Hospitals, which account for over 40 percent of U.S. health care expenditures, are changing rapidly and dramatically. Growing costs, advancing technology, and an aging population are driving these changes. As health care costs have increased, both public health financing programs, such as Medicare and Medicaid, and private health insurers have fundamentally reformed their methods for paying for and managing hospital-provided health care. Such reforms have not generally been implemented, however, in hospitals operated directly by the federal government, including those operated by VA. Hospital care accounts for the largest component of national health care expenditures. In 1995, hospitals accounted for 40 percent or about $441 billion of the nation’s estimated $1.1 trillion in health care expenditures. The next largest component of health care expenditures, physician services, accounted for just about 19 percent. (See fig. 1.1.) The American Hospital Association (AHA) groups hospitals into two primary categories—community and noncommunity. Community hospitals include all nonfederal, short-term general, and other special hospitals whose facilities and services are available to the public. Noncommunity hospitals include federal hospitals, long-term hospitals, hospital units of institutions, psychiatric hospitals, hospitals for tuberculosis and other respiratory diseases, chronic disease hospitals, institutions for the mentally retarded, and alcoholism and chemical dependency hospitals. For 1995, AHA reported that it had 6,291 hospitals registered in the United States, including 5,194 community and 1,097 noncommunity hospitals. The community hospitals included 3,092 nongovernment not-for-profit, 752 investor-owned for-profit, and 1,350 state- and local government-owned hospitals. This report focuses primarily on community hospitals when discussing non-VA hospitals. Such hospitals accounted for 873,000 of the nation’s 1,081,000 beds and almost 31 million of the approximately 33 million hospital admissions in 1995. VA hospitals account for 16 percent of all noncommunity hospitals. In fiscal year 1995, VA operated 173 of the 1,097 noncommunity hospitals, with an average of 50,787 hospital beds and admission of 844,626 patients. In addition to hospitals, the VA health care system included 375 outpatient clinics, 130 nursing homes, and 39 domiciliaries in 1995. For fiscal year 1995, VA obligated about $16.5 billion to maintain and operate its facilities and, on a limited basis, contract for care from non-VA providers. Over $8.4 billion (51 percent) of its obligations were for operating VA hospitals (see fig. 1.2). VA hospitals differ from community hospitals in the following ways: Whom they can and do serve. Community hospitals generally have no restrictions on whom they can serve. A hospital’s target population is limited primarily by the facility’s capabilities and business decisions. In contrast, VA hospitals have historically been limited to treating mainly veterans—adult males. Recent eligibility and contracting reform legislation, as discussed below, has broadened the types of patients VA hospitals may treat. Whom they can buy care from and sell care to. Community hospitals have few restrictions on their ability to contract to buy or sell patient care or nonpatient care services. Historically, VA facilities have been limited primarily to sharing health care services with other federal hospitals and with their medical school affiliates. Recent legislation has removed most restrictions on VA contracting. Who pays for the care provided. Most community hospital revenue comes from payments for patients sponsored by public payers (primarily Medicare and Medicaid) and private health insurers. Small portions also come directly from patients and state and local governments as operating subsidies. VA hospitals receive funding through an annual appropriation process. VA receives virtually no funding through Medicare and Medicaid and before August 1997 returned recoveries from private health insurance (other than a portion needed to cover the cost of operating the recovery program) to the general fund in the Department of the Treasury. Although VA facilities relied almost entirely on appropriated funds, they were allowed to retain certain payments resulting from sale of health care resources to the Department of Defense (DOD), other federal facilities, and certain other providers. In addition, although most VA hospitals, like their community counterparts, focus on short-term acute care services, other VA hospitals focus more on psychiatric and long-term care services. Under the AHA definitions, hospitals that primarily focus on psychiatric care, long-term care, or specialty services, even if they also provide some short-term care, are considered noncommunity hospitals. Systemwide, over 50 percent of VA’s 50,787 operating beds in fiscal year 1995 were devoted to long-term care (intermediate medicine), specialized services (rehabilitation of the blind, treatment of spinal cord injuries, and rehabilitation medicine), or psychiatric care (see fig. 1.3). About 18 percent of VA hospitals provide mainly psychiatric care. In administering the veterans’ health benefits program authorized under title 38 of the U.S. Code, some of VA’s responsibilities are like those of the Health Care Financing Administration (HCFA) in administering Medicare benefits and like those of private health insurance companies in administering health insurance policies. For example, VA is responsible for determining under the statute (1) which benefits veterans are eligible to receive, (2) whether and how much veterans must contribute toward the cost of their care, and (3) where veterans may obtain covered services (in other words, whether they must use VA-operated facilities or may obtain needed services from other providers at VA expense). Similarly, VA, like HCFA and private insurers, is responsible for ensuring that the health care benefits provided to its beneficiaries—veterans—are (1) medically necessary and (2) provided in the most appropriate care setting whether that is a hospital, nursing home, or outpatient clinic. In operating a health care delivery program, VA’s role is like that of the major private-sector health care delivery networks as operated by Kaiser Permanente. For example, VA strives to ensure that its facilities (1) provide high-quality care, (2) are used to optimum capacity, (3) are located where they are accessible to their target population, (4) provide good customer service, (5) offer potential patients services and amenities comparable with those of competing facilities, and (6) operate effective billing and collection systems. Historically, VA health benefits were focused on hospital care; outpatient care for most veterans was limited to coverage of services that would prepare the veterans for hospitalization, obviate the need for hospitalization, or provide treatments needed following a hospitalization. The Veterans’ Health Care Eligibility Reform Act of 1996, enacted in October 1996 (P.L. 104-262), eliminated the obviate-the-need provision and made all veterans eligible for comprehensive outpatient care. Any person who served on active duty in the uniformed services for the minimum amount of time specified by law and who was discharged, released, or retired under other than dishonorable conditions is eligible for some VA health care benefits. The amount of required active-duty service varies depending on when the person entered the military and an eligible veteran’s health care benefits depend on factors such as the presence and extent of a service-connected disability, income, and period or conditions of military service. Although all veterans meeting the above basic requirements were eligible for hospital, nursing home, and at least some outpatient care, before October 1996, 38 U.S.C. 1710 established a complex priority system— based on factors such as the presence and extent of any service-connected disability, the incomes of veterans with nonservice-connected disabilities, and the purpose of care needed—to determine which services were covered and which veterans received care within available resources. All veterans’ health care benefits included medically necessary hospital and nursing home care, but certain veterans, referred to as category A or mandatory-care category veterans, had the highest priority for receiving care. More specifically, the old law required VA to provide hospital care, and, if space and resources were available, allowed VA to provide nursing home care to veterans who had service-connected disabilities, were discharged from the military for disabilities incurred or aggravated in the line of duty, were former prisoners of war, were exposed to certain toxic substances or ionizing radiation, served during the Mexican Border Period or World War I, received disability compensation, received nonservice-connected disability pension benefit, or had incomes below the means test threshold (as of January 1996, $21,001 for a single veteran or $25,204 for a veteran with one dependent plus $1,404 for each additional dependent). For higher income veterans who did not qualify under these conditions, VA could provide hospital and nursing home care if space and resources were available. These veterans, however, known as category C or discretionary care category veterans, had to pay a part of the cost of the care they received. Under the old law, VA provided three basic levels of outpatient care benefits: comprehensive care, which included all services needed to treat any service-connected care, which was limited to treating conditions related to a service-connected disability; and hospital-related care, which provided only the outpatient services needed to (1) prepare for a hospital admission, (2) obviate the need for a hospital admission, or (3) complete treatment begun during a hospital stay. Separate mandatory and discretionary care categories applied to outpatient care. Figure 1.4 summarizes mandatory and discretionary VA health benefits under the old law. The Veterans’ Health Care Eligibility Reform Act of 1996 (P.L. 104-262) eliminated the criterion to obviate the need for hospital care and expanded eligibility for comprehensive outpatient services to all veterans. In addition, the act provides the following: Expressly states that the availability of health care services for veterans in the mandatory care category is limited by the amounts appropriated in advance by the Congress. The act has authorized appropriations of $17.25 billion for fiscal year 1997 and $17.9 billion for fiscal year 1998.