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Hospitals raise their defenses, fearing that specialty outfits may soon take over the neighborhood.

Cardiac, orthopedic and surgical specialty hospitals are threatening to erode competing community hospitals' profitability--even in the absence of significant price competition.

Competition for high-profit cases is leading community hospitals to leave quality and efficiency measures on the back burner, according to a Jan. 25 study from the Center for Studying Health System Change. The new study challenges recent hospital comparison reports from the Centers for Medicare & Medicaid Services and the Medicare Payment Advisory Commission.

Specialty hospitals' impact on the health care industry has incited ambivalence among politicians and health care workers. Debate over whether specialty hospitals meet the definition of a hospital--and more specifically, whether Congress should encourage or impede specialty hospital development--sparked CMS in 2005 to extend the moratorium on allowing physician-owners of specialty hospitals to refer Medicare patients to their hospitals.

Significant physician ownership among specialty hospitals is at the center of the debate. Physicians have an aggregate 34-percent ownership share in cardiac hospitals and an aggregate 80-percent ownership share in orthopedic and surgical hospitals, according to the May 2005 study from CMS and the Department of Health and Human Services. Although the average share per physician for these hospitals is about 1 percent to 2 percent, physician ownership raises three primary conflict-of-interest concerns among industry experts and competing community hospitals.

First, physicians who own or invest in specialty hospitals may find it difficult to balance clinical decisions with financial ones. Second, physician-owners' influence on patient flow could lead them to favor the most profitable cases. This threatens community hospitals' financial viability--high-profit cases help community hospitals to subsidize costs related to low-profit cases and community services. Third, it's in specialty hospitals' financial interest to avoid treating patients who are underinsured or uninsured.

The Siphoning Effect: Specialty Hospitals Draw From Community Hospitals' Bread And Butter

One of the health care industry's most prevalent underlying concerns is whether specialty hospitals undermine the financial viability of community hospitals. Specialty hospitals are a new market that's already growing rapidly in concentrated areas. Today, Kansas, Oklahoma, South Dakota and Texas are home to 60 percent of the nation's specialty hospitals. Many industry experts are so concerned about their effects on competing community hospitals that they suggest imposing certificate-of-need requirements to limit their growth, HSC points out. If specialty hospitals continue to grow, their effects on community hospitals may become more significant. Employers and health plans fear that specialty hospitals are contributing to a "medical arms race" that's driving up coverage costs, notes HSC.

Specialty hospitals obtain most of their patients by capturing market share from community hospitals, according to MedPAC's March 2005 study. But because specialty hospitals are not currently as widespread as community hospitals, specialty hospitals' impact on community hospitals' market share is not great enough to undermine their financial viability, according to MedPAC's findings. On the contrary, specialty hospitals have increased price competition with community hospitals to some degree, challenges HSC. Even without irrefutable evidence that specialty hospitals are driving up costs, community hospitals still share a perceived need to compete with them by developing dedicated cardiac, orthopedic and surgical treatment centers, the HSC study reveals.

To preclude potential declines in profitability and patient erosion, community hospitals have raised prices on less-competitive services, HSC points out. "There's no question that physician-owned specialty hospitals have caused general hospital competitive juices to flow," notes HSC senior researcher Robert A. Berenson. "But those juices are flowing toward expansion of lucrative specialty services--not necessarily toward improved quality and efficiency," he warns.

Physician-Owners Lean Toward Self-Serving Referrals

Physician-owned specialty hospitals may be a direct threat to community hospitals' ability to offset their high-cost patients and programs with high-profit cases. Medicare could fix this problem by improving its payment system for diagnosis-related groups, points out Steve Guterman, senior program director for the Commonwealth Fund.

Specialty hospitals tend to treat patients that are more profitable, the MedPAC report reveals. Furthermore, specialty hospitals seem to favor the least complex cases; CMS found that specialty hospitals tend to treat less-severe cardiac cases than community hospitals after visiting hospitals in six market areas. Specialty hospitals also treat fewer Medicaid patients than community hospitals in the same market, MedPAC says.

Physician-owners are the primary source of specialty hospitals' Medicare patient referrals, according to the CMS study. Although physician-owners did not, in all cases, refer patients to their own hospitals, they were responsible for 48 percent to 98 percent of all Medicare admissions to specialty hospitals, CMS finds. Furthermore, some purchasers in the HSC study believe that referring physician-owners increase volume by inducing patient demand for elective procedures. In addition, the higher volume more than offsets the savings achieved from lower prices from competition, leading to increased aggregate costs, HSC reports.

Inaccurate Medicare payment rates are to blame for the imbalance between specialty hospitals' and community hospitals' Medicaid admittance levels, Guterman suggests in a recent commentary on the CMS and MedPAC studies. Proposals to adjust DRGs to reflect complexity and cost-related differences among Medicare patients more accurately have remained stagnant for more than 10 years. Low payments for most Medicaid patients and no payments for uninsured patients incentivize specialty and community hospitals alike to favor high-profit cases over others, Guterman claims.

"The lack of explicit financing of the broader (and unprofitable) missions of health care facilities is a major failure, with implications far beyond the question of whether or not specialty hospitals should be allowed," concludes Guterman.