Background on Maryland’s All Payer Hospital Rate Setting System

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1 MARYLAND’S ALL -PAYO R HOSPITAL PAYMENT SYSTEM Harold A Cohen, Ph. D Executive Summary 's all -payer hospit al payment system from a policy p ersp ective This paper describes Maryland . Accordingly, its focus is on the legislative principles that gave the system its initial purpo ses; the rate setting tenets an d approaches that were adopted by the HSCRC in its efforts to achieve those purposes; the results achieved by the HSCRC and the hospital industry in controlling costs and meet ing v arious social responsibilities; the key hospital financing issues that remain to be addressed; the remarkable benefits which the regulatory approach has conferred on Maryland as to the less desirable effects of competition in California and other states ; and, finally, the compared relevancy of the main ideas of the successful hospital rate settin g effort to future health reforms in Maryland and other jurisdictions . In establishing the HSCRC , the Maryland legislature articulated four key rate setting principles: efficiency, access for all, equity among payers and solvency for all efficient and effective hospitals. ection; The legislature did not prescribe detailed methodologies; instead, it pointed out a clear dir created a small, independent agency with provider and consumer representation; and insisted on public accountability onded by establishing credible, widely - for all parties. The HSCRC resp ; by substituting strong financial incentives for traditional administrative endorsed objectives ; and by using sanctions; by involviI1g the hospital industry in the setting of budgetary standards , technically sound methodologies and flexible, case -by-case responses to address information es. special needs and circumstanc The results achieved by th e Maryland hospital rate setting system have fulfilled the legislature's original intents . Maryland's costs have gone from 23.6% above to 4.6% below the national average; we have virtually no cost shifting; all Marylanders ha ve access to needed hospital services; solvency has been maintained for all efficient hospitals; and our hospitals have generally retained or nced their reputations for clinical and teachin g excellence. This performance far exceeds the enha national standar 20 years and is cl early preferable to the rampant cost -shifting and d over the last 15- patient dumping that have characterized California's unregulated hospital market during the same period. The principles established in the Maryland hospital rate settin g system are relevant to other health care sectors and provide useful bases for consideration of future health reform strategies. The challenge of solving today's problems is great but no larger than the hospital services issues the legislature addressed and solved in 1974. Maryland [1]

2 MARYLAND’S ALL -PAYO R HOSPITAL PAYMENT SYSTEM This paper describes Mar -payer hospital payment system from a policy perspective. Thus, yland's all the focus is on the founding policy as sumptions and principles behind the all -pay er system, the rms in Maryland goals of the system, its results and the lessons it offers for future health care refo and in other jurisdictions . BACKGROUND A. Hospital rate regulation in was created by an act of the 1971 Maryland l egislature. The Maryland law passed with strong support of the Maryland Hospital Association (MHA). It is worth noting that the (MHA) i s unique among hospital associations in that it is controlled by hospital trustees rather 1 The law created t Cost Review Commission he Health Services . than by hospital administrators (HSCRC) , an independent agency with seven members appointed by the Governor. The HSCRC was given broad responsibilities regarding the public disclosure of hospital f inancial data and trustee relationships and was g tes which iven the authority, beginning July 1, 1974 to set hospital ra 2 ylanders. would apply to all Mar The Maryland law gave the HSCRC authority to set hospital rates for all payers. However, federal law, which takes precedence, governed the methods by w hich Medicare and Medicaid paid hospitals. The HSCRC believed that hospitals should operate under consistent payment incentives and that the payment me thods of Medicare and Medicaid , which were cost -based at that time, were contrary to the interests of eff icient hospitals arid to those of the citizens of Maryland. Therefore, the HSCRC negotiated with representatives of both Medicare arid Medicaid and, effective July 1 , 1977, obtained a waiver of federal law that required Medicare and Medicaid to begin payin g 3, 4 -approved rates. pitals on the basis of HSCRC hos , while the HSCRC has been approving Thus hospital rates since 1974, th ose rates have covered all payers only since the Medicare Waiver w as in1977. granted FOUNDING LEGISLATIVE PRINCIPLES B. irs t, hospital cost s had The creation of the HSCRC grew out of the balancing of two concerns. F 5 Second , in 1965. been rising very rapidly in the U.S. since t he creation of Medicare and Medicaid hospitals servin paying patient s were th reatened with insolvency and the g large proportions of non- patients who relied upon them for care were threatened with a loss of access. Medicare, Medicaid and Maryland Blue Cross, which represented th e vast bulk of Maryland's insured population, did not recog nize the costs of providing care to the uninsured as part of the reimbursa ble cost base. Therefore, the legislature adopted three key goals. These were ( 1) to constrain hospital cost growth; (2) to ensure that hospitals would have the financial ability to pr ovide efficient, hig h quality services to all Marylanders; and (3) to increase the equity or fairness of hospital financing. [2]

3 , access, solvency and equity In pursuit of these overarching goals of cost containment the , These were: legislature embraced certain founding principles. Prin ciple One: A Maryland Solution ionally dictated program, was judged to be the preferable A Maryland solution, rather than a nat the legislature's objectives, especially in the area or cost containment. T route to meet ing he ved that it was i mport ant to have accessible local regulators who would concern legislature belie deral bureaucracy was seen as too remote and themselves with local hospital issues. The Fe nd- burdened with national concerns to be able to respond in a timely way to Maryla ific issues. spec Principle Two: Social Mission The legislature believed that public service, including the provision of medical care to the indigent and the operation of medical education programs, was an essential pubic duty of the hospital ls were encouraged to serve all patients in need without regard to their ability to industry. Hospita pay and the financing of uncompensated care and medical education costs was treated as a responsibility to be shouldered by all payers. Principle Three: Fairness and Equit y As noted above, the legislature believed that all payers should equitably share the burden of financing the social mission. The HSCRC was given the status of an independent commission to s. Fairness and ensure that it would not favor one payer, especially Medicaid, over other payer equity was also supposed to extend to individual patients. Individuals were to be charged for services delivered to them and should not be forced to pay for or be subsidized by other patients. In ad co of social this context, the equitably spre sts of treating the uninsured were regarded as a form protection to any Marylander unable to pay for care at any time. insurance that would provide equal Principle Fo ur: Solvency Must Be Earned Hospitals have an obligation to fulfill their mission in an efficient and effective manner. Society has an obli gation to maintain the solvency of efficient and effective hospitals. Principle Five: Regulation The legislature came to the conclusion that reg ulation was appropriate in the market for hospital services. The market, left to its own devices, had not and would not produce results consistent with the legislature's goals of cost containment , access, solvency or equity. In particular, the market 6 inance the social mission. could not be trusted to f Principle Six: Public Accountability Hospitals should be accountable to th e public through rate reviews and public access to data. individual incl uding the extent and nature of a ll trustee relationships. Information re garding an [3]

4 patient should be confidentia l. Regulators should be held accountable through open meeting laws, isons of Maryland results with the Administrative Procedures Act, legislative oversight, and compar those of other states. Principle Seve n: Trust and Cooperation this principle was manifest in many ways. The act did not spell out The legislature's commitment to by w hich the HSCRC was to set rates. Instead, it simply required that the rates how the methods 7 The regulators were must be consistent with the goals of solvency, efficiency, equity and access . trusted to respond to individual market and hospital situations. The mixed - provider and non provider makeup of the HSCRC, and the requirement that their deliberations be held in open meetings, engendered a high degree of cooperation. In addition, the act of giving the HSCRC broad authority over the money spent by employers for their employees and the money received by provider s indicates a strong degree of trust Hospit als also contributed to the cooperative effort. For example, some hospitals that, because of their location, did not face a solvency problem accepted limitations on their charges as part of the overall effort to protect the financial viability of hospitals with large uncompensated care burdens. All the hospitals agreed to be efficient in order to make the guarantee of access an affordable social objective. Principle Eight: Prospective Payment The legis lature did not specify how rates were to be developed, but it did specify that they were to -based reimbursement be prospective. This requirement contrasted sharply with the traditional cost believed that methods employed at that time by Medicare, Medicaid and Blue Cross. The legislature patients and payers should know in advance what hospital charges would be and that hospitals should kI1ow in advance what they would be paid. C. PAYOR SYSTEM TENETS OF THE ALL- As noted above, the HSCC legislation did not establish the method by which hospital rates were to be set in Maryland. In its initial adoption and ongoing revision of its rate setting methods, the HSCRC has attempted to be faithful to the legislative principles that were enumerated in the previous section. The HSCRC has tried to design payment systems and to use rate setting techniques that are the technical expressions of the legislature’s founding vision. Several of the key tenets of payment system design adopted by the HSCRC follow directly from the legislative finding that the market, left to its own d evices, would not produce cost containment, access, equity or solvency for efficient and effective hospitals. The legislature set in place a public utility model of regulation for hospitals, but the causes of failure in the hospital market differed substa ntially from those that usually afflict public utility markets. Although there are many such differences, the most important was probably the ubiquity of health care (especially hospital) 8 The availability of insurance coverage with small deduc tibles and coinsurance costs, insurance. coupled with employer payment of fall or a large proportion of the associated premiums, removed the usual cost sensitivity of consumers from the hospital economic system. [4]

5 It is useful to consider what the restaurant business m ight look like if most people had pre -paid food insurance (or unlimited expense accounts). Menus would surely be replete with all the latest gastronomic inventions if chefs and servers were paid more when fully insured diners ate more expensive meals. We would probably have graduated by now to a “le Cirque” standard of culinary excellence (with solid golden arches!) whereby low cost meals would be dismissed by restaurateurs and the public as low quality threats to community health status. he lack of normal market forces that could be relied upon to produce efficiency, and In response to t in order to promote the achievements of the goals of access, equity and solvency, the HSCRC developed its own philosophy of regulation. The key tenets the HSCRC injected into its All- Payor regulatory system were as follows. Control versus Profit Control The HSCRC adopted the view tha t there is no thing wrong w hen an efficient provider is ear nin g profits. However, there is something wr i ncreases in cost. The ong with financing virtually unlimited need to maintain afforda bility requires the regulator to contain pa yments to hospitals but does not require limits on profits. Prospective Establishment of Attainable and Predictable Targets If regulation is to work, hospitals must know what is expected of them and the targets must not be 9 While arbitrary. The paying community must accept the target s as reasonable and affordable. the HSCRC's approach was to provide markets may work through Adam Smith’s "Invisible Hand,” nd.” a “visible ha -Shifting No Cost All patients, and their payers, should be charged according to the resources consumed in treating them. Markets work best if prices reflect costs. This view is consistent with the equity principle. The most important corollary of this principle is that pay ers should save money by reducing hospital costs rather than by shifting costs to other payers. Minimize Market Intrusions The HSCRC believed that the ancient medical dictum of "Above all else, do no har m,” could be applied to regulators as well as doctor s. The HSCRC endeavored to design the least intrusive payment system that would accomplish social goals. Use Incentives People respond to incent ives. The major problem with the hospital services market in the early 10 The HSCRC saw its job as 1970s in Maryland was that appropriate i ncentives were not in place. -making process, the appropriate incentives. People are most adopting, through a cooperative rule likely to respond appropriately to incentives and targets they believe are reasonable. This fact is a [5]

6 very important aspect of the principle of cooperation and trust. It is very hard to design a payment una incentives . The HSCRC believed the and nticipated system that does not have unforeseen industry was more likely to respond to the anticipated incentives and to work cooperatively to achieve the legislature’s objectives, if it was part of the incentive setting process and accepted the 11 Finally , the HSCRC believed that the in centives . reasonableness of the incentives and targets should be applie d consistently over time s people a re encouraged to learn how to respond to them rather than that to day's encouraged behavior will be tomorrow's discouraged behavior. mation Infor information needed to It does not help to set up the right incentives if the providers do not have the 12 . Fairness in identifying inefficient hospitals requires detailed data . respond to those incentives require detailed d ata to make informed decisions. Buyers Medical Practice The most important cost issue is medical practice. Ho spitals and their trustees are responsible for the efficiency of the medicine is practiced in their hospital. The payment system do es influence the way medicine is practiced. Thus, the HSCRC' s role was to create a system with incentives for both 13 hospitals and payers to make me practice more efficient . While several hospitals felt that their physic ians Boards were responsible for medical practice, on balanc e, the industry and not their accepted this formulation. The industry did not accept that were responsible for the state's admission rate but they a responsibility for the way patients were treated after they were adm itted. ccept Focus on Outliers hospitals were part of t All he inefficiency problem, but some hospitals were considerably more inefficient than others. The HSCRC determined to constrain the cost increases of the least efficient hospitals m ore than the co st increases of other hospitals. Hospitals which did not attai n their targeted level of efficiency were expected to lose money and eventually go out of business. Long Term View The HSCRC believed that Maryland's cost problems could be solved via a long te approach that rm ting hospital delive did not destroy the exis m.. The HSCRC tried to act deliberately without ry syste causing short -term havoc. The most important application of this principle and the reasonable target principle was the HSCRC's decision that hospital cost increases in Maryland could be held to levels approximately three percentage points below the national average rate of increase. Since the historical performance in the hospital industry had been inflation plus approximately 4.5%, the 14 HSCRC set a t arget of inflation plus 1.5%. The industry accepted this initial level of financing as reasonable. Flexibility has allowed for changes in targets and methods as the m arket and other for public review of performance. factors have changed. Annual di sclosures allowed [6]

7 Appropriate Capacity I tives ncen unne fewer resources than an unnec essarily filled bed. This An cessary empty bed wastes far observation w as an important consideration in designing the payment system and the meas ures of not want to encourage hospitals to unnecessarily fi ll b efficiency. The HSCRC did eds in order to lower their unit e HSCRC wanted uni ts of service to be produced in an costs. Nevertheless, th . Long tem policy should lead to elimination of excess capacity while short te rm efficient manner policy must not encourage the filling up of ex isting capacity. 15 D. RESULTS OF THE ALL -PAYOR SYSTEM Cost Containment In 1974, the year before the HSCRC began setti ng rates, hospital costs per a dmi ssion i n Maryland were 23.6% above the national average. By 2005, the most recent for which data are available, year hospital casts per case in Maryland had fallen to 5.1% bel ow the national average. Despite less favorable performance versus the U.S. in the period 1994- 1998 (a period of heavy use of managed care cost containment nationally) , th e long te rm performance of Maryland has been impressive. Over this period (1975 rate of increase of cost -2005) Maryland h as experienced the absolute lowest 16 per admission of any state . Hospital expenditures per capita by state compiled by the Office of the Actuary at the Health Care Financing Administratio n (HCFA). That analysis covered the 1980 was to 1991 period. Maryland's ann ual rate of increase over the period 7.6% compared to the nd's per capita h ospital expenditures dropped from national rate of 8.9%. During the period, Maryla 17, 18 al average. 92% of the national average to 81% of the nation The HSCRC reached a compact with the hospital industry that the most inefficient hospitals would have to bear more of the burden of cost contair1rrtent. T hat agreement has been honored by both sides over the last twenty years. The first year the HSCRC published hospital -specific costs per adjusted admission data was 1977. The eight hospitals with costs per admission more than 25% above the statewide averag e in 1977 either exhibited lower than average cost increases or were out 19 of business by 1993. Equity and Cost Shifting The Medicare waiver has allowed Maryland to achieve wh at is by far the most equitable hospital payment system in the U.S. The most recent national data available on payment equity is for 2005. The average mark -up of charges over cost at a hospital in the United States if over 150% per the American Hospital As sociation Annual Hospital Statistical Guide. This means that hospitals nationally mark -up their posted charges by 1.5 times the underlying costs. Charges are posted at such artificially high levels to recoup un- recovered from uninsured patients (who pay only about 20- 30% of cost), Medicare (who pays about 98% of cost) and state Medicaid (which pays on average 80% of cost). Private insurers face these dramatically marked -up charges and then attempt with the most market leverage) to negotiate steep discounts. Only the largest private i nsurers (those are successful in these attempts however. Smaller insurers, faced with the monopoly power of large [7]

8 hospitals or hospital systems must pay these unreasonable posted charges. In Maryland, because of the All -shifting”), all -Payer system (which prevents this type of “cost -up of payers pay the HSCRC established rates for hospital services. These rates reflect a mark up has been uniform and steady ove r the life of the Rate Setting approximately 18%. This mark- System. It includes a provision for financing of uncompensated care in the system. Thus, all payers are contributing equitably to the financing of care to the uninsured. There is no cost -shifting in payers pay for the care they receive and also their fair share of social costs Maryland. Patients and in the system. Access to Care and Other Social Objectives There are no longer any public government -operated acute care hospitals in Maryland. The indigent and uninsured hav e access to all hospitals. At a he ari ng an the possible sunset of the HSCRC, the Legal Aid Bureau testified that they had no cases of patient dumping in Maryland while in neighboring states such cases were com mon. The unins ured tend to go to ho spitals loca ted near where they live and hospitals with a history or welcoming them. As a result, the burden or uncompensated care is not evenly distributed. However, while nationally un compensated care has tended to concentrate in public government -owned hospitals and teaching hospitals over time, Maryland's system, while still concentrated, is actually less so now than it was in 1979, the first 24, 25 time the HSCRC published uncompensated care data for all hospitals. increased sharing of This the burden of un f social responsibility by compensated care represents the broad acceptance o ent rate sett Maryland's hospitals. Under the curr ing system, the burden of financing uncompensated care falls inequitably upon payers at hospitals with high percentages of uncompe nsated care in their rates. Between 1979 and 2005, uncompensated care in Maryland rose from 5.8% of revenue to 8.0% of revenue and from $70,000,000 to $ 800,000,000. Many of the year to year dramatic increases bility and coverage of the State’s Medicaid program. have been associated with reductions in eligi The HSCRC system financed hospital access for patients previously insured by that program. While the provision of uncompensated care is concentrated, the provision of medical education to physicians in training is even more so, with the top two hospitals incurring approximately 73% of the cost. Unlike the uncompensated care, the costs of medical education are not spread throughout 26 the hospital system. The financing of medical education falls inequit ably upon the patients and payers who use teaching hospitals. of Efficient and Effective Hospitals Solvency Seven Maryland hospitals have closed since the HSCRC began setting and one other hospital went through a bankruptcy procedure. All were identified as higher cost hospitals. The hospital closure rate in Maryland has been at approximately the national average. Mar yland’ s hospitals showed profits of 4.5% of revenue in 2006. This profit level was higher than average for the pre vious rate setting or pre -rate setting periods. M aryland hospital profits had been approximately 1% annually in the pre -rate setting p eriod and afterwards were generally below 1.5 % through 1982. Profits have 5% ve been in the 3- exceeded 2.5% most years in the period 1982 - 1994. Since 1994 profits ha [8]

9 range Nationally, hospital profits have been closer to 5- 6% over that pe riod. Many economists familiar with the Maryland system believe that the rate setting system provides the hospitals with a far greater degree of financial predictability and stability. This has proven to be a benefit to Maryland hospitals in terms of their acce ss to the municipal bond markets and their bond ratings. Because of this financial stability it has been argued that Maryland hospitals face less financial risk than hospitals nationally. It is not unexpected that their profit levels have averaged about a1% less than hospitals nationally. Profits are generally reflect rewards for the level of financial risk faced by – there may be less long term economic institutions in a particular market. Where there is less risk need for higher rewards. We believe t he Maryland hospital market reflect this general economic icant social missions, have re mained result. Thus far, efficient hospitals, including those with signif solvent in Maryland. Public Accountability Through Information understand how little It is difficult for people who are used to Maryland's magnificent public data to hospital data is typically available in other states. Maryland’s data is very current. For example, in early January of 2005, discharge data is already available through September 30, 2004. Maryland's reporting forn1at; wage, salary and fringe hospital data bases include accounting do a uniform benefit data; case mix or hospital d ischarge data; outpatient surgery , emergency room, clinic charge data; and monthly charging and compliance d ata. The HSCRC maintains public records involving trustee dealings, approved rates, and audited fina ncial statements. Much of the data in this paper is ed in the HSCRC's annual disclosure report. report FINANCING ISSUES AND CURRENT PR OJECTS E. UNRESOLVED HOSPITAL payer system have been impressive, several steps need to be taken: While the results of the all- Incentives and Targets for Outpatient Services Develop Quality Measures As the market becomes more price sensitive, it is important for consumers and their sponsors to make decisions based both on relative efficiency and on relative quality of care. The HSCRC is implementing the nation’s first All- Payor hospital pay for performance system. It is base d on Nationally endorsed process measures and will be correlated to outcomes measures on a risk adjusted basis. The rewards and incentive payments built into the system will be substantial and seek to increase the quality of care of all Maryland hospitals . Stimulate Investment in Health Information Technology and Electronic Medical Record In order to continue the benefits realized by the Maryland system in the areas of efficiency and quality improvement, it is crucial that the system move rapidly toward the adoption of beneficial health information technologies and the establishment and use of a global electronic medical record [9]

10 (EMR). The HSCRC is promoting the adoption of these technologies and is spearheading the development of the interoperable exchange of important clinical and administrative data on all patients across all sites of care in the State. The implementation of a full fledged interoperable medical record system will confer substantial additional benefits to the citizens of Maryland in the form of improved efficiency, quality of care, and patient safety. F. RELEVANCY OF THESE FINDINGS TO FUTURE HEALTH REFORMS The lesson of Maryland’s approach is that good results will follow if the incentives in the insurance market encourage carriers to target all people equally and reward carriers and clinicians who develop more efficient ways to manage the care of the very ill. The concepts and methods are applicable to different financing mechanisms and different jurisdictions. Maryland’s experience in hospitals rate regulation suggests that the cooperative establishment of appropriate incentives can yield enormous social and economic benefits to other jurisdictions. [10]

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