Generous Medicare Payments Spur Specialty Hospital Boom

October 26, 2003

INDIANAPOLIS - The hospitals here - hospitals across the
United States, for that matter - covet patients like Robert
E. Wilson. Mr. Wilson, 79, has had two open-heart
operations, five angioplasties, three cardiac
catheterizations and an implanted defibrillator. Just last
month, he checked into the Heart Center of Indiana to get
his first stent, a tiny bit of wire scaffolding that helps
keep arteries open.

Mr. Wilson's primary health insurance is Medicare, and
Medicare pays generously for cardiac care - so generously
that hospitals and doctors scramble after the business.

The Heart Center, a 60-bed hospital that cost $60 million
and boasts not just the most sophisticated new imaging
technology but an executive chef and what it calls "room
service," opened last December. Indeed, all four major
hospital groups in Indianapolis are investing in new heart
hospitals, collectively spending $215 million on multistory
buildings with catheterization labs and bedside computers.

Cranes have been raised over construction sites in places
like Milwaukee, Phoenix and Houston, too, with money
flowing into new hospitals specializing not just in cardiac
care, but in other well-reimbursed specialties like
orthopedics and surgery. In a report this month, the
General Accounting Office, the investigative arm of
Congress, counted at least 26 specialty hospitals under
construction across the country.

Medicare - which pays for some $100 billion of inpatient
hospital care annually, and sets the pattern for many
private insurers, as well - is not the sole driver of this
investment. But health executives say that Medicare's
payment system for hospitals, with its emphasis on
procedures and its weak ties to the actual costs of
providing care, exerts a strong influence on which medical
needs in a community are met.

Amid the building boom here in Indianapolis, some hospitals
are laying off employees or scaling back programs, like
psychiatric care, that are less generously reimbursed.
Preventive care and case management, health experts add,
get short shrift.

"The incentives are terribly misaligned," said Samuel R.
Nussbaum, a doctor and former hospital executive who is now
the chief medical officer of Anthem, a large health insurer

Creating Excess Demand A study of Indianapolis health care
last year concluded that the construction of so many new
heart hospitals could create excess demand for treatment
rather than produce better cardiac care.

"Improving clinical quality did not appear to be a driving
force for new facilities or services," said the report, by
the Center for Studying Health System Change, a nonprofit
research group. "Given these market conditions, provider
competition could, alternatively, result in higher use
rates and costs."

In Washington, lawmakers rushing to complete a compromise
bill that would establish a Medicare prescription drug
benefit are now turning their attention to the growth of
specialty hospitals. The Senate version of the Medicare
bill would make it harder for doctors to invest in and
refer patients to such hospitals, and full-service
hospitals are lobbying hard for the provision.

Hospitals will typically not disclose how much they profit
from a particular procedure, like a coronary bypass or
angioplasty. And Medicare - with little information about
the cost of treatment - cannot say, either. But one
full-service medical center that is leading the lobbying
campaign against specialty hospitals, Sioux Valley Hospital
in South Dakota, estimates that it makes nearly $1,500 for
a typical coronary bypass under Medicare, while it loses
almost $1,800 treating a case of simple pneumonia and
$2,500 on a patient with kidney failure.

Cardiac procedures "are absolutely our highest margin
business," said Becky Nelson, the president of Sioux
Valley, who estimates that they account for 13 percent of
the hospital's patient volume but 28 percent of its
profits. Costs and payment levels vary so widely around the
country that Dr. John Birkmeyer, a surgeon who studies
health care at Dartmouth Medical School, estimates that
some hospitals may make nearly $20,000 on a coronary

In Indianapolis, there is recognition that reimbursement
levels have influenced hospitals' behavior.

"We're working on a payment system that has been
jerry-rigged so many times, we've been looking for the
loopholes," said Jack C. Frank, an executive at Community
Health Network, which opened the Indiana Heart Hospital
this year in partnership with local doctors.

Hospital Building Boom Just 20 minutes southeast of the
Heart Center of Indiana, Mr. Frank's $60 million center
says it is the nation's first all-digital heart hospital,
using electronic patient records to track care. Roughly 45
minutes to the south, construction is well under way on the
latest - and most expensive - competitor here, the St.
Francis Cardiac and Vascular Care Center, expected to cost
about $65 million when it opens next year.

Even some of the people building the hospitals worry that
Indianapolis may not be able to support them all, though
heart disease is the leading cause of death among Indiana

"It can't work," said Daniel F. Evans Jr., the chief
executive of Clarian Health Partners, whose Clarian
Cardiovascular Center is the most modest of the
undertakings, at $30 million, and the only one built within
a full-service hospital.

Executives, of course, vigorously defend the decisions to
build their own facilities. Heart hospitals, they say, help
pay for money-losing cases, like accident victims or
patients with congestive heart failure.

"Cardiac care has been a source of some margin, which has
been very important in subsidizing some services," said
Robert J. Brody, the chief executive of St. Francis
Hospital and Health Centers.

Nothing in the Medicare legislation before Congress would
directly alter the hospital payment system. But advocates,
mainly Republicans, for provisions aimed at encouraging
more beneficiaries to enroll in private health plans say
that bigger plans would have more leverage to negotiate
better prices.

"The prices are being fixed" by the government, said Thomas
A. Scully, who runs Medicare as administrator of the
government's Centers for Medicare and Medicaid Services.
Local insurance companies would be much better at deciding
how to pay doctors and hospitals to deliver quality care,
he said.

Payment System Is Dated The current system was adopted in
1983, in an effort by the federal government to control
costs. Until then, Medicare basically reimbursed hospitals
for their costs of delivering care, an arrangement that
offered them no incentive to keep hospital stays short. The
new plan established fixed prices for treating a specific
disease or performing a given procedure. Some cases might
cost more and some less, but the price Medicare paid was
supposed to represent the average.

As a cost-control mechanism, the system has been largely
successful. The problem, say hospital executives and
industry analysts, is that after 20 years, the payments are
out of whack: Medicare frequently pays too much for some
kinds of care and too little for others.

To take account of the rapid changes in medicine, like new
technologies and treatments, Medicare collects data on
hospital charges - essentially list prices for everything
from a cardiac catheterization to bypass surgery to
treatment for pneumonia. The agency then tweaks prices
relative to one another, updating its payment schedule once
a year.

But charges often bear little relation to a hospital's
actual costs, any more than a car's sticker price directly
indicates what it costs to build the car. And hospitals
rarely, if ever, lower their charges, say industry
analysts, even when their costs fall significantly.

"Administered price systems tend to break down over time,"
said Joseph P. Newhouse, a Harvard University professor of
health policy who is a member of the Medicare Payment
Advisory Commission. "If you're overpaid, everybody smiles
on the way to the bank, and you may induce more services."

Just how overpaid is unclear. Many hospitals lack the
accounting systems to determine their exact expenses for
specific procedures. Hospitals also have tremendous
discretion in allocating expenses across departments, let
alone procedures.

In the case of a coronary bypass, for example, hospital
charges increased nearly 30 percent from 1993 to 2001, even
as the average hospitalization decreased to 9 days from
nearly 12 days, according to data from the Healthcare Cost
and Utilization Project of the Agency for Healthcare
Research and Quality, a government group in Rockville, Md.

Profitability Varies Widely What seems certain is that
there are wide variations in the profitability of different
hospital services under Medicare. Mark Wietecha, who
directs health care consulting for Kurt Salmon Associates,
estimates that the profit margin for surgery, including
cardiovascular cases, is about 15 percent for some
hospitals, compared to just 2 percent for gastrointestinal

"People build their business plans and facilities on these
profitabilities," he said.

In Indianapolis, the rush to build heart hospitals is
leading to what appears to be significant duplication of

Heart transplants are offered only by St. Vincent and
Clarian, which is affiliated with Indiana University, but
many services are available at all four heart hospitals. In
fact, St. Vincent's new heart hospital, the Heart Center of
Indiana, competes directly with its parent hospital for
patients. And some doctors at Clarian who have invested in
the Heart Center are sending profitable cases there,
according to Mr. Evans, Clarian's chief executive, working
on only the most difficult - and expensive - cases at his

The construction boom here was influenced by the threat of
a new competitor, the MedCath Corporation, a for-profit
chain with 11 heart hospitals in nine states that opened
discussions with some local doctors. To avert MedCath's
entry into the market, Community Health and St. Vincent
made deals of their own with doctors to build facilities.

Hospital executives here are quick to agree that more needs
to be done to help people stop smoking or lose weight -
steps that could help prevent the diseases they make money
treating. "Our reimbursement is all around acute care,"
said Sister Sharon Richardt, a St. Vincent executive. "I
think where the flaw is we need to keep people well. We
need to start reimbursing for prevention."

But Medicare was created nearly four decades ago to prevent
the financial catastrophe that often occurred when an older
person suffered a heart attack or when a disease like
cancer was diagnosed. Payments are therefore "episodic"
rather than intended to encourage hospitals and doctors to
prevent disease or coordinate care, said Dr. Gerard F.
Anderson, a former federal health official who helped
develop the system and now teaches at the Johns Hopkins
Bloomberg School of Public Health.

Patients Can Lose Patients like Corinne Walker, an
83-year-old Indianapolis woman who suffers from congestive
heart failure, are not always well served. In late 2000,
she developed cellulitis, a serious bacterial infection, in
her legs, and spent months in three hospitals. No one
bothered talking to her personal doctor, Ms. Walker said.
To her, it seemed as if the people treating her virtually
ignored her heart condition, although it contributed to her

"They were working on my legs, period," Ms. Walker said.
Only after she was sent home, with a nurse orchestrating
her care, was she finally able to get better, Ms. Walker

In Indianapolis, the treatment of chronic conditions "has
fallen through the cracks," acknowledged Mr. Frank, the
Community Health Network executive. With long hospital
stays and few options for aggressive intervention,
congestive heart failure is a particularly money-losing
diagnosis, executives say; the Sioux Falls hospital says it
loses $1,200 on the average case.

Even so, there is little constituency - outside a circle of
policy analysts - for overhauling a payment system that
produces such results.

Many hospitals have figured out how to make the most of the
status quo. Tenet Healthcare has been formally accused of
abusing the system by which Medicare pays for the most
expensive cases. But hospitals generally try to fit their
care into the most lucrative billing codes.

"In fact, you see a great deal of gaming going on," said
David Butz, a health economist at the University of

Lawmakers, meanwhile, focus on small fixes to the system.
With cuts in spending on cancer or heart disease
politically unpalatable, they tend, under lobbying
pressure, to expand coverage or increase payments.

Impetus to refine the existing system has also been blunted
by the unwillingness of Congress to better analyze the cost
of care, policy analysts say. Some experts say that
Medicare's administrative expenses - 2 to 3 percent of its
overall budget - have been kept too low.

Armed with more information, they say, Congress could
realign the incentives to cut costs and improve care.

"We have a limited budget," Dr. Christopher M. Callahan,
the director of the Indiana University Center for Aging
Research, said. "From a public health perspective," he
added, the question is: "Where would those dollars best be