most important predictor of general hospital profitability was the extent of competition from other general hospitals in the same market area. General hospitals in less competitive markets (i.e., those with fewer competitors) had higher profits than general hospitals 

in less competitive markets. Contrary to the conjecture that entry by specialty hospitals erodes the overall operating profits of general hospitals, general hospitals residing in markets with at least one specialty hospital have higher profit margins 

than those that do not compete with specialty hospitals. These findings are also consistent with economic theory, which suggests that firms will enter markets in which 

extant profit margins are comparatively higher. 

Third, though often cited as a significant policy concern, there is no evidence that 

physician self-referral is a problem in specialty hospitals. Physician self-referral is 

likely to play a relatively minor role in specialty hospitals, for four reasons: (1) the 

vast majority of studies of higher utilization resulting from self-referral are based 

on physician ownership of ancillary services, rather than acute care hospitals; (2) 

there is no direct evidence that physician self-referral is motivated disproportionately by financial incentives; (3) there is no evidence that self-referrals result in 

worse outcomes than other types of referral; and (4) in the case of physician ownership of acute care facilities, it is likely that the magnitude of financial incentives 

is limited. 

APPENDIX A 

2004 Survey of Specialty Hospital 

Instruction: 

1. These results will be kept strictly confidential. Under no circumstances will 

the data leave the control of ASHA and its principal contracted researcher, John 

Schneider. Only aggregate data will be presented publicly (e.g., means and standard 

errors). 

2. All responses, unless otherwise noted, should refer to your previous full fiscal 

year. If your facility has not been open for an entire fiscal year, indicate so at the 

beginning of the questionnaire. Also, unless otherwise specified, responses should 

refer to the main patient care facility. 

3. Please answer each question as accurately as possible. In the event that it is 

not possible to answer a question, use the following codes: Unknown = DK, Refused 

= RF, Not applicable = NA. Before resorting to these codes try to at least provide 

a reasonable estimate. 

4. For technical questions contact John Schneider at john-schneider@uiowa.edu 

or 319–331–2122. 

124 

Question Response 

1. Name of facility: 

2. Zip code (main patient care facility) 

3. Has your facility been open for at least one whole fiscal year? 

(1=Yes; 0=No) 

4. Beginning date of most recent full fiscal year (MM/DD/YYYY) 

Licensing & Accreditation 

5. Is your facility licensed in your state as an inpatient hospital? (1=Yes; 0=No) 

6. Accredited by Accreditation Association for Ambulatory 

Health Care? (1=Yes; 0=No) 

7. Accredited by Joint Commission on Accreditation of Health 

Care Organizations (JCAHO)? (1=Yes; 0=No) 

8. Other accrediting organizations (1=Yes; 0=No) Specify: 

History 

9. First calendar year in which facility was licensed as inpatient hospital 

10. First calendar year in which beds were added, if different 

from Q9 

Beds and Capacity 

11. Total bed capacity 

12. Number of staffed inpatient beds 

13. Number of operating rooms 

14. Number of intensive care beds 

15. Number of recovery beds (all stages) 

16. Do you maintain & staff an urgent/emergent care center? 

(1=Yes; 0=No) 

17. If Q16 = yes, how many hours per day is the care center 

staffed? 

Ownership Structure (Q21–Q24 sum to Q20) 

18. Total number of owners 

19. Total number of physician owners 

20. Total number of physician owners who admit 28 at least 5 

patients per year 

21. Number of physicians in Q20 with 0–1% ownership stake 

22. Number of physicians in Q20 with 2–5% ownership stake 

23. Number of physicians in Q20 with 6–9% ownership stake 

125 

Question Response 

24. Number of physicians in Q20 with 10% or more ownership 

stake 

Volume and Case Load 

25. Number of inpatient discharges 

26. Number of inpatient days (overnight stay) 

27. Number of inpatient days (observation days) 

28. Number of surgeries (overnight stay) 

29. Number of outpatient surgeries (no overnight stay) 

Patient Care Revenue 

30. Total gross patient care revenue (inpatient + outpatient) $

31. Outpatient revenue as percent of total gross patient revenue (Q30) % 

Sources of Patient Revenue (Q32–Q35 sum to 100%) 

32. Medicare revenue as percent of gross patient revenue % 

33. Medicaid revenue as percent of gross patient revenue % 

34. Commercial (private health plan) insurance revenue as percent of gross patient revenue % 

35. Other revenue as percent of gross patient revenue % 

Charity Care 

36. If your state has a charity care risk pool, do you pay into it? 

(1=Yes; 0=No) 

37. If the answer to Q29 was yes, indicate annual amount paid 

into risk pool 

$

38. Charity careas a percentage of gross patient care revenue % 

Taxes Paid29

39. State income tax paid previous tax year $

40. Federal income tax paid previous tax year $

41. Property tax paid previous tax year $

Expenses and Income 

42. Total operating expenses $

43. Net income after all expenses but before taxes $

Nurse Staffing 

44. Total number of full-time equivalent (FTE) RNs 

45. Average patient to RN ratio (e.g., for 3:1 write ‘‘3;’’ for 5:1 

write ‘‘5’’) 30

126 

Question Response 

Quality 

46. Do you employ a computerized physician order entry 

(CPOE) system? (1=Yes; 0=No) 

47. Do you employ an electronic medical record (EMR) system? 

(1=Yes; 0=No) 

48. Do you attempt to collect patient satisfaction data on all patients post-discharge? (1=Yes; 0=No) 

49. Percent of admitting physicians with admitting privileges at 

community / general hospitals in market area 

% 

50. Number of admitted inpatients transferred to community / 

general hospitals in market area 

51. Do you have a transfer arrangement with one or more community / general hospitals in market area? (1=Yes; 0=No) 

Competitors 

52. Number of inpatient hospitals in market area which you 

consider to be competitors 

53. Number of outpatient surgery centers and clinics in market 

area which you consider to be competitors 

28 Admitted for inpatient care 

29 All tax information should refer to the most recent full tax year. Facilities organized as partnerships typically allocate taxes to owners. In these cases please provide and estimate of the total tax liability for the entity for all owners combined. 

30Patient to nurse ratios are expected to vary by stage of care (i.e., first and second stage recovery) and by 

shift. For this question, estimate an overall facility average; i.e., report the average number of patients per 

RN across all stages of care. 

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f 

Hospitals & Health Networks. 

Focus On Therapeutic Outcomes, Inc. 

Knoxville, Tennessee 37909 

March 18, 2005 

The Honorable Nancy Johnson, Chairman 

Subcommittee on Health 

House Ways and Means Committee 

U. S House of Representatives 

Washington, DC 20515 

Dear Chairman Johnson: 

Focus On Therapeutic Outcomes, Inc., (FOTO), a national medical rehabilitation 

outcomes database designed for providers, patients and payers of rehabilitation care, 

is pleased to submit this statement for the record in conjunction with a hearing conducted under your leadership by the Subcommittee on Health of the House Ways 

131 

and Means Committee on March 15, 2005. The hearing provided the Subcommittee 

an opportunity to hear what CMS is doing to relate physician payment to quality 

and to learn what some physician groups are able to achieve with their systems of 

quality improvement. 

Due to a paucity of outcomes measures at this time, considerable discussion revolves around the use of process measures and claims data and perhaps a combination of the two. As was mentioned by two of the witnesses who testified at the hearing, valid and reliable outcomes measures are needed and in order to use such 

measures as a basis forreimbursement, precise risk-adjustment is essential. 

Perhaps no other area offers such a unique and ripe opportunity for paying on 

the basis of outcomes than the rehabilitation therapies. Valid and reliable functional 

outcomes measures currently exist in rehabilitation and precise risk-adjustment is 

available to facilitate the development of a pay-for-performance process in the outpatient rehabilitation therapies. Moreover, given the impending expiration of the 

moratorium on the therapy cap, it could not be more timely to explore pay-for-performance as an alternative payment method required by the Balanced Budget Act 

of 1997. 

FOTO, the leading purveyor of valid and reliable outcomes measures for outpatient rehabilitation therapy has amassed records from over 1.6 million patients 

treated by more than 13,000 clinicians in twelve years using scientifically-based, 

valid and reliable assessment instruments, which determine a patient’s level of 

function prior to intervention, periodically during intervention and at the conclusion 

of rehabilitation intervention. These data reflect changes in functional health during 

the rehabilitation experience. The data are used to assess and predict resources necessary for specific patient interventions including the appropriate number of visits, 

time and amount of improvement to be expected. In addition, the data reflect patient satisfaction resulting from the rehabilitation experience. Results are tabulated 

and reports are benchmarked to the national database, which is privately owned, 

confidential and independent of all providers and payer-related organizations. The 

robust FOTO database has been compiled from more than 13,000 clinicians in over 

1500 outpatient rehabilitation customers who are primarily hospital outpatient departments, therapy clinics and physician offices. The data collection process is independent of the type of provider, and therefore it is applicable to patients treated by 

chiropractors and many physicians who treat patients with physical function deficits. 

The FOTO Experience 

FOTO uses instruments that have been proven scientifically valid and reliable 

and have their origin in widely known and accepted instruments, such as the SF– 

36, SF–12, Lysholm Knee Inventory, Oswestry Low Back Pain Questionnaire, Neck 

Disability Index, Lower Extremity Functional Scale, Shoulder Flexi-Scale, and Back 

Pain Functional Scale. Through extensive research, much of which is published in 

peer-reviews journals, FOTO has used these instruments to develop a patientfriendly survey instrument that provides highly accurate information describing 

physical function and patient satisfaction. 

The database is robust with valuable rehabilitation and patient information, so 

all FOTO reports are risk-adjusted. Risk-adjustment allows appropriate case-mix 

adjustment, which improves appropriate patient comparisons. FOTO uses risk-adjusted data to predict the number of visits necessary and degree of benefit derived 

from rehabilitation. No other acute rehabilitation outcome system combines outcomes and efficiency to allow payers to utilize outcomes data as a basis for provider 

reimbursement. The ability to accurately predict resources necessary to accomplish 

successful rehabilitation is of profound value to providers and payers as continued 

strides are taken to improve quality, enhance patient satisfaction and contain 

health care costs. 

Implications 

Retrospective analysis of the database has allowed FOTO to develop predictive 

models. Such information enables clinicians to practice evidence-based rehabilitation, payers to determine appropriate use of resources, employers to save money, 

and patients to feel confidence and express satisfaction knowing their rehabilitation 

is based on the most accurate, up-to-date, scientific information. Moreover, the data 

and methodology can be used as the basis of a pay-for-performance system for the 

outpatient therapies, thus aligning the incentives in rehabilitation therapy. 

Aligning Incentives 

For nearly two decades employers have been concerned about the rising cost of 

health care. Business owners have expressed a desire to pay for health care in the 

same manner used to purchase any commodity; contracting with vendors to provide 

a service delivered on time, at a known price and quality; and rewarding betterthan-standard performance. In 2001, the Institute of Medicine published a landVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00135 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
132 

mark report, which essentially embraced such a philosophy. Crossing the Quality 

Chasm: A New Health System for the 21st Century, outlined a strategy that included broad themes to make healthcare safer and more accountable and called for 

an alignment of incentives in health care delivery. That is, incentivizing health providers for the delivery of high-quality care. 

The March to Pay-for-Performance 

In recent years numerous public and private sector developments have demonstrated a growing interest in value purchasing in health care delivery. 

• The Medicare Modernization Act (MMA) of 2003 included a number of health 

care quality provisions and demonstrations including theHospital Quality Initiative and a pilot program with members of the Premier alliance of not-for-profit 

hospitals. 

• In their 2004 publication Pay for Performance’s Small Steps of Progress, 

PriceWaterhouseCoopers reported that as many as one-third of health plans indicate they have a pay-for-performance program in place. 

• In testimony before this subcommittee on February 10, 2005, Glenn Hackbarth, 

chairman of the Medicare Payment Advisory Commission (MedPAC), stated 

that a good pay-for-performance program would reward absolute high levels of 

quality and those showing significant improvement. In addition, risk-adjustment is needed because providers treating the sickest patients should not be penalized for failing to show enough improvement on quality measures. Hackbarth 

went on to suggest that providers should be held accountable on measures that 

are within their control and that patient experience should be introduced as 

soon as means are available to collect such data. For example, rehabilitation 

providers should be judged on patient functional improvement. 

With the availability of FOTO’s robust, risk-adjusted database, which precisely 

quantifies functional improvement, it is indeed possible to judge and reimburse rehabilitation providers and suppliers on the basis of their patient’s functional improvement. 

The National Quality Forum (NQF) has identified various components that will 

make introduction of value purchasing acceptable and even appealing to all health 

system stakeholders: 

1. Choosing and using quality measures that: 

• have a clear and compelling application, 

• do not impose an undue burden on those who provide data, 

• help providers improve quality of care, and 

• help consumers select plans, providers and/or treatments. 

These quality measures should be held constant over time to permit 

benchmarking and measurement improvement and be open to improvement based 

on the scientific approach to care. The process should use risk adjusting for more 

accurate benchmarking and have audit standards for assessing implementation. 

2. Voluntary approaches to quality measurement and reporting have failed to engage the entire health system. On the contrary, mandating participation and reporting increases compliance, bolsters data accuracy and value, and has potential to create a system that is more equitable for all stakeholders. Once captured, data must 

be routinely and publicly reported in a common set of measures. 

3. Quality measures should possess the integrity that allows benchmarking individual patients to a national standard as well as measuring results of care on a patient-by-patient basis. Thus, information can be used to guide and accurately assess 

benefits of treatment. Data can be used as the basis for determining payment predicated on a comparison of results of intervention to the time, cost and quality parameters revealed by the database. 

FOTO, Inc., has developed a Value Purchasing Payment Algorithm, a methodology for the rehabilitation therapies that is consistent with the above NQF criteria, 

with the recommendations of MedPAC and of the Institute of Medicine. The Focus 

On Therapeutic Outcomes, Inc. value purchasing process for outpatient rehabilitation services rewards higher quality of care (i.e., better functional outcomes) and 

more efficient rehabilitation services (i.e., fewest possible visits). 

The process is based on risk-adjusted patient self-report of functional abilities and 

an established number of rehabilitation visits provided per episode as determined 

by the robust FOTO database. Clinician/patient episodes are classified according to 

whether the number of visits for a patient was less than, the same as, or exceeded 

the predicted (established) number and whether the patient’s change in functional 

health status was below, equal to, or greater than predicted by the database. The 

133 

number of visits required and the change in functional health status expected, are 

risk-adjusted by diagnosis, severity of functional ability, age and acuity of symptoms. Clinicians are reimbursed in accordance with their performance compared to 

the risk-adjusted data provided by FOTO. Clinicians with patient experiences that 

are more efficient (fewer visits) and more effective (better outcomes) are paid a 

bonus. Clinicians who are less efficient (more visits) and less effective (worse outcomes) are penalized. The patient interface is an attractive, user-friendly computer 

program that provides valuable functional information to the clinician for timely patient treatment. Once the necessary data are submitted, visit and functional outcomes data are matched to the risk-adjusted payment algorithm. In short, it is clinically relevant, easily collected data that creates a system change that empowers and 

incentivizes clinicians to deliver the most effective care in the most efficient manner. 

FOTO joins other organizations who have submitted statements on this topic in 

supporting continuation of demonstration projects and studies on pay-for-performance. Such activities should be extended to the rehab therapies in an effort to develop and refine suitable alternatives to the therapy caps. Paying for results allocates resources to what is effective in caring for patients while shifting away from 

care that is ineffective, costly and possibly fraudulent. The FOTO value purchasing 

process for outpatient rehabilitation services results in: Care Based on Need—Payment Based on Results. 

Business and industry have been paying for performance for decades and leaders 

in the business community have difficulty understanding why all health providers 

are paid the same irrespective of the end result. ‘‘What can be more American than 

pay-for-performance,’’ they ask. Progressive businesses, the ones recognized with 

awards for high-quality, are pleased to see the ‘‘American way’’ coming to health 

care. 

Health care quality has long been talked about, but progressive organizations who 

are now ‘‘walking the walk’’ are considered leaders in the field. These leaders are 

discovering that using data with valid and reliable quality indicators is the most 

efficient, clinically-relevant and administrative friendly way of aligning the incentives described in Crossing the Quality Chasm. Focus On Therapeutic Outcomes, 

Inc., is one of these leaders and is eager to share its vast experience, robust database and valid and reliable methods with the committee, the Congress and CMS in 

an effort to hasten the alignment of incentives in the delivery of outpatient rehabilitation services. 

Thank you for the opportunity to submit comments on this important and timely 

issue and, more importantly, thank you for the leadership in pursuit of efforts to 

obtain better value for the Medicare dollar. 

Sincerely, 

Ben Johnston, Jr. 

Chief Executive Officer 

————— 

Based on Need—Payment Based on Results 

Value Purchasing in Rehabilitation 

Focus On Therapeutic Outcomes, Inc 

Knoxville, TN 

Focus on Therapeutic Outcomes 

F O T O 

FOTO 

• A national outcomes database 

• In existence for thirteen years 

• Over 1500 providers 

• Over 1.6 million patients 

• Over 13,000 clinicians 

Designed for providers, patients and payers of outpatient rehabilitation 

care 

134 

• Uses scientifically-based, valid and reliable assessment instruments, which determine the: 

• Severity of a patient’s condition. 

• Patient’s response during treatment. 

• Effectiveness of intervention. 

• Patient’s level of function 

• Prior to intervention 

• Periodically during intervention 

• At the conclusion of rehabilitation intervention 

• Patient’s satisfaction with the rehabilitation experience. 

• Appropriate resource utilization. 

• Predict the expected duration (# of visits) of treatment 

• Predict expected outcome 

Risk Adjustment 

• The ability to accurately predict the resources necessary to accomplish successful rehabilitation. 

• Robust database 

• Valuable rehabilitation and patient information 

• Able to predict 

• Number of visits 

• Satisfactory outcome 

Analysis 

• Results and reports are risk-adjusted and benchmarked to the national database. 

• Analyses are independent of provider, payer or national association 

• Amount of improvement per visit. 

• Amount of improvement per dollar spent 

• Wide variety of patient conditions, payer types and treatment settings. 

• Results used to predict and manage care. 

• Patient satisfaction with the rehabilitation experience. 

Implications 

• Clinicians enabled to practice evidence-based rehabilitation using benchmarked 

reports to direct and validate treatment choices. 

• Payers obtain the reliability to determine the appropriate use of resources. 

• Patients get the confidence and satisfaction associated with the knowledge that 

their rehabilitation is based on the most accurate, up-to-date, scientific information. 

• A positive effect on access due to efficient use of patient and staff time. 

Conclusion 

• This methodology, available now, represents the future—evidence-based rehabilitation. 

• Through retrospective analysis FOTO has developed predictive models, which 

are based on scientifically valid and reliable data-gathering instruments. 

• This results in improved quality of rehabilitation intervention at the lowest 

cost. 

• Allows payers to ‘‘pay-for-results.’’ 

Care Based on Need—Payment Based on Results 

f 

Statement of Steven Jones, Little Rock, Arkansas 

Ladies and Gentlemen: 

My name is Steven Jones, D.O. I am an orthopedic surgeon in Little Rock, AR. 

I am writing in reference to the Ways & Means Committee meeting on Tuesday. 

Specialty hospitals must continue to exist. Employees of nearly 100 facilities would 

be in danger of losing jobs. Whole communities are at risk. But most importantly, 

the citizens deserve the right to make their own healthcare decisions and 

135 

1Dr. John C. Nelson, ‘‘Competition works’’, The Washington Times, 2/10/05 

the opportunity to access the high quality of care that single specialty hospitals provide. Please do not allow the moratorium on specialty hospitals to continue. Patients must be allowed to have a choice in health care. 

I feel opponents of specialty hospitals have misrepresented the industry. Here are 

the facts: 

• Concerns over the so-called cherry picking of profitable patients are eliminated 

by DRG reform • The American Surgical Hospital Association is not aware of any facilities that 

will open within a year of the expiration of the moratorium • Surgical hospitals serve Medicare and Medicaid patients • True! 40 specialty hospitals don’t have ERs. Also True! 400 general hospitals 

don’t have ERs • Physician investment averages 2% in specialty hospitals, according to the Government Accounting Office—hardly a conflict of interest • Studies done in the 1980s show no inappropriate referrals by surgeons and over 

85% of specialty hospital cases are outpatient • Take a look at the general hospitals in your area, more than likely they are 

expanding, not closing departments or closing their doors altogether • The Wall Street Journal and The Washington Times have both supported the 

industry with opinion pieces. 

f 

Statement of Karen Kerrigan, Small Business & Entrepreneurship Council 

Chairman Johnson, Ranking Member Stark and Members of the House Ways and 

Means Committee, I am pleased to provide this written testimony with respect to 

physician-owned specialty hospitals on behalf of the Small Business & Entrepreneurship Council (SBE Council) and its nationwide membership of small business 

owners and entrepreneurs. 

The SBE Council is a nonpartisan small business advocacy organization with 

more than 70,000 members nationwide. For more than ten years the SBE Council 

(formerly the Small Business Survival Committee) has worked to advance policies 

that protect small business and promote entrepreneurship. We are proud to count 

physician owners/investors of specialty hospitals among our diverse members. My 

name is Karen Kerrigan and I serve as President & CEO of the SBE Council. 

As you know, the Medicare Payment Advisory Commission (MedPAC) will soon 

be presenting a report to Congress on the costs, utilization rates, and practice patterns of physician-owned specialty hospitals as compared to full-service general hospitals. While MedPAC is expected to make positive recommendations, including 

changes to the diagnostic related group (DRG) payment system, they are also expected to recommend the extension of the 18-month moratorium on physician-owned 

specialty hospitals. Such an extension is pointless and would be a serious mistake. 

On behalf of the SBE Council, we urge Committee members to reject legislative efforts that would hamstring these innovative hospitals from fully 

providing the health care services that patients need and want. Patients deserve quality health care, not needless meddling by government. 

Opponents of specialty hospitals, including the American Hospital Association 

(AHA) and the Federation of American Hospitals (FAH), have unfortunately resorted to spreading misinformation in an effort to suppress the healthy competition 

provided by specialty facilities. 

Opponents of competition have made numerous, inaccurate accusations regarding 

specialty hospitals. These fallacious claims were addressed by Dr. John C. Nelson, 

president of the American Medical Association (AMA), in a recent letter-to-the-editor 

in The Washington Times. As Dr. Nelson points out the hospital industry is offering 

‘‘a blizzard of skewed statistics,’’ yet conveniently ignores straightforward economic 

principles with respect to the benefits of specialty hospitals—namely, that ‘‘. . . 

Competition works. And in the hospital industry, the addition of specialty 

hospitals to the mix gives patients more choice, forcing existing hospitals 

to innovate to keep patients coming to them. This is a win-win situation in 

providing better quality of care.’’ 1

The Wall Street Journal editorial board also expressed its forthright assessment 

when it wrote, ‘‘what the critics really want is to take away consumer choice, 

forcing patients into treatment at less-optimal facilities for no reason other than to 

136 

2 Editorial, ‘‘In the (Specialty) Hospital’’, Wall Street Journal, 1/3/05. 3 Editorial, ‘‘Bolstering specialty hospitals’’, The Washington Times, 1/24/05 

prop up the current system. But the other side of the equation is ensuring that consumers have a choice of places to spend those dollars, which means competition 

among hospitals.’’ 2

Not only are specialty hospitals important to the marketplace because they provide competition to incumbents, but they are well regarded by patients, who give 

them high marks. Specialty hospitals have a very high rate of successful procedures; 

higher nurse-to-patient ratios; with their innovative care and extra attention to customer service a positive development for health care consumers. Furthermore, physicians are attracted to specialty hospitals because they provide faster, surer access 

to operating rooms with fewer bureaucracy-induced delays, quality nursing staffs, 

readier access to the latest medical and information technologies, and well-trained 

support personnel. 

Communities are welcoming specialty hospitals with open arms because of their 

exceptional patient care and economic development attributes such as good jobs, 

property and sales tax revenues, as well as the care they give to indigent patients. 

Specialty hospitals often offer emergency services and attract patients from afar 

who are drawn by the specialty services. 

Specialty hospitals succeed because, as part owners, physicians not only treat patients, but they also make sure facilities operate efficiently. Physician partners 

are true small business owners, weighing cost-effectiveness, return on investment and quality and efficiency along with traditional factors relative to patient 

care. They take an active part in decision-making on issues such as capital expenditures on medical/surgical equipment, patient billing and protocols of care. 

The entrepreneurial physician owners behind specialty hospitals are working hard 

to take health care delivery in a new and refreshing direction. An extension of the 

federal government’s moratorium on specialty hospitals would be, at its core, an act 

of protectionism that stifles progress and innovation. 

‘‘Tweaking’’ and micromanaging health care delivery by the government has already proven to be expensive and inefficient, littered with unintended consequences 

for consumers. Industrial planning has failed at every attempt—there is absolutely 

no reason to believe that the government will be successful in this modern day initiative to micromanage what is a very positive development in the hospital industry. 

Again, we thank you Chairman Johnson for hosting this important hearing. I urge 

you to give every consideration to legislation that would hamper the ability of specialty hospitals to deliver their innovative, efficient and live-saving services to patients. As The Washington Times editorial board recently advocated, ‘‘In the new 

Congress, the Republican leadership should make sure choice and competitiveness in health care trump special interests like the AHA’s—We hope to 

see a law that keeps specialty hospitals going and ignores MedPAC’s advice.’’ 3

We couldn’t agree more, and the SBE Council urges you to oppose the extension 

of the moratorium on specialty hospital development. 

Please do not hesitate to contact me if you have questions about the SBE Council’s position on this issue. 

f 

Statement of Jane Orient, Association of American Physicians and 

Surgeons, Tucson, Arizona 

Madam Chairman and Members of the Committee: 

The Association of American Physicians and Surgeons was founded in 1943 to preserve private medicine. We represent thousands of physicians in all specialties nationwide, and the millions of patients that they serve. I am the executive director. 

Members of the Association of American Physicians and Surgeons collectively 

agree that Congress should not extend, make permanent or broaden the moratorium 

on physician-owned specialty hospitals contained in the Medicare Modernization 

Act. A resolution to this effect was passed without dissent at our 2004 annual meeting. 

Responsible competition and the dynamics of the free-market encourage innovation and reduce costs. Furthermore, specialty facilities have consistently delivered 

superior results in terms of patient outcomes, operating efficiency, and patient satisfaction; therefore AAPS believes that it is not in the best interests of patients, phyVerDate Aug 31 2005 04:49 Apr 13, 2006 Jkt 026371 PO 00000 Frm 00140 Fmt 6633 Sfmt 6621 E:\HR\OC\26371.XXX 26371
137 

sicians or taxpayers for government to arbitrarily limit the growth of physicianowned single-specialty hospitals. 

A joint study by the Federal Trade Commission and the Department of Justice 

strongly endorsed expansion of competitive, free-market choice as a means for delivering excellent medical care and containing costs. Their conclusion was echoed by 

the Medicare Payment Advisory Commission (MedPAC) at a recent presentation of 

preliminary study findings in which they acknowledged that specialty hospitals can 

serve as a ‘‘wake up call’’ for community hospitals to improve quality of care and 

service. 

The growth of physician-owned specialty hospitals over the last 10 years represents a free-market trend that should be encouraged, not stifled by Congress. 

In the relatively short number of years that specialty hospitals have been a part 

of the medical landscape, innovation is one of the words that are consistently applied to their work. Innovation drives quality improvements. These physician-owned 

hospitals show innovation in a number of ways. First, they utilize the newest, cutting-edge technology and equipment. They also operate with a high nurse-to-patient 

ratio. And the care at these facilities is specifically designed to meet and exceed patient expectations. 

Not only do these facilities provide premium care, because of their efficient business models, physician-owned specialty hospitals are able to pass cost savings on to 

patients and taxpayers while maintaining the highest quality of care. These innovative facilities encourage quicker turn-around in operating facilities, lower labor costs 

and ease patient transportation. Because the physician-partners at specialty hospitals are involved in decision-making, hospitals are able to introduce and adapt to 

new procedures and methodology, resulting in innumerable cost-saving measures. 

The choice of these physicians is deliberate and it is based largely on the management model of the specialty hospitals. Traditional hospital management is based on 

the bureaucracy of hospital administrators making decisions, rather than physicians 

who are aware of patients’ needs. At physician-owned facilities, decisions are always 

based on the need of the patient, rather than the preference of an administrator. 

At these facilities, because physicians are involved in all steps of the decision-making progress, a premium is placed on maximizing efficiency. 

The physician ownership model couples doctors with administrators to oversee everything from quality to operations to purchasing. Because of this, physician-ownership proves to be the most cost effective business model for hospitals. 

The U.S. Congress continues to enact onerous regulations effecting physicians 

under the guise of reducing costs to the taxpayers. The moratorium on specialty hospitals is one example. Such hospitals could help reduce the cost of federal health 

programs paid for by the taxpayers, while enhancing access to the highest quality 

of health care that the American taxpayers expect. 

Please do all you can to lift the moratorium. 

f 

Statement of John W. Strayer III, National Center for Policy Analysis 

Madam Chairman and Members of the Subcommittee: 

Placing a moratorium on physicians referring patients to specialty hospitals is the 

latest example of a negative third party influence. Physician-owned specialty hospitals are innovative centers of medical care that increase the quality of care, without jeopardizing access, while striving to keep costs competitive and affordable. 

Physician-owned specialty hospitals are a major force for introducing greater competition and innovation into the American health care system. Just as greater competition has served us well in so many other sectors of the American economy, freemarket solutions can be a force for delivery of more benefits in the health care field 

as well. 

Because of their very nature, physician-owned specialty hospitals are designed to 

maximize efficiency and quality of care, resulting in better patient outcomes. At a 

time when the U.S. Congress is debating ‘‘performance pay’’ based on patient outcomes, an easing of the moratorium on physician referrals to physician-owned specialty hospitals would seem most appropriate in helping to attain better outcomes. 

At physician-owned specialty hospitals, physicians choose to practice in an environment where sound medical decisions can be made without third-party second 

guessing due to bottom line considerations. The unique atmosphere of a specialty 

hospital offers physicians the opportunity to work where they can be most effective 

and where they have access to cutting edge technology and specialized support staff. 

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The growth of specialty hospitals is an example of how new and innovative entrants in an existing market help fuel competition for cost, quality and access. When 

a superior product or service goes into existing markets, competitors are forced to 

raise quality and re-examine costs. The final result is a higher rate of productivity, 

translating to lower costs and better quality to the patient. That point cannot be 

overemphasized. And the specialty hospitals are the new market entrants that make 

it possible. 

Patients should be afforded the choice of facility with the newest equipment, and 

best record of results. They deserve the best treatment available. That is why patients in increasing numbers are choosing a facility with the best outcomes and 

quality of care. That is why they are choosing specialty hospitals. 

With a majority of specialty hospital staff dedicated to a specific field and focused 

on efficient methodology, time between operative procedures and post-procedure 

turnaround is reduced, resulting in increased productivity in all aspects of the hospital. 

Such productivity is one of the hallmarks of specialty hospitals. 

The General Accountability Office (GAO) conducted a study of MedCath Hospitals, 

a group of 12 heart hospitals across the country, and their impact on neighboring 

general and community hospitals. The GAO’s conclusions found that their cost effectiveness and rate of high positive outcomes outweighs any perceived disadvantages 

experienced by general and community hospitals. 

A study by the Lewin Group compared MedCath facilities to peer hospitals which 

conduct open-heart surgery and found MedCath hospitals measured better in a 

broad range of categories. According to the Lewin Group, MedCath patients experienced shorter stays and were discharged to home, rather than to short-term care 

facilities. This is important because it means reduced costs to Medicare and Medicaid. In turn, with the decrease in Medicare/Medicaid costs, taxpayers are less apt 

to subsidize treatment at specialty hospitals. 

At a time when the federal budget deficit requires the U.S. Congress to vigorously 

pursue any and all avenues of potential savings, Congress must revisit the onerous 

regulations that increase the cost of health care, discourage improvements in patient outcomes, and place an undue burden on precious taxpayers dollars. 

Given the many benefits that specialty hospitals are delivering to patients, I believe our laws and government related enabling regulations must be written to allow 

for an expansion of the physician-owned specialty hospitals network. On behalf of 

those in need of medical care in America today, I ask that you act accordingly. 

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