Hospital Costs: Cost Control Efforts at 17 Texas Hospitals (Letter
Report, 12/09/94, GAO/AIMD-95-21).

This report provides information on how the increased use of managed
care may have influenced cost control efforts at 17 urban hospitals in
Texas. GAO identifies the types of costs that are subject to these
hospitals' control and those that are not. GAO also highlights cost
control efforts that are significantly changing how the 17 hospitals
operate.

--------------------------- Indexing Terms -----------------------------

 REPORTNUM:  AIMD-95-21
     TITLE:  Hospital Costs: Cost Control Efforts at 17 Texas Hospitals
      DATE:  12/09/94
   SUBJECT:  Managed health care
             Health care cost control
             Hospital administration
             State-administered programs
             Health care programs
             Health care planning
             Internal controls
             Health maintenance organizations
             Health resources utilization
             Cost effectiveness analysis
IDENTIFIER:  Medicare Program
             Medicaid Program
             Dallas (TX)
             Fort Worth (TX)
             Houston (TX)
             Medicare Prospective Payment System
             
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Cover
========================================================================== COVER


Report to the Ranking Minority Member
Committee on Ways and Means
House of Representatives

December 1994

HOSPITAL COSTS - COST CONTROL EFFORTS
AT 17 TEXAS HOSPITALS

GAO/AIMD-95-21

Hospital Costs Control Efforts


Abbreviations
========================================================================= ABBREV

  AIDS - Acquired Immune Deficiency Syndrome
  HMO - Health Maintenance Organization
  JCAHO - Joint Commission on the Accreditation of Healthcare Organizations
  PPO - Preferred Provider Organization
  PPS - Prospective Payment System

Letter
========================================================================= LETTER


B-259150

December 9, 1994

The Honorable Bill Archer
Ranking Minority Member
Committee on Ways and Means
House of Representatives

Dear Mr.  Archer: 

As you requested, this report provides information on how the increased use of
managed care may have influenced cost control efforts at 17 Texas urban
hospitals.  It specifically identifies the types of costs that are subject to
these hospitals' control and those that are not.\1 It also highlights cost
control efforts that are significantly changing how the 17 hospitals operate. 
This report documents and expands upon the briefing provided to you on
September 28, 1994. 

During the last decade, employers have increasingly turned to managed care
health plans to constrain the steadily rising cost of health benefits.  Managed
care plans generally use discounted and fixed reimbursement mechanisms that
provide incentives for hospitals to limit costs.  Enrollment in managed care
health plans, such as health maintenance organizations (HMOs) and preferred
provider organizations (PPOs), has increased throughout most of the nation. 
HMOs have existed since the 1930s, but their market penetration has increased
significantly over the past 10 years.  PPOs are a relatively new development,
having begun operations only about 10 years ago.  As of December 31, 1992, HMOs
enrolled 16.3 percent of the population.  In addition, 19.5 percent of the
population was enrolled in PPOs.\2 Managed care enrollment grew to more than
half of all employees covered by employer- sponsored group health insurance in
1992. 

In 1992, approximately 80 percent of community hospitals contracted with at
least one managed care health plan.  Combined with previous pressures for
discounts and the use of fixed reimbursement from Medicare, Medicaid, and other
payers, the increase in managed care has impacted hospitals.  During 1993,
total hospital revenues and expenses grew at their lowest annual growth rate
since 1985.\3 Industry officials attributed this slower growth in part to
competition for managed care business and corresponding hospital cost control
efforts.  While managed care market penetration in Texas lags national
averages, the number of patients enrolled in managed care plans has increased
rapidly at most of the 17 hospitals.  One of the 17 hospitals, for example,
reported that managed care revenues as a percentage of total revenues increased
from zero percent to nearly 40 percent since 1989, representing nearly 90
percent of its revenues from commercial sources.  Thus, your office was
specifically interested in how managed care was affecting specific Texas
hospitals. 


--------------------
\1 Unless otherwise noted, the term "costs" refers to total hospital operating
costs. 

\2 American Managed Care and Review Association Foundation Managed Health Care
Data Base. 

\3 American Hospital Association National Panel Survey. 


   SCOPE AND METHODOLOGY
---------------------------------------------------------------------- Letter :1

To identify cost factors to be reviewed at the 17 Texas hospitals, we held
discussions with officials from hospitals; government agencies; and
associations representing hospitals, physicians, payers, and consumers. 
Additionally, we reviewed the literature on hospital costs and cost control
techniques.  Based on this research, we identified the following 10 cost
factors to review:  physician practice patterns, medical technology, labor,
supplies and drugs, case complexity, administration, information systems,
medical professional liability, regulations and accreditation, and AIDS
treatment. 

We then judgmentally selected 17 Texas urban general care hospitals located in
the Dallas, Fort Worth, and Houston metropolitan areas to review their data
related to the 10 cost factors.  We selected the specific hospitals to ensure a
variety of ownership type and size.  The 17 hospitals include 7 for-profit
hospitals, 7 not-for-profit hospitals, and 3 government hospitals.  Because we
did not use statistical methods to select the 17 hospitals, the results of our
work do not necessarily represent conditions at other hospitals and cannot be
used to characterize other hospitals.  Also, because our work often involved
data that these hospitals regarded as proprietary or sensitive, we agreed not
to identify individual hospitals in examples cited in our report and not to
disclose any data they wished to protect.  However, figures 1 through 4 provide
some general information on characteristics of the 17 hospitals. 

   Figure 1:  Beds in Service at the 17
   Hospitals

   (See figure in printed edition.)

Hospital Size by Number of Beds:  Total number of beds in service in the
inpatient acute care units of a hospital at the end of its fiscal year. 

Source:  Unaudited Medicare Cost Reports. 

   Figure 2:  Fiscal Year 1993 Net
   Patient Revenues at the 17 Hospitals
   (Dollars in millions)

   (See figure in printed edition.)

Net Patient Revenues:  Total charges for hospital services less charity care
provided, contractual allowances, and other discounts. 

Source:  Unaudited Medicare Cost Reports. 

   Figure 3:  Fiscal Year 1993
   Operating Expenses at the 17
   Hospitals (Dollars in millions)

   (See figure in printed edition.)

Operating Expenses:  Total costs for hospital services delivered. 

Source:  Unaudited Medicare Cost Reports. 

   Figure 4:  Fiscal Year 1993
   Operating Profit Margins at the 17
   Hospitals

   (See figure in printed edition.)

Operating Profit Margin:  Difference between total operating revenues and total
operating expenses, expressed as a percentage of total operating revenue. 

Source:  Unaudited Medicare Cost Reports. 

Prior to visiting the hospitals, we developed financial profiles for each of
them to gain an understanding of their financial conditions and business
operations.  We developed the profiles by reviewing and analyzing unaudited
Medicare Costs Reports covering the hospitals' fiscal years 1987 through 1993. 
Specifically, we calculated financial performance ratios for each hospital,
including patient and payer mix ratios, capital structure measures, liquidity
ratios, and profitability measures.  We also reviewed and analyzed the
hospitals' most recent audited financial statements and reports when such
information was available.  In addition, we reviewed major trade publications
to identify specific hospital activities and transactions that may affect their
revenues, costs, or financial performance. 

During our visits to the 17 hospitals, we interviewed administrators, chief
financial officers, and other high-ranking officials and requested that the
hospitals prepare specific cost information concerning (1) the hospitals'
experiences with regard to the 10 cost factors, (2) specific cost control
measures and initiatives taken in response to the effect of these cost factors,
and (3) obstacles to the hospitals' efforts to control costs.  Some of the
hospitals did not provide some of the requested cost information to us because
it was not readily available from their information systems.  The cost
information provided to us by the hospitals was unaudited and could not be
quickly or easily verified. 

We performed our work between November 1993 and August 1994 in accordance with
generally accepted government auditing standards.  We did not obtain comments
from the 17 hospitals on the contents of this report. 


   RESULTS IN BRIEF
---------------------------------------------------------------------- Letter :2

As enrollment in managed care health plans increases, the 17 Texas hospitals
are experiencing a shift in commercial reimbursement from fee-for-service
payments equaling hospital charges to negotiated discounts and fixed
payments.\4 These emerging reimbursement methods have reduced margins from
commercial revenue sources and limit these hospitals' abilities to cover (1)
losses realized on uninsured patients and (2) lower margins realized on
patients covered by fixed-rate payments, primarily from Medicare\5 and
Medicaid.  Additionally, fixed payment methods shift financial risk to the 17
hospitals as they stand to lose money if costs exceed preestablished payment
rates.  Managed care health plans generally seek to contract with less costly
hospitals in service networks\6 that offer the full array of inpatient and
outpatient services across a wide geographic area.  As such, the 17 hospitals
are competing on the basis of price and most have entered into service networks
to attract managed care business. 

To maintain profitability under negotiated discount and fixed rate
reimbursement systems, the 17 hospitals reviewed are engaging in a variety of
cost control measures.  These measures include attempts to standardize
physician practice patterns to eliminate unnecessary procedures, acquiring
medical technology through joint ventures with other hospitals to reduce
capital outlays, and other activities that reduce costs by decreasing
expenditures or increasing efficiencies.  Officials also cited factors they
believed were more difficult to control that limit cost control efforts,
including medical professional liability and the inability to obtain discounts
on sole source drugs and medical supplies. 


--------------------
\4 Most of the 17 hospitals' managed care contracts currently provide
discounted fee, per diem, and case-based reimbursement.  Five have contracts
based on capitated prepayments, but hospital and industry officials we spoke
with told us that capitated prepayment will comprise an increasing percentage
of the 17 hospitals' revenues in the near future. 

\5 Medicare implemented the Prospective Payment System (PPS) in 1983.  Under
PPS, Medicare pays hospitals a predetermined fixed rate for each Medicare
discharge, based on a patient's diagnosis.  This payment system is similar to
those subsequently adopted by some managed care payers and was intended to
provide hospitals incentives to improve efficiency and contain costs. 

\6 A service network is a group of different types of health care providers,
which can include hospitals, physicians, and allied health care professionals
that are affiliated through common ownership, joint ventures, or other legal
arrangements. 


   MANAGED CARE REIMBURSEMENT METHODS
   HAVE INFLUENCED THE 17 HOSPITALS'
   ENVIRONMENT
---------------------------------------------------------------------- Letter :3

An increasing number of employers offer managed care health plans because they
believe that such plans are less costly than traditional fee-for-service
indemnity plans.  Managed care is characterized by a wide variety of health
care plans, including HMOs and PPOs.  Managed care plans attempt to reduce
costs by employing several strategies.  First, managed care plans attempt to
control costs by directing patients to a limited number of less costly or more
efficient hospitals.  Limiting the number of providers also affords managed
care payers leverage in price negotiations if they cover enough enrollees to
significantly affect the hospitals' business volume.  Second, managed care
payers use payment methods that lower prices and provide hospitals with
incentives to control costs.  These methods include negotiated discounts and
fixed per diem, case, and capitated rates.\7 Third, managed care payers employ
utilization review techniques, such as hospital preadmission review, intended
to reduce costs by avoiding what they deem as unnecessary admissions and
lengthy stays. 

The increase in the proportion of hospital patients covered by fixed-rate
payment systems as managed care market penetration increased has given
hospitals enhanced incentives to control their costs.  Moreover, the propensity
of managed care plans to contract with a limited number of hospitals has
introduced more price competition into the market than was the case in the past
when indemnity insurance and the fee-for-service reimbursement method
predominated.  Hospital and industry officials in Texas told us that the
combination of fixed-rate payment and increased price competition has
significantly affected the hospital environment in the state over the past few
years.\8

Under fee-for-service reimbursement, hospitals are paid based upon their
charges for each service and item furnished to patients.  Hospitals have little
incentive to control costs because, as long as charges are high enough, they
recover their costs.  Also, hospitals have little incentive to control service
use under fee-for-service because the more services are provided, the more
revenue is received.  On the other hand, fixed-rate payment methods give
hospitals incentives to control costs and service use because costs above the
payment rate for a patient result in a loss on that patient. 

The shift away from fee-for-service toward fixed-rate payment has had another
effect on the 17 Texas hospitals.  In the past, hospitals were able to use
profits on fee-for- service patients to cover (1) losses realized on uninsured
patients and (2) lower margins realized on patients covered by fixed-rate
payments, primarily from Medicare and Medicaid.  As the pool of fee-for-service
patients has steadily decreased, this strategy has become less and less viable. 
This, in turn, has further enhanced the cost control incentives of fixed-rate
payment systems in general and managed care plans in particular. 

In addition to offering low-cost, quality care, hospitals must often enter into
service networks with other providers that offer a full range of inpatient and
outpatient services over a wide geographic area to attract managed care
contracts.  Managed care payers that we spoke to prefer to negotiate one
contract with a service network for all types of medical care rather than many
contracts for specific ones.  Additionally, managed care payers prefer that
services be convenient for enrollees regardless of where they live or work.  As
a result, most of the 17 hospitals have recently joined service networks with
other providers to compete for managed care contracts.  As discussed in the
appendixes, these service networks may provide hospitals with additional
opportunities to reduce costs and improve quality, but will also entail
significant investments. 


--------------------
\7 Per diem rates reimburse hospitals a fixed amount per day.  Case rates
provide fixed reimbursement for an entire stay, such as an admission for
coronary artery bypass surgery.  Capitation involves prepaying a hospital a
fixed amount per enrollee per month. 

\8 One of the 17 hospitals did not negotiate discounted, case rate, or
capitated contracts with managed care plans because hospital management
believed that the hospital could remain profitable by offering high quality
care on a fee-for- service basis to its commercial patients.  As more of its
commercial patients enrolled in managed care plans, however, they were directed
to other, less costly hospitals.  The hospital's occupancy rate declined,
resulting in a negative fiscal year 1993 operating margin. 


   TRENDS AND COST FACTORS AT THE 17
   HOSPITALS
---------------------------------------------------------------------- Letter :4

Appendixes I through X discuss in greater detail how each of the 10 cost
factors affected the 17 hospitals we reviewed.  Many of the hospitals are
taking actions to control costs associated with the 10 factors; however,
numerous obstacles may impede their cost control efforts.  Below, we synopsize
the cost control trends and provide a few examples of cost control techniques
and obstacles. 


      PHYSICIAN PRACTICE PATTERNS
      (APPENDIX I)
-------------------------------------------------------------------- Letter :4.1

Physician practice patterns are a major determinant of hospital costs at the 17
hospitals we visited, according to hospital officials.  Currently, physician
practice patterns vary greatly within these hospitals, resulting in
significantly different costs for physicians performing the same procedure. 
One hospital reported that average costs by physician for the same procedure
varied from $11,111 to $21,714 due to practice pattern differences such as the
number and type of ancillary services used. 

Cost Control Techniques:  As these hospitals derive an increasing percentage of
their revenues from discounted, per diem, case rate, and capitated plans, they
have started to work with physicians to standardize practice patterns to reduce
unnecessary costs.  Initial attempts by these hospitals to standardize practice
patterns have lowered costs for selected procedures.  For example, after one
hospital achieved a more standardized physician practice pattern for a specific
procedure, average costs associated with performing the procedure dropped from
$14,500 to $11,171, or about 23 percent. 

Obstacles:  In most cases, hospital costs do not directly affect the amount
physicians receive for their services.  Therefore, physicians have little
financial incentive to change their practice patterns.  Further, physician
objections to economic credentialing may limit the hospitals' ability to
enforce standard practice patterns.\9


--------------------
\9 Credentialing involves the periodic review of the licenses, education, and
training of all physicians seeking appointment in a hospital.  It is similar to
background checks of prospective nonphysician employees.  Credentialing is
designed to ensure that physicians are capable of performing their assigned
duties.  Economic credentialing encompasses these checks and also considers the
likely cost of a physician's practice patterns compared to those of other
physicians. 


      MEDICAL TECHNOLOGY (APPENDIX II)
-------------------------------------------------------------------- Letter :4.2

Technology has been a major cost driver at the selected hospitals, but managed
care has changed technology acquisition incentives for most of these hospitals. 
Officials from the four hospitals that perform the most complex and costly
procedures provided information indicating that capital outlays for medical
technology as a percentage of operating expenses are decreasing, due in part to
the changed incentives.  Three of these four hospitals quantified 1993 outlays
for medical technology, which ranged from 1.8 percent to 4 percent of total
operating expenses. 

Cost Control Techniques:  The 17 hospitals are taking various steps to minimize
expenditures on technologies, including using existing assets more efficiently,
entering into joint ventures with other providers, analyzing acquisition
proposals to ensure that decisions weigh both cost and clinical factors, and
discontinuing some low volume services. 

Obstacles:  Concern about medical professional liability continues to motivate
the 17 hospitals to acquire new medical equipment.  Under tort law, providers
whose techniques and equipment do not meet the community standard of care may
be vulnerable to malpractice suits.  Further, officials at these hospitals
stated that legal issues, such as constraint of trade and anti-trust, may limit
joint ventures and other equipment-sharing arrangements.  We recently reported,
however, that neither the Department of Justice nor the Federal Trade
Commission has ever challenged a joint venture.\10


--------------------
\10 Health Care:  Federal and State Antitrust Actions Concerning the Health
Care Industry (GAO/HEHS-94-220, August 5, 1994). 


      LABOR (APPENDIX III)
-------------------------------------------------------------------- Letter :4.3

Labor represents a major operating expense for the 17 hospitals.  Salary and
benefits expenses ranged from 38 to 62 percent of these hospitals' total
operating expenses in 1993.  Cost increases have slowed in recent years as
shortages have abated. 

Cost Control Techniques:  The 17 hospitals are adopting or assessing staff
requirements daily and are sending staff who are not needed home, reducing work
forces, cross-training workers to perform multiple jobs, lowering the skill mix
of their employees, and coordinating with allied health schools to minimize the
risk of future labor shortages. 

Obstacles:  Professional licensing requirements and the increasing complexity
level of patients in the 17 hospitals limit the hospitals' ability to reduce
the skill mixes of their employees.  Additionally, technological innovations
often create the need for more highly skilled employees that command higher
salaries. 


      MEDICAL SUPPLIES AND DRUGS
      (APPENDIX IV)
-------------------------------------------------------------------- Letter :4.4

Nine of the 17 hospitals provided medical supply and drug costs incurred during
1992 and 1993.  The combined cost of medical supplies and drugs at these
hospitals ranged from 8.1 to 13 percent of 1993 operating expenses.  Of the
nine hospitals, eight reported increases in medical supply costs in 1993,
averaging over 14.4 percent, and nine reported increases in drug costs,
averaging 14.5 percent.  Hospital officials stated that new medical supplies
and drugs are responsible for a disproportionate share of the growth in total
medical supply and drug costs. 

Cost Control Techniques:  Sixteen of the 17 hospitals are entering or have
entered group purchase contracts with other health care providers to obtain
greater discounts from suppliers.  Many of the 17 hospitals are also
controlling costs by negotiating contracts that provide suppliers with
financial incentives to reduce utilization, establishing formularies to
encourage the use of less expensive generic or therapeutic drug substitutes,
and educating physicians on lower cost alternative supplies and drugs. 

Obstacles:  As one would expect, most of the 17 hospitals are less successful
in using group purchasing leverage to obtain discounts on new and sole source
medical supplies and drugs. 


      CASE SEVERITY
      (APPENDIX V)
-------------------------------------------------------------------- Letter :4.5

The 17 hospitals are treating an increasing number of less severe cases in
outpatient settings, leaving the costliest and most severe cases in inpatient
care.  As the hospitals derive an increasing percentage of their revenues from
discounted and fixed-rate reimbursement, they have an incentive to reduce costs
by providing diagnostic testing prior to admission and discharging patients to
less costly treatment settings as quickly as possible. 

Cost Control Techniques:  Ten of the 17 hospitals are adopting or developing
clinical pathways\11 to more efficiently treat patients and to quickly
discharge patients to less expensive treatment settings.  One hospital, for
example, saw average charges decrease by $15,000 per patient after developing a
clinical pathway for one of its coronary surgical procedures.  To reduce
inpatient case complexity, a few of the 17 hospitals are focusing more on
preventive outpatient measures.  These measures attempt to reduce admissions or
minimize complications following admissions of patients in plans paying the
hospital capitated fees. 

Obstacles:  Social factors beyond some of the 17 hospitals' control, such as
crime-related injuries and uninsured or underinsured patients, increase costs
and limit the hospitals' ability to reduce case severity and move some patients
to less costly settings.  While these social factors significantly increased
costs at the 3 public hospitals, officials from 8 of the other 14 hospitals
stated that these factors increased costs at their hospitals as well. 


--------------------
\11 Clinical pathways are guidelines for specific diagnoses that include the
sequence and timing of major interventions by physicians, nurses, and staff of
ancillary departments such as laboratory, dietary, and radiology. 


      ADMINISTRATION
      (APPENDIX VI)
-------------------------------------------------------------------- Letter :4.6

Sixteen of the 17 hospitals quantified administrative expenses as a percentage
of 1993 operating expenses.  The administrative expenses for these hospitals
ranged from 14.7 percent to 32.8 percent of operating expenses.\12 Officials
from 16 of the 17 hospitals reported that managed care is increasing
administrative costs by complicating the billing processes, expanding
utilization controls, and increasing contract management activities.  One
hospital estimated that total additional administrative costs increased by over
$1 million annually, or by 3.4 percent, due to the requirements of managed care
health plans. 

Cost Control Techniques:  To cut costs associated with billing, utilization
control, and contract management, most of the 17 hospitals are contracting more
with billing companies, automating administrative functions, or attempting to
reduce variation in contract terms and requirements. 

Obstacles:  Hospital officials stated that their hospitals cannot automate all
billing and collecting for all managed care payers because some do not have
adequate information systems.  Further, some managed care payers currently
enjoy leverage in contract negotiations because they can offer the hospitals a
significant volume of business.  As a result, they successfully resist contract
standardization. 


--------------------
\12 The term "administrative costs" includes costs such as general
administration, general accounting, patients' accounts and admitting, data
processing, and medical records. 


      INFORMATION SYSTEMS (APPENDIX
      VII)
-------------------------------------------------------------------- Letter :4.7

As the 17 hospitals assume greater financial risk under managed care contracts
that provide fixed reimbursement, the need to accurately track costs by
specific procedure and payer becomes more important to avoid financial losses. 
As these hospitals negotiate capitated contracts and enter into service
networks with other providers to offer the full range of inpatient and
outpatient care, they will also need accurate information on costs incurred in
other settings.  In addition, to successfully compete for managed care
contracts, the hospitals are investing in clinical information systems to
adequately manage service delivery and report treatment outcomes. 

Cost Control Techniques:  Most of the 17 hospitals have either begun to
develop, acquire, or research better cost and clinical information systems. 

Obstacles:  The cost associated with information systems and the time needed to
implement the systems may prevent some of the hospitals from upgrading their
systems before managed care represents a significant portion of their business. 
For example, one hospital plans to invest $63 million over the next 4 to 5
years to upgrade its cost and clinical systems.  Officials at the hospital
estimated that managed care would represent 25 percent of their hospital's
revenues by the end of fiscal year 1994. 


      PROFESSIONAL LIABILITY (APPENDIX
      VIII)
-------------------------------------------------------------------- Letter :4.8

None of the 17 hospitals could quantify all costs related to liability.  While
hospital and industry officials stated that defensive medicine is a significant
component of their liability-related costs, none could measure this specific
cost.  Costs associated with liability that were measurable, such as those for
self-insurance funding, catastrophic coverage, legal fees and salaries, and
settlements, varied greatly among the hospitals.  Measurable liability costs at
the 17 hospitals ranged from less than 1 percent to over 7 percent of operating
expenses during 1993.\13 Limited liability for public hospitals and differences
in the types of services the 17 hospitals deliver accounted for some of the
variation in hospital costs.  Further, some of the hospitals have experienced
increases in liability costs, while others experienced decreases.  At some
hospitals, measurable liability costs varied greatly from year to year due to
large, one time settlements and the introduction of new, high-risk services. 

Cost Control Techniques:  The 17 hospitals are attempting to minimize liability
costs by self-insuring, intensifying risk management programs, and more closely
screening prospective employees and physicians. 

Obstacles:  Officials stated that one obstacle hospitals face in controlling
liability costs is their inability to control the rising number of claims filed
against them.  Also, some hospital officials stated that because some
physicians carry insufficient liability coverage, their hospitals are at risk
of becoming "deep pockets" in malpractice claims. 


--------------------
\13 The 17 hospitals did not provide consistent liability- related cost data. 
Their cost estimates include various mixes of insurance costs, damages, risk
management, and other expenses. 


      REGULATORY AND ACCREDITATION
      COSTS (APPENDIX IX)
-------------------------------------------------------------------- Letter :4.9

While officials at most of the 17 hospitals stated that the cost of compliance
with numerous laws and regulations set by regulatory bodies was significant and
increasing, they did not routinely quantify and analyze these costs.  For our
review, four hospitals estimated their costs of complying with regulations and
accreditation standards.  These estimates ranged from 0.6 percent to 5.6
percent of 1993 operating expenses.  However, while officials from the four
hospitals stated that their hospitals would discontinue some compliance
activities in the absence of regulations and accreditation standards, their
hospitals would continue others, such as utilization review and quality
improvement, because they are designed to protect the health and safety of
patients and employees. 

Cost Control Techniques:  The 17 hospitals have attempted to minimize
compliance costs by taking actions, such as forming group purchasing
cooperatives to obtain discounts from infectious waste disposal contractors. 

Obstacles:  Many regulations and standards require costly hospital actions in
response to factors that are beyond the hospitals' control, such as the
outbreak of diseases. 


      AIDS (APPENDIX X)
------------------------------------------------------------------- Letter :4.10

Only 3 of the 17 hospitals treat a significant number of AIDS patients. 
However, all 17 hospitals incur costs to comply with guidelines, known as
"universal precautions", intended to minimize the spread of AIDS.  Officials
from most of the hospitals stated that their hospitals would implement these
precautions in the absence of AIDS because they protect employees and patients
from other infectious diseases. 

Cost Control Techniques:  When the first cases of AIDS were diagnosed, the
disease was treated primarily on an inpatient basis.  Although inpatient care
is still typically required, especially during the last stages of the disease,
the three hospitals are providing more care in less costly outpatient settings. 
Through discharge planning and case management programs, the three hospitals
are coordinating with community resources, such as home health care and hospice
arrangements, to minimize AIDS treatment costs. 

Obstacles:  The 3 hospitals may have difficulty controlling future AIDS-related
costs because of the changing demographics of the recently diagnosed AIDS
population.  According to one hospital official, a growing number of AIDS cases
involve women and children, who have limited access to residential or medically
managed day care in the community.  As a result, the hospitals may have to
provide more costly inpatient care to these patients until they can be
transferred to community facilities. 

Unless you publicly announce its contents earlier, we plan no further
distribution of this report until 30 days from its issue date.  At that time,
copies of this report will be made available to interested parties upon
request.  Please contact me at (202) 512-8549 if you or your staff have any
questions concerning this report.  Major contributors to this report are listed
in appendix XI. 

Sincerely yours,

John W.  Hill, Jr.
Director, Financial Management Policies
 and Issues


PHYSICIAN PRACTICE PATTERNS
===================================================================== Appendix I


   PHYSICIAN PRACTICE PATTERNS ARE A
   SIGNIFICANT COST DRIVER IN HOSPITALS
------------------------------------------------------------------- Appendix I:1

Industry officials and officials from the 17 hospitals stated that physician
practice patterns are a significant determinant of hospital costs.  Although
the Texas Medical Practice Act generally prevents the 17 hospitals from
employing physicians, physicians affect the hospitals' costs because they admit
and discharge patients, order tests and prescribe medications, choose the type
and quantity of medical supplies used, and make numerous clinical decisions
regarding specific patient treatment.  Under fee-for- service reimbursement,
hospitals have little incentive to monitor physician practice patterns because
payers reimburse hospitals for most services provided.  However, as the 17
hospitals derive an increasing percentage of their revenues from discounted and
fixed reimbursement plans, they are beginning to work with physicians to
standardize practice patterns to avoid unnecessary costs. 

Currently, physician practice patterns at the 17 hospitals vary greatly,
resulting in significantly different costs across physicians performing the
same procedure.  For example, officials from one hospital that analyzed its
physicians' practice patterns for total hip replacement surgery reported that
severity-adjusted\1 cost ranged from an average of $11,111 for one physician to
$21,714 for another and length of stay ranged from an average of 5.8 days to 12
days.  The hospital determined that the variation resulted from physician
practice pattern differences involving surgical preparation, the number and
types of ancillary services ordered, the length of time patients spent in the
operating room and in intensive care, and the type of prosthesis\2 used. 
Another hospital analyzed the propensity of its physicians to perform Cesarean
deliveries instead of less expensive delivery practices and reported that, all
factors being equal, some physicians were twice as likely to perform Cesarean
deliveries than others. 


--------------------
\1 The hospital adjusted costs for case severity by excluding from its analysis
certain types of hip replacement cases that involve longer lengths of stay and
higher costs. 

\2 A prosthesis is an artificial device to replace a missing part of the body. 


   THE 17 HOSPITALS CITE MANAGED CARE
   AS MOTIVATING PRACTICE PATTERNS
   ANALYSIS
------------------------------------------------------------------- Appendix I:2

Most of the 17 hospitals have to varying degrees begun to analyze their
physicians' practice patterns to reduce costs.  Their efforts have focused on
high-volume and high-cost procedures, including orthopedic surgeries, such as
total knee and total hip replacement, and cardiovascular surgeries, such as
coronary artery bypass graft surgery and cardiac catheterization. 

Typically, the hospitals work with their physicians to collect data related to
diagnosis, resource utilization, and cost.  The hospitals and physicians then
use the information as the basis for discussions about the appropriateness and
necessity of costly utilization patterns.  The objective of the discussions is
for the hospitals and the physicians to establish standardized treatment
protocols for the diagnoses studied.  Although one hospital has analyzed its
physicians' practices for 40 procedures, most of the 17 hospitals have either
reviewed and accumulated data for only a few procedures or identified those
procedures they are going to begin evaluating.  In addition, some hospitals
have analyzed the practices of only their own physicians while others are
comparing their physicians' practice patterns with the practices of physicians
at other hospitals. 


   INITIAL EFFORTS HAVE LOWERED COSTS
   FOR SELECTED PROCEDURES
------------------------------------------------------------------- Appendix I:3

According to officials at 6 of the 17 hospitals, initial efforts to standardize
physician practice patterns have produced significant cost reductions.  Several
examples of cost reductions that hospital officials have attributed primarily
to efforts to standardize physician practice patterns follow. 

Since it began attempting to standardize its physicians' practice patterns 4
years ago, one hospital has decreased the average costs for 40 procedures
analyzed by an average of 35 percent and reduced the average length of stay by
an average of 15 percent, from 10 days to 8.5 days. 

A second hospital initiated a project in October 1992 to reduce the costs
associated with coronary surgical procedures.  The effort resulted in estimated
annual cost savings of about $1,000,000, or an over 18 percent cost reduction
for the procedures. 

A third hospital worked with its physicians to standardize practice patterns
involving total hip replacement and total knee replacement surgeries.  While
average length of stay for hip replacement patients remained constant at 7.4
days subsequent to the standardization effort, average costs declined from
$14,143 to $12,759, or about 10 percent.  For total knee replacement, average
length of stay declined from 9.1 to 6.8 days and average costs fell from
$14,500 to $11,171, or about 23 percent. 


   SAVINGS ON STANDARDIZING MAY BE
   LIMITED
------------------------------------------------------------------- Appendix I:4

While hospital officials stated that they encountered few problems while
working with physicians to standardize practice patterns, some officials
identified the following factors that may impede cost reductions. 


      PHYSICIAN REIMBURSEMENT
----------------------------------------------------------------- Appendix I:4.1

Industry officials stated that physicians are generally reimbursed a fixed
amount per procedure, which is not influenced by the type or number of hospital
services they order.  As a result, the physicians do not have a financial
incentive to abide by standard practice patterns that change or reduce the
services they order.  Moreover, the hospitals currently lack quality data for
patient outcomes to determine whether the standardized practice patterns have
an adverse impact on patient care.  Some hospital officials stated that
physicians require assurance that patient outcomes will remain constant or
improve before they agree to alter their practice patterns. 


      ECONOMIC CREDENTIALING
----------------------------------------------------------------- Appendix I:4.2

Hospital officials also noted that physician resistance to hospitals
considering physician financial performance in their credentialing processes
may limit their ability to enforce standard practice patterns.  Other officials
stated, however, that as global and capitated reimbursements increase for
hospitals and physicians, and as hospitals and physicians forge new
relationships to compete for managed care contracts, physicians will be
encouraged to reduce costs by following standard practice patterns. 


MEDICAL TECHNOLOGY
==================================================================== Appendix II


   THE 17 HOSPITALS BELIEVE MANAGED
   CARE HAS CHANGED TECHNOLOGY
   INVESTMENT INCENTIVES
------------------------------------------------------------------ Appendix II:1

Officials from most of the 17 hospitals stated that managed care creates an
incentive for their hospitals to limit expenditures on new technologies that
increase costs because hospitals may have difficulty recouping their
investments when revenue is based on discounted or fixed rates rather than
costs or charges.  This trend is different from the 1980s when nonprice
competition, cost- and charge-based reimbursement, and medical liability risk
provided incentives for hospitals to rapidly adopt costly new medical
technology.\1 Additionally, managed care provides an incentive for the 17
hospitals to compete more on the basis of price because managed care payers
prefer to contract with less costly hospitals.  To be price competitive, most
of the 17 hospitals are taking specific steps to reduce medical technology
costs by using existing equipment more efficiently.  While nonprice competition
remains important, most hospital officials stated that managed care has
introduced an incentive for hospitals to realize quality by specializing in
fewer services and reducing the proliferation of new technology. 

Hospital officials stated that most of the expensive, new equipment is
purchased by hospitals that perform the most complex and costly procedures such
as organ transplants.  The four hospitals we visited that performed the most
complex procedures provided information concerning their annual expenditures on
medical technology that indicates that they are spending a decreasing
percentage of their annual operating expenses on medical equipment.  While data
alone do not demonstrate a cause-and-effect relationship, officials from all
four of these hospitals cited revenue constraints associated with an increase
in managed care business as a significant factor responsible for the decreasing
percentage of annual operating expenses devoted to medical equipment.  One
hospital spent over $13 million in fiscal year 1993 on medical equipment, or
3.6 percent of operating expenses.  The hospital plans to reduce 1994
expenditures to just over $7 million.  Another hospital's annual expenditures
for medical equipment have remained constant at about $20 million since fiscal
year 1991.  In fiscal year 1991, this amount represented 4.8 percent of
operating expenses.  In fiscal year 1993, this amount decreased to 4 percent. 
A third hospital spent $2.7 million on medical equipment in fiscal year 1993,
or 1.8 percent of its operating expenses.  This amount was down from $3 million
in fiscal year 1992.  Officials from a fourth hospital told us that while their
hospital does not budget a specific amount annually for medical equipment
expenditures, such expenditures as a percentage of annual operating expenses
has declined over the past 5 years. 


--------------------
\1 Hospital Costs:  Adoption of Technologies Drives Cost Growth
(GAO/HRD-92-120, September 9, 1992). 


   OPTIONS TO REDUCE CAPITAL OUTLAYS
------------------------------------------------------------------ Appendix II:2

The following are options hospitals are taking to reduce capital outlays for
technology. 


      USING EQUIPMENT MORE EFFICIENTLY
---------------------------------------------------------------- Appendix II:2.1

To be price competitive, many of the 17 hospitals are taking specific steps to
reduce medical technology costs by using existing equipment more efficiently. 
For example, one hospital is building a regional training center to instruct
physicians to use new medical technologies such as laparoscopes\2 proficiently. 
While the laparoscope is itself a cost reducing technology, the hospital wants
to maximize cost reductions by training physicians how to best use the
technology.  Other hospitals are avoiding the acquisition of costly technology
by extending the hours that existing assets are used.  For example, one
hospital avoided acquiring a third magnetic resonance imaging machine by
expanding imaging hours for its existing two machines from 8 to 12 hours per
day.  Several hospitals are realizing efficiencies by acquiring medical
technology through joint ventures with other hospitals and health care
providers.  By increasing the number of patients that use one piece of
equipment, the hospitals reduce per use costs. 


--------------------
\2 A laparoscope is an instrument introduced surgically into the abdomen for
examining pelvic organs. 


      ANALYZING NEW ACQUISITION
      PROPOSALS
---------------------------------------------------------------- Appendix II:2.2

Several of the 17 hospitals have reduced their acquisition of new medical
technologies because incurring such additional costs without the ability to
increase discounted or fixed managed care reimbursement would erode operating
margins.  Five of the hospitals are not acquiring new medical technology, but
rather are only replacing and maintaining existing assets.  Of those hospitals
that continue to acquire new medical technology, the decreasing proportion of
cost- and charge-based reimbursement has prompted most to employ methods to
analyze acquisition proposals to ensure that decisions consider cost
effectiveness as well as clinical effectiveness.  Some hospitals have informal
committees that review acquisition proposals and prioritize those that are
approved.  Other hospitals have more formal technology assessment groups that
review and prioritize proposals.  The hospitals in multi-hospital chains are
also subject to corporate office influence in acquisition decisions.  These
committees and groups weigh such factors as forecasted utilization by payer in
calculating the net present value of investments in medical technologies. 
Hospital officials stated that fewer new acquisitions are approved as a result
of fixed managed care reimbursement and the smaller operating margins
associated with managed care. 


      SPECIALIZING IN FEWER SERVICES
---------------------------------------------------------------- Appendix II:2.3

Whereas nonprice competition once involved the proliferation and duplication of
advanced medical technology, officials from 8 of the 17 hospitals stated that
the hospitals are or will be offering fewer of the highly specialized services
to achieve the treatment quality required by managed care payers.  According to
hospital officials and industry experts, managed care payers prefer to contract
with high-volume hospitals because such hospitals are believed to produce
better patient outcomes.  Hospital officials and industry experts stated that
in order to secure managed care contracts for procedures such as open heart
surgery, hospitals must perform at least 350 to 400 procedures per year.  As a
result, some of the 17 hospitals are not purchasing the medical technology that
would be required to offer services with an expected low volume or have
discontinued low volume services.  For example, a hospital official stated that
one hospital service network did not have a member hospital that performed a
high volume of open heart surgeries.  To realize high volume, the service
network designated only certain geographically dispersed member hospitals to
perform all of the service network's open heart surgeries.  One of the 17
hospitals is a member of this service network and was not designated to perform
open heart surgeries.  Consequently, it discontinued most complex
cardiovascular services and is referring patients to the nearby designated
member hospital.  As a result, the hospital purchases significantly less new or
replacement cardiovascular technology.  One hospital official's opinion was
that 80 percent of the open heart surgery units in the metropolitan area would
close as a result of managed care plans' emphasis on obtaining quality by
contracting with high-volume hospitals. 


   LIMITATIONS ON COST SAVINGS
------------------------------------------------------------------ Appendix II:3

Several factors may impede attempts to minimize medical technology costs. 

Medical liability.  Several hospital and industry officials stated that
concerns about professional liability have not diminished.  Under tort law,
providers whose techniques and equipment do not meet the community standard of
care may be vulnerable to malpractice suits. 

Geographic constraints.  Geographic constraints and managed care payer
requirements may limit service networks' abilities to avoid the duplication and
proliferation of medical technology.  For example, one hospital that belongs to
a service network is opening a new special care unit even though a hospital
located nearby, that is not a member of the service network, currently operates
the same type of unit and has excess capacity.  Hospital officials stated that
they were opening the unit because the only other hospital in the service
network that offers such care is located 35 miles away and some managed care
payers have indicated that the service network will have to offer the care
locally if it wants to retain its contracts. 

Legal issues.  Industry and hospital officials expressed concern about possible
federal antitrust actions against service networks that reduce the number of
hospitals that offer certain types of medical procedures or individual
hospitals that participate in technology sharing arrangements.  We recently
reported, however, that thus far, the Department of Justice and the Federal
Trade Commission have not challenged hospital joint ventures, which can include
agreements to share patients, personnel, equipment, support services, and
medical, diagnostic, or laboratory facilities.\3

Ownership issues.  Officials from two hospitals involved in service networks in
which member hospitals are not owned by a single entity told us that forging
agreement among member hospitals as to which should perform certain high-volume
services and which should discontinue such services will be difficult. 


--------------------
\3 Health Care:  Federal and State Antitrust Actions Concerning the Health Care
Industry (GAO/HEHS-94-220, August 5, 1994). 


LABOR
=================================================================== Appendix III


   LABOR HAS BEEN A SIGNIFICANT COST
   FACTOR BUT INCREASES HAVE SLOWED
----------------------------------------------------------------- Appendix III:1

Labor is a significant component of the 17 hospitals' operating expenses. 
During fiscal year 1993, these hospitals' salary and benefits expenses ranged
from 38 percent to 62 percent of their total operating expenses, according to
the hospitals' Medicare cost reports.  Due to the magnitude of labor-related
expenses, hospital officials stated that changes in revenue caused by managed
care are forcing hospitals to continually search for ways to reduce labor
costs. 

According to officials of the 17 hospitals, labor costs rose rapidly at their
hospitals during the late 1980s and early 1990s.  These officials identified a
shortage of nurses as the primary factor responsible for the rapid labor cost
increase.  Officials stated that their hospitals' intense competition to fill
vacant positions prompted hospitals to increase wages significantly and offer
prospective nurses incentives such as hiring bonuses, reduced work weeks, and
increased differentials for night and weekend shifts.  For example, from 1989
to 1990, one hospital's hourly nurse wage rate increased by 13 percent while it
increased its nursing staff from 850 to 1,057, more than 24 percent.  In other
cases, some of these hospitals could not fill their vacant positions and had to
resort to paying their nurses overtime or contracting with temporary nursing
services, which generally cost more than employing nurses directly. 

According to hospital officials, labor cost increases at the 17 hospitals have
slowed since the early 1990s.  However, salaries for some professionals
continue to rise rapidly due to a shortage of trained personnel.  These
professionals include physical therapists, nurse practitioners, nurses for
special settings such as operating rooms, medical technologists, and medical
transcribers.  However, salaries for most classes of nurses and other hospital
staff have stabilized as open positions at the hospitals have declined.  For
example, one hospital had not raised salaries for nurses since 1991 and had
eliminated most shift differentials. 


   HOSPITALS TAKING ACTIONS TO MINIMIZE
   COSTS
----------------------------------------------------------------- Appendix III:2

The hospitals reviewed are taking various actions aimed at minimizing labor
cost increases.  These actions include the following. 

Assessing daily staff needs.  Officials from four hospitals stated that their
hospitals review nursing requirements at the beginning of each shift.  If the
hospitals' patient census is low or its patient mix requires fewer nurses or
support staff, they send excess staff home without pay or request that the
staff take annual leave. 

Reducing work forces.  Officials from six hospitals stated that their hospitals
have recently reduced their work force either through layoffs, attrition, or
offering employees early retirement incentives.  One hospital eliminated 1,520
positions during 1993 through a combination of such actions.  The same hospital
plans to eliminate another 600 positions in 1994.  An official from this
hospital stated that the hospital undertook this staff reduction effort to
lower costs and be more competitive in its managed care pricing strategies. 
Another hospital reduced its payroll by 150 employees to reduce costs. 

Cross-training.  Seven hospitals are cross-training workers to enable them to
perform multiple jobs.  For example, one hospital is cross-training nurses to
practice in multiple specialties and in both inpatient and outpatient settings. 
Another hospital is cross- training respiratory therapists to use
electrocardiographs\1 during night shifts when the volume of both procedures is
low. 

Altering skill mix.  Nine hospitals are reducing the skill mix of their nursing
staff to include fewer registered nurses and more support staff. 

Coordinating with allied health schools.  Hospitals, in conjunction with the
metropolitan hospital councils, are attempting to minimize the risk of future
labor shortages by coordinating with local allied health schools to help ensure
that graduates possess skills that correspond to hospitals' projected
requirements. 


--------------------
\1 An electrocardiograph is an instrument for recording changes of electrical
potential occurring during the heartbeat to diagnose heart irregularities. 


   LIMITATIONS TO HOSPITAL EFFORTS TO
   REDUCE LABOR COSTS
----------------------------------------------------------------- Appendix III:3

Hospital officials identified several obstacles to controlling labor costs. 
The following are some examples. 

Legal barriers.  Some hospital officials stated that state licensing
requirements and Joint Commission on the Accreditation of Health Care
Organizations (JCAHO) standards require hospitals to maintain a more highly
skilled nurse mix than they would maintain in the absence of these rules.  One
hospital, for example, estimated that it incurs from $1 to $9 per hour per
nurse in additional salary expenses, depending on the type of nurse, because it
believes that the standards require them to use more highly skilled nurses than
they would otherwise use. 

Technological change.  Hospital officials stated that technological innovations
often create the need for more highly skilled employees or employees with new
skills that command higher salaries.  For example, one industry official stated
that hospitals recently began utilizing nuclear medicine technology, which
requires trained nuclear medicine technologists.  However, area allied health
schools have not yet graduated enough nuclear medicine technologists to meet
hospitals' requirements.  The official provided data indicating that as of
December 31, 1993, area hospitals reported that 29.3 percent of their nuclear
medicine technologists positions were currently vacant.  As a result of this
shortage, according to the industry official, salaries for these technologists
have risen rapidly. 

Patient complexity.  As discussed in appendix V, the 17 hospitals treat an
increasing proportion of less severe cases in an outpatient setting while the
most severely ill patients remain in the hospital.  Hospital officials stated
that the increasing severity of inpatients restricts their ability to reduce
the skill mix of their nursing staffs. 


MEDICAL SUPPLIES AND DRUGS
==================================================================== Appendix IV


   DRUGS AND SUPPLY COSTS INCREASING AT
   MOST OF THE 17 HOSPITALS
------------------------------------------------------------------ Appendix IV:1

Officials of the 17 hospitals stated that costs incurred for medical supplies
and drugs are significant and increasing.  Of the 9 hospitals that provided
medical supply and drug costs incurred during 1992 and 1993, 8 reported an
increase in medical supply costs, averaging 14.4 percent, and all 9 reported
increases in drug costs, averaging 14.5 percent.  The combined cost of medical
supplies and drugs at these hospitals ranged from 8 to 14 percent of 1993
operating expenses.  One hospital, for example, reported that from 1992 to 1993
it experienced a 17.6 percent increase in medical supply costs and a 46.6
percent increase in drug costs, while patient admissions dropped by 25.7
percent. 

Officials of most of the 17 hospitals stated that a relatively small number of
new drugs and supplies are responsible for a disproportionate amount of their
total drug and supply costs.  For example, one hospital official stated that
115 out of 2,200 line- item drugs account for 80 percent of his hospital's drug
expenditures.  Of these 115 line items, about one third are recently introduced
drugs.  Another hospital reported that 15 recently introduced drugs, or 0.6
percent of its 2,400 line items, accounted for over 34 percent of its drug
costs since 1991.\1 One hospital official emphasized that a few medical
supplies, such as catheters and intravenous tubing, are responsible for most of
their hospitals' medical supply cost growth. 


--------------------
\1 While some drug therapies increase hospitals' pharmaceutical costs, they may
reduce overall hospital costs, according to hospital officials.  For example,
hospital officials stated that their hospitals often avoid surgeries for
prostate enlargement by treating patients with Proscar.  Hospital officials
also stated that using Neupogen to stimulate white blood cell production
decreases overall costs by reducing antibiotic use and shortening patients'
length of stay. 


   HOSPITALS EXERCISING COST CONTROL
   TECHNIQUES
------------------------------------------------------------------ Appendix IV:2

The following are examples of techniques hospitals are using to control costs
associated with medical supplies and drugs. 


      GROUP PURCHASING
---------------------------------------------------------------- Appendix IV:2.1

All of the 17 hospitals are working to negotiate better purchase contracts. 
Sixteen of the 17 hospitals are entering or have entered group purchase
contracts with other health care providers to increase volume, which helps the
group obtain greater discounts from pharmaceutical companies and medical supply
manufacturers.  Nine of the 17 hospitals provided estimates of cost savings
achieved through these contracts, which ranged from 2 to 85 percent discounts
from previous costs.  One hospital estimated savings in fiscal year 1994 of
$4.7 million on its group purchases of drugs and another $7 million on other
supplies.  These savings represented 45 percent of its annual drug costs and 38
percent of its annual supply costs.  Another hospital projects 5-year savings
of over $13 million on group purchases of medical supplies and laboratory
equipment. 


      FIXED RATE CONTRACTS
---------------------------------------------------------------- Appendix IV:2.2

To control medical supply costs, some of the 17 hospitals are negotiating fixed
price contracts with vendors.  Under fixed price contracts, vendors agree to
provide all supplies needed for a predetermined price.  Such agreements change
vendor incentives from selling hospitals as many medical supplies as possible
to limiting the number of medical supplies provided.  For example, one hospital
is negotiating a fixed price contract for sutures used in surgical procedures. 
The hospital anticipates that the proposed contract will encourage the vendor
to help it minimize supply utilization through efforts such as more efficient
packaging of supplies and fixed payment rates for supplies per procedure. 


      DRUG FORMULARIES
---------------------------------------------------------------- Appendix IV:2.3

Formularies are lists of selected pharmaceuticals and their appropriate dosages
felt to be the most useful and cost effective for patient care.  Hospitals
often develop their formularies under the aegis of a pharmacy and therapeutics
committee.  Formularies can be used to limit the number of drugs maintained by
the hospital, which decreases inventory carrying costs and can increase
hospitals' buying leverage when negotiating group purchase contracts.  These
committees have successfully reduced drug costs by eliminating duplicative or
unnecessary drugs, utilizing therapeutic and generic substitutions, and
restricting the use of certain expensive drugs when necessary.  For example,
one hospital estimates annual drug cost savings of over $500,000 through recent
formulary changes and restrictions.  One hospital service network involving 4
of the 17 hospitals is considering standardizing formularies across all member
hospitals.  Hospital officials predict that this standardization will enable
the hospitals in the service network to negotiate significantly higher
discounts through existing group purchase contracts because they will be buying
a larger volume of fewer drugs. 


      PHYSICIAN EDUCATION
---------------------------------------------------------------- Appendix IV:2.4

Many of the 17 hospitals are successfully reducing drug and medical supply
costs through physician education programs.  For example, one teaching hospital
employs teams comprised of physicians, pharmacists, and administrators to
identify and alter inefficient prescribing practices.  By promoting cost
awareness among physicians, the hospitals hope to prompt them to utilize
expensive drugs and supplies more efficiently and use lower cost alternatives
when appropriate.  For example, one hospital has initiated a program to reduce
the cost of anti-rejection drug therapy by educating physicians to use less
expensive drugs.  The hospital estimates that this program will reduce
anti-rejection therapy costs by 50 percent, resulting in annual savings of
$350,000.  The same hospital has attempted to reduce expenditures on imaging
agents by educating physicians to use less expensive contrast media when
performing certain cardiovascular procedures.  The hospital anticipates annual
savings exceeding $400,000. 


   HOSPITALS HAVE DIFFICULTY OBTAINING
   DISCOUNTS ON NEW, SOLE SOURCE DRUGS
   AND SUPPLIES
------------------------------------------------------------------ Appendix IV:3

Most of the 17 hospitals are less successful in controlling the rising costs of
new and sole source drugs and medical supplies.\2 Vendors are less willing to
offer discounts on new and sole source items.  Vendors and manufacturers
aggressively market new and sole source drugs and supplies to physicians, who
in turn expect hospitals to provide these items.  For example, one hospital is
experiencing increasing demand for a costly new, sole source drug to better
control bleeding during heart surgery.  Not only does the drug cost $100 per
dose, but its use also increases medical supply costs because it requires
expensive equipment to deliver.  In addition, the hospital expects demand for
the drug to increase in the future as more of its physicians use the drug.  An
official from another hospital stated that the hospital is now using a new
aortic valve in heart surgeries.  Because the valve is available from only one
source, the hospital has not been successful in negotiating discounts from its
suppliers.  Six hospitals provided estimates of the costs of new and sole
source drugs.  At one hospital, these drugs represented 65 percent of
pharmaceutical costs. 


--------------------
\2 New drugs include those that have been on the market for 5 years or less. 
Sole source drugs and medical supplies include those with no available generic
or therapeutic substitutes. 


CASE SEVERITY
===================================================================== Appendix V


   INPATIENT CASE MIX IS INCREASING IN
   SEVERITY
------------------------------------------------------------------- Appendix V:1

The 17 hospitals are increasingly treating only their most severe and costly
cases in the inpatient setting.  For example, as measured by the hospitals'
Medicare case mix indices, Medicare inpatient case severity and relative
costliness increased by an average of 19.3 percent during the period spanning
fiscal years 1986 through 1992.  Hospital and industry officials stated that
case severity and costliness is increasing for non-Medicare patients as well. 
Hospital and industry officials attributed this increase to treating a greater
number of less severe cases, such as cataract removal and hernia repair, in
less costly outpatient settings, leaving only the sickest patients in the
hospital. 


   HOSPITALS TAKING MEASURES TO REDUCE
   CASE SEVERITY AND LENGTH OF STAY
------------------------------------------------------------------- Appendix V:2

Officials from nine hospitals stated that their hospitals have taken measures
to reduce inpatient case severity prior to admitting patients.  The following
are examples. 

Two hospitals monitor the frequency of visits to hospital- affiliated primary
care physicians by patients enrolled in a capitated insurance plan.  The
hospitals identify enrollees who have not been to primary care physicians for
periodic evaluations and encourage them to schedule appointments.  Hospital
officials stated that while primary care evaluations involve some costs in the
short run, they believe they reduce costs in the long run by enabling
physicians to diagnose illnesses such as cancer in their early stages when they
are less costly to treat. 

One hospital provides free transportation to prenatal care treatment for
pregnant women covered by fixed Medicaid reimbursement who are at high risk of
delivery complications.  The officials stated that the hospital realizes
positive margins on deliveries without complications for Medicaid patients, but
incurs losses when complications arise because Medicaid reimbursement for
treating most complications is below hospital costs. 

One hospital estimated that its program to minimize substance abuse by pregnant
women saves $5,795 per infant as a result of reduced neonatal intensive care
unit utilization. 

Two hospitals participate in a national association that works with communities
to improve local residents' nutrition, income and education, housing, family
relations, and other factors that affect health status. 

Hospitals are also taking steps to deliver acute care more efficiently so that
they can more quickly discharge patients to less expensive treatment settings. 
While all 17 hospitals engage in activities such as case management, discharge
planning, and utilization review to reduce costs associated with inpatient
procedures, officials from 10 of the hospitals stated that their hospitals have
augmented these activities through the implementation of clinical pathways. 
Clinical pathways are guidelines for specific diagnoses that include the
sequence and timing of major interventions by physicians, nurses, and staff of
ancillary departments such as laboratory, dietary, and radiology.  For example,
one hospital's clinical pathway for uncomplicated pneumonia directs a nurse to
obtain blood cultures on days three through five, a radiologist to obtain a
chest x-ray on day four, and physicians and other departments to perform tasks
at specified pathway intervals.  Another hospital's clinical pathways include
identifying factors such as advanced age, single parenthood, and immobility
that may require social worker assistance to facilitate discharge.  Typically,
a case manager is responsible for verifying that physicians, nurses, and
ancillary department staff are treating the patient at the time and in the
manner specified by the pathway.  By adhering to the pathway, hospitals attempt
to minimize delays, decrease utilization, and quickly discharge patients to
less expensive treatment settings such as skilled nursing facilities and home
health care.  For example, one hospital reported that the length of stay for
coronary artery bypass patients on the clinical pathway was 8 days, compared to
13.5 days for patients not on the pathway, reducing charges by almost $15,000
per patient. 


   SOCIAL FACTORS CONTRIBUTE TO HIGH
   SEVERITY LEVELS
------------------------------------------------------------------- Appendix V:3

Notwithstanding hospital efforts to minimize costs associated with increasing
inpatient severity, hospital officials cited several social factors beyond
their control that contribute to case severity and limit their ability to move
patients to less expensive treatment settings.  While social factors
significantly increased costs at the 3 public hospitals, officials from 8 of
the 14 private hospitals stated that those factors increased costs at their
hospitals as well.  These social factors include the following. 

Crime.  Officials from six hospitals identified crime as a factor increasing
hospital costs.  One hospital reported that crime- related medical care
consumes 10 percent of its budget.  During 1992, hospital charges for stabbing
cases averaged $10,200.  Charges for gunshots wounds averaged $16,890.  The
same hospital is also incurring costs exceeding $1.6 million to install
security upgrades to prevent the increasing number of gang-related criminal
activities inside the hospital.  The upgrades include closed circuit television
equipment, handheld metal detectors, and defenses against infant abduction. 
The hospital also will not discharge and provide less costly home health care
to patients who live in high crime neighborhoods because the hospital will not
send nurses and aides into the unsafe areas to provide care. 

Uninsured and underinsured patients.  Officials from five hospitals reported
treating a large percentage of their patients through their emergency rooms
because the patients are either uninsured or underinsured.  In some cases, the
patients are suffering from nonemergency conditions but lack the financial
resources to obtain less expensive outpatient treatment.  In other cases, the
patients are suffering from advanced stages of diseases that could have been
treated on an outpatient basis, but the patient lacked the resources to obtain
such treatment. 

Family fragmentation.  Officials from two hospitals indicated that one cause of
prolonged inpatient stays involves patients not having family members who are
willing or able to provide support subsequent to discharge. 

Homelessness.  Officials from four hospitals stated that they cannot discharge
patients to a home health care setting when the patient has no home.  Officials
of one hospital stated that the hospital frequently admits homeless patients
who have complications caused by overexposure to inclement weather. 


ADMINISTRATIVE
==================================================================== Appendix VI


   MANAGED CARE ADDS COSTS
------------------------------------------------------------------ Appendix VI:1

Managed care has increased administrative costs at 16 of the 17 hospitals by
requiring them to perform additional tasks involving billing, utilization
control, and contract management.  These hospitals quantified annual
administrative expenses as a percentage of fiscal year 1993 operating expenses,
ranging from 14.7 percent to 32.8 percent.  Reported administrative expenses
during fiscal year 1993 were about $9 million at one of the smaller hospitals
and about $112 million at one of the larger hospitals.  One hospital estimated
that total additional administrative costs due to managed care requirements
exceed $1 million annually, which represented 3.4 percent of that hospital's
fiscal year 1993 administrative expenses. 


      BILLING
---------------------------------------------------------------- Appendix VI:1.1

Officials of most of the 17 hospitals stated that managed care contracts add
complexity to the billing process beyond that required for payers such as
Medicare, Medicaid, and commercial fee-for-service insurers.  While government
and commercial fee-for-service policies generally involve deductibles,
copayments, and varying collection time frames, managed care contracts can
involve discounts, straight per diems, tiered per diems, global payments, carve
outs,\1 per member per month capitation, stop loss provisions, and other
features that traditional reimbursement measures do not have.  Further, most
government and commercial fee-for-service payers generally accept the standard
form, UB 82, as an invoice.  Many managed care payers, however, require
hospitals to submit additional information with their invoices that applies
their contracts' reimbursement terms and conditions to the charges on the
invoices. 

Because the hospitals implemented their existing billing systems before
complicated managed care contracts became a significant source of hospital
revenue, they cannot generate managed care bills without significant manual
intervention to ensure that the hospitals bill the maximum amounts allowable
under plan reimbursement provisions and hospital collections are not delayed
because required documentation does not accompany the bills.  As a result,
hospitals have added additional employees to their billing departments to
perform manual tasks.  For example, one hospital has added 15 new employees to
assist in the collection of managed care revenues. 


--------------------
\1 Carve outs provide hospitals with a higher level of reimbursement for
certain high cost procedures than the hospitals would receive for most other
procedures. 


      UTILIZATION CONTROL
---------------------------------------------------------------- Appendix VI:1.2

Many of the 17 hospitals have also added additional employees to oversee
utilization control activities required by managed care.\2 Hospital admitting
departments obtain precertification for managed care enrollees before
performing certain procedures, providing certain treatments within specified
time frames, or initiating procedures costing more than set dollar thresholds. 
Frequently, hospitals must obtain recertification for patients when, for
example, length of stay exceeds a specified number of days.  To obtain
recertification, hospital personnel must determine when managed care contracts
require such actions, identify the payer representative authorized to certify
or recertify, and prepare associated documentation.  Hospitals face substantial
financial risk for these managed care utilization controls.  One hospital
official informed us that his hospital incurred over $1 million in unreimbursed
costs during 1993 due to failure to obtain precertifications or
recertifications for patients prior to delivering care. 


--------------------
\2 Some hospital and industry officials stated that expenditures on utilization
controls, while increasing administrative costs, could decrease overall
hospital costs by reducing unnecessary utilization. 


      CONTRACT MANAGEMENT
---------------------------------------------------------------- Appendix VI:1.3

Sixteen of the 17 hospitals have added personnel or created entirely new
departments to handle managed care administration.  These departments are
responsible for tasks such as managed care business development, contract
pricing strategy formulation, contract modeling, contract negotiation,
performance evaluation, contract administration, and contract renegotiation. 
For capitated managed care contracts, hospitals are incurring additional costs
for actuarial support and risk pool management.  One hospital staffs its
managed care department with 30 employees. 


   HOSPITALS EMPLOYING METHODS TO CUT
   COSTS
------------------------------------------------------------------ Appendix VI:2

Fourteen of the 17 hospitals are taking actions intended to reduce
administrative cost increases associated with their managed care business.  The
following are specific examples of the steps they are taking. 

Six of the 17 hospitals reported attempting to reduce costs associated with
unique payer billing requirements by contracting with all payer electronic
billing companies for assistance.  These companies apply payer-specific
computer edits and filters to hospital bills to identify those that are
prepared in a manner inconsistent with specific government and commercial payer
requirements.  Hospitals add, delete, or correct information on the identified
bills before submitting them to the payers.  One hospital spends more than
$100,000 annually on such contracts, but officials stated that they save more
than that amount by reducing administrative staff and improving collection
time. 

Thirteen of the 17 hospitals reported attempting to minimize costs by
automating more administrative functions associated with billing and
collecting, utilization control, and contract management. 

Officials from 7 of the 17 hospitals stated that their hospitals have minimized
the need for additional contract management personnel by consolidating their
activities with those of other hospitals in their service network. 

Four of the 17 hospitals reported making efforts to reduce contract
administration and billing costs through contract standardization. 


   OBSTACLES TO ATTEMPTS TO CONTROL
   COST INCREASES
------------------------------------------------------------------ Appendix VI:3

Several factors limit the success of hospital attempts to control
administrative cost increases resulting from managed care.  First, hospital
officials stated that their hospitals cannot automate all billing and
collecting because some managed care payers do not have necessary information
systems and others do not represent sufficient revenues to make such efforts
cost beneficial.  Second, hospital officials stated that consolidation of
administrative functions within service networks is slowed where, as in the
case of 4 service networks involving 6 of the 17 hospitals we reviewed, member
hospitals are independently owned.  Third, hospital officials stated that some
managed care payers enjoy leverage in contract negotiations because they
represent a large number of potential patients.  As a result, they successfully
resist the hospitals' standard contracts in lieu of negotiating their own
standard contract and forcing hospitals to conform to their requirements. 


INFORMATION SYSTEMS
=================================================================== Appendix VII


   HOSPITALS REQUIRE ADDITIONAL COST
   AND CLINICAL INFORMATION TO BE
   SUCCESSFUL MANAGED CARE PROVIDERS
----------------------------------------------------------------- Appendix VII:1

Officials from several hospitals stated that the acquisition or development of
cost and clinical information systems represents the largest single investment
their hospitals will make during the next few years.  As the 17 hospitals
assume greater risk under managed care contracts that provide fixed
reimbursement, they must be able to accurately track and assess direct and
indirect costs by specific procedure and payer to avoid financial losses. 
Tracking costs by procedure is becoming critically important to the hospitals
because inaccurate direct cost measurement or misallocations of overhead to
specific procedures can cause the hospitals to pursue poor pricing strategies
during contract negotiations.  Tracking costs by payer is also becoming
important to the hospitals because they need to accurately monitor financial
performance during contract execution and be able to project future costs
associated with specific payers. 

For example, one hospital official stated that the hospital lost millions of
dollars when it negotiated managed care contracts using cost data from a system
that did not accurately track costs by procedure or payer.  The hospital
subsequently acquired a system that enabled it to analyze costs in this manner
and found that certain procedures that appeared profitable under its old
costing system had actually caused the hospital to lose money.  Further,
certain procedures that management had deemed unprofitable with data from the
old system actually made money for the hospital.  Management used the new
system to change its pricing strategy, renegotiate the hospital's managed care
contracts, and monitor contract performance.  The hospital currently
experiences positive margins on its managed care business. 

To successfully compete for managed care contracts, the 17 hospitals are
recognizing that they must have adequate clinical information to ensure
treatment quality.  As the hospitals work with physicians to standardize
practice patterns to improve quality and reduce costs, they are exploring ways
to generate clinical information that associates practice changes with
variations in patient outcomes.  In addition, to develop and monitor clinical
pathways that do not compromise patient outcomes while minimizing costs, the
hospitals are investigating methods to develop clinical information that
correlates the sequence and amount of nursing and other types of care with
patient outcomes.  Regarding outcomes, the hospitals are studying ways to
provide clear clinical indicators about the effectiveness of specific treatment
from the standpoint of the physician, patient, and the patient's employer.  For
example, physicians that we spoke to informed us that outcome information
pertaining to surgical success rates, surgical complications, and infections
are important to demonstrate quality.  Patients are often concerned about their
functional status and well-being after treatment, and employers about their
employees' recovery time and productivity at work. 

Most of the hospital officials stated that their hospitals need to upgrade
their cost and clinical information systems for managed care and have either
begun to develop, acquire, or research better systems.  Currently, four of the
hospitals are relying predominantly on cost information systems that allocate
costs to departments rather than to specific procedures.  Officials of three of
these hospitals told us that they are currently bidding on managed care
contracts without knowing whether the contracts will generate positive margins. 
Further, six of the hospitals could not provide margins by specific payer. 
Regarding clinical information, several of the hospitals are not currently
using automated information systems to track physician practice patterns,
monitor clinical paths, and report outcome data. 


   HEALTH CARE SERVICE NETWORKS
   COMPOUND HOSPITAL INFORMATION NEEDS
----------------------------------------------------------------- Appendix VII:2

As most of the 17 hospitals develop service networks with other hospitals and
physician organizations, they are searching for ways to develop additional cost
and clinical information to reduce financial risk and ensure treatment quality. 
Because the hospitals and members of their service networks will contract
together with insurers and employers to provide comprehensive health care, they
are exploring methods to integrate their cost and clinical systems.  The
integrated systems will need to enable the hospitals and other members of their
service networks to analyze cost and clinical information on an "as needed"
basis and initiate timely corrective action to control costs and improve
treatment quality across their patients' entire continuum of care, including
care provided in inpatient hospital settings, subacute care settings,
outpatient centers, and primary care clinics. 

To manage their patients in a cost-effective manner and avoid losing track of
their patients' status, the hospitals and members of their service networks are
evaluating ways to maintain integrated and comprehensive clinical records about
their patients.  The master patient index and the electronic medical record are
examples of key components of comprehensive clinical records.  The master
patient index keeps track of every encounter a patient has with the hospital
and other members of its service network.  The electronic medical record tracks
treatment provided at various stages of care which helps the hospital and
members of its service network to coordinate care and reduce duplicate testing
and service delivery. 


   LIMITATIONS TO IMPLEMENTING
   INFORMATION SYSTEMS
----------------------------------------------------------------- Appendix VII:3

The high cost associated with comprehensive cost and clinical information
systems and the time required to implement such systems may prevent the 17
hospitals from upgrading their systems before managed care represents a
significant portion of their business.  Several examples follow. 

One large hospital, which has already spent between $25 million and $35 million
upgrading various information systems and spends about $2.5 million a year
operating them, has developed a 5-year plan for its clinical information
system.  The hospital expects to spend approximately $20 million over the next
5 years upgrading its clinical system and has scheduled completion of the
phase-in of patient computerized medical records for 1998.  Currently, the
hospital has 20 managed care contracts.  Hospital management predicts that
managed care will be the hospital's largest commercial revenue source within
the next year. 

An official of a second hospital stated that the hospital's biggest investment
over the next few years will be information systems.  The hospital estimates
that it will spend over $46 million over 3 years developing, acquiring, and
implementing a system that will combine cost, patient outcome, and clinical
data.  Key components of the system including the master patient index and the
electronic medical record are not scheduled to be fully implemented until late
1997.  Currently, managed care contracts are responsible for 26 percent of the
hospital's revenues.  According to a hospital official, the hospital expects to
have virtually no commercial fee-for-service business in 5 years. 

A third hospital is currently assessing its need to meet emerging managed care
information requirements.  Its initial estimates for upgrading over 40 systems
that were designed for fee-for-service business are about $45 million for
clinical systems and about $18 million for cost systems.  The hospital expects
to upgrade its systems over the next 4 to 5 years.  Hospital officials stated
that managed care will represent the primary source of commercial revenue by
fiscal year 1994. 

In the near future, hospitals that do not have comprehensive information
systems that provide critical cost and clinical data may have difficulty
obtaining profitable managed care contracts.  The loss of profitable managed
care business could impede the hospitals' development and implementation of
comprehensive information systems, which would further compromise their
positions as viable managed care providers. 


PROFESSIONAL LIABILITY
================================================================== Appendix VIII


   HOSPITALS COULD NOT MEASURE ALL
   LIABILITY COSTS
---------------------------------------------------------------- Appendix VIII:1

None of the 17 hospitals could quantify all costs related to professional
liability.  Hospital liability costs include self-insurance funding,
catastrophic insurance coverage, risk management, legal expenses, damages
awarded, and defensive medicine.  Although hospital and industry officials
believed that defensive medicine is a significant liability-related cost
hospitals incur, they could not effectively segregate defensive medical
practices from prudent practices or measure costs associated with purely
defensive practices.  In addition, most hospital officials stated that their
hospitals engage in risk management activities to reduce liability related
cost.  The hospitals, however, do not segregate risk management activities
which are designed to reduce professional liability from activities which are
designed to promote quality assurance and compliance with accreditation
standards.  Several hospital officials and industry experts stated that some
staff time must be devoted to researching medical records and providing
depositions after malpractice claims are filed.  None of the hospitals could
attach dollar amounts to these activities. 


   MEASURABLE LIABILITY COSTS INCREASED
   AT SOME HOSPITALS, DECREASED AT
   OTHERS
---------------------------------------------------------------- Appendix VIII:2

The 17 hospitals were able to quantify costs associated with liability
insurance premiums, self-insurance funding, legal fees and salaries,
settlements, and/or claims paid.  The amounts and trends provided by the
hospitals for these liability costs varied greatly.  Seven hospitals reported
that these measurable liability costs were increasing, while 11 hospitals
reported that they were decreasing or had not changed.  The 17 hospitals'
reported liability costs as a percentage of total annual operating expenses in
1993 ranged from less than 1 percent at one hospital to over 7 percent at
another. 

Limited liability for public hospitals, differences in the types of treatment
hospitals provide, and large one-time settlements account for some of the
variation in the hospitals' liability costs.  Texas' Civil Practice and
Remedies Code limits liability for hospitals which are units of local
government to $100,000 per individual and $300,000 per occurrence but does not
similarly limit the liability for profit and not-for-profit hospitals.  One
public hospital's liability costs have risen steadily in recent years. 
However, hospital officials reported that without liability limits, a much
larger portion of the hospital's budget would be required to cover liability
costs.  The type of services hospitals provide also affect liability costs. 
For example, one hospital experienced a dramatic increase in its annual
self-insurance contribution from $259,650 to $1,793,304 after it began offering
obstetric services, a high-risk service.  Large one-time settlements can also
cause significant variations in the hospitals' liability costs.  For example,
one hospital's liability-related expenses rose by over 440 percent from 1992 to
1993 as a result of one multimillion dollar loss. 


   HOSPITALS ATTEMPTING TO MINIMIZE
   LIABILITY COSTS
---------------------------------------------------------------- Appendix VIII:3

The 17 hospitals are attempting to minimize liability costs by self-insuring,\1
employing risk management programs, or more closely screening prospective
employees and physicians.  Most of the hospitals self-insure for professional
liability because trust fund contributions to cover potential awards\2 are
relatively small compared to the cost of commercial insurance.  Hospital
officials stated, however, that they also purchase commercial insurance
umbrella policies to cover catastrophic damage awards over their self-insurance
coverage.  To minimize the risk of potential claims, some of the 17 hospitals
are intensifying risk management programs to research and follow up on patients
after a negative incident occurs.  Risk management efforts also help hospitals
settle some claims without going to trial, which often results in the hospital
paying less to cover damages.  To minimize the risk of adverse outcomes before
they occur, several hospitals started screening prospective physicians and
allied health employees more closely to ensure that they do not credential
physicians who have a history of medical malpractice or hire employees who have
exhibited problem behavior that could increase the hospitals' liability costs. 


--------------------
\1 Hospitals self-insure by contributing amounts to trust funds based on the
expected future settlement costs of open claims. 

\2 Trust fund contributions are based on liability costs from previous years,
then adjusted for contingencies. 


   HOSPITALS FACE OBSTACLES IN
   CONTROLLING LIABILITY COSTS
---------------------------------------------------------------- Appendix VIII:4

One obstacle hospitals face in controlling liability costs is their inability
to control the rising number of claims.  According to a 1994 study prepared by
the Texas Medical Association and Tonn and Associates,\3 the percentage of
Texas physicians that were sued or subject to a liability claim rose from 10.8
percent in 1988 to 14.4 percent in 1992.  The study also found that Tarrant and
Harris counties, where 11 of the 17 hospitals are located, were among the Texas
counties with the highest claims frequencies.  In 1992, for example, 15.9
percent of physicians in Tarrant county and 14.7 percent in Harris county had
at least one claim filed against them.  Because plaintiffs have successfully
argued that Texas hospitals can be responsible for the negligence of physicians
practicing in their facilities,\4 hospital officials stated that plaintiffs can
also file claims against hospitals when they file against physicians.  Of the
17 hospitals, 4 reported an increase in liability claims. 

Another obstacle identified by several hospitals to controlling their liability
costs is physician underinsurance.  According to Texas Hospital Association
data, most Texas hospitals perceive physician underinsurance as an obstacle to
controlling liability costs.  Hospital officials stated that physicians
carrying insufficient liability coverage put hospitals at risk of becoming
"deep pockets" in malpractice claims.  For example, 1 of the 17 hospitals we
visited was a co-defendant in a malpractice suit involving two of its
physicians where the plaintiff was seeking large damages.  The two physicians
settled out of court for the limits of their professional liability coverage,
leaving the hospital as the sole defendant for the remaining damages in the
case. 


--------------------
\3 Medical Professional Liability:  An Examination of Claims Frequency and
Severity in Texas, February 1994. 

\4 According to industry officials, in Texas, plaintiffs typically establish
hospital liability through either the ostensible agency doctrine or by
establishing hospital negligence in the selection and review of medical staff. 


   EFFECT OF MANAGED CARE ON COSTS IS
   UNCLEAR
---------------------------------------------------------------- Appendix VIII:5

Officials of the 17 hospitals expressed mixed views on the effect of managed
care on hospital liability costs.  Some hospital officials stated that managed
care could increase malpractice claims and related costs if hospitals
inappropriately shorten patients' lengths of stay or reduce treatment.  In
addition, hospital officials noted that because managed care enrollees
sometimes change primary care physicians, the continuity of patient care is
sometimes interrupted.  These changes could result in an incorrect or
incomplete transfer of the patient's medical information from one physician to
another.  According to the hospital officials, patients are also less likely to
sue a physician they have seen for years than a newly selected physician in a
managed care plan.  Conversely, other hospital and industry officials stated
that managed care could decrease related hospital costs by curtailing defensive
medicine practices.  Physicians have been primarily reimbursed on a
fee-for-service basis, which provides an incentive to increase treatment. 
However, as physicians and hospitals form service networks to compete for fixed
reimbursement contracts, physicians have a financial incentive to minimize the
number of defensive tests and procedures they perform. 


REGULATORY AND ACCREDITATION COSTS
==================================================================== Appendix IX


   HOSPITALS SUBJECT TO NUMEROUS
   REGULATIONS AND ACCREDITATION
   STANDARDS
------------------------------------------------------------------ Appendix IX:1

Numerous government agencies and accrediting bodies promulgate regulations and
standards that are intended to achieve a variety of public health and workplace
safety objectives, according to officials from the 17 hospitals.  One hospital
identified 18 regulatory agencies and accreditation bodies that impose
requirements including federal agencies such as the Health Care Financing
Administration and the Drug Enforcement Administration, state agencies such as
the Texas Department of Health and the Texas Department of Agriculture,
municipal agencies such as the city health department, and accreditation bodies
such as the Joint Commission on the Accreditation of Healthcare Organizations
(JCAHO).  These government agencies and regulatory bodies require hospitals to
engage in activities as diverse as performing fire and disaster drills,
documenting many hospital activities, and compiling and filing data. 

While all hospital officials agreed with the public health and workplace safety
objectives of the government regulations and accreditation standards, officials
from 12 hospitals stated that some requirements either did not effectively
achieve the objectives or were unnecessarily cumbersome.  For example, several
hospital officials we visited cited the Occupational Safety and Health
Administration's requirement that hospitals provide tuberculosis respirator
masks to physicians and employees as a costly regulation that may not be
effective in reducing the spread of tuberculosis.  Officials from one hospital
stated that the hospital would spend about $500,000 in fiscal year 1994 to
purchase the masks.  Several hospital officials stated that many of the JCAHO
accreditation standards cost thousands of dollars per year and do not improve
health care delivery.  Officials from six hospitals, however, stated that most
requirements and standards are reasonable and would be performed in the absence
of government agency and accreditation body mandates. 


   FEW HOSPITALS QUANTIFY TOTAL
   REGULATORY AND ACCREDITATION COSTS
------------------------------------------------------------------ Appendix IX:2

While officials from 9 hospitals stated that compliance costs were significant
and increasing, none of the 17 hospitals routinely quantified and analyzed
total annual compliance costs.  All 17 hospitals provided costs associated with
select compliance efforts such as the Medical Waste Tracking Act of 1988, which
governs the management of infectious waste.  However, most hospital officials
stated that they did not collect aggregate compliance costs because of the
associated expense and no perceived benefit. 

Four hospitals estimated their annual regulatory and accreditation compliance
costs for our review.  The following table lists estimated annual costs and
costs as a percentage of fiscal year 1993 operating expense. 



                           Table 1
           
              Estimated Costs of Complying with
           Regulations and Accreditation Standards

                    (Dollars in thousands)

                                                  Costs as a
                        Fiscal year 1993       percentage of
Hospital                compliance costs  operating expenses
--------------------  ------------------  ------------------
1                                 $1,049                 0.6
2                                  1,427                 2.5
3                                  2,424                 5.6
4                                  5,365                 3.7
------------------------------------------------------------
Source:  Unaudited information provided by the four hospitals. 

These cost estimates include amounts for requirements that are not unique to
the hospital industry.  For instance, each hospital included compliance costs
imposed by laws such as the Americans with Disabilities Act and the Clean Air
Act, which are not specific to the hospital industry.  Further, while officials
from the four hospitals indicated that they would discontinue some activities
in the absence of regulatory and accreditation requirements, their estimates do
not represent costs that the hospital would not incur in the absence of those
requirements.  The estimate provided by Hospital 3, for example, included
$378,000 for quality improvement and utilization review.  Hospital officials
stated that they would continue most quality improvement and utilization review
activities even in the absence of regulatory and accreditation requirements. 


   HOSPITALS HAVE LITTLE CONTROL OVER
   REGULATORY AND ACCREDITATION COSTS
------------------------------------------------------------------ Appendix IX:3

Hospital officials stated that they have little or no control over regulatory
and accreditation compliance costs.  The 17 hospitals have attempted to
minimize compliance costs when possible by taking actions such as incinerating
infectious waste or forming group purchasing cooperatives to obtain discounts
from infectious waste disposal contractors.  However, hospital officials stated
that many costly regulations and standards result from the outbreak of
diseases, technological developments, new professional standards, and other
factors that are not subject to hospital control.  For example, the outbreak of
multidrug-resistant tuberculosis has triggered regulatory requirements for
hospitals to construct negatively ventilated rooms and purchase more expensive
filtration masks. 


AIDS
===================================================================== Appendix X


   COSTS ASSOCIATED WITH AIDS PATIENTS
------------------------------------------------------------------- Appendix X:1

All 17 hospitals incur costs to comply with Centers for Disease Control
guidelines intended to protect hospital employees and patients from acquiring
infectious diseases such as AIDS, which are transmitted by exposure to bodily
fluids.  These guidelines, known as "universal precautions," increase costs by
requiring hospitals to purchase protective materials and train staff in
risk-reduction methods.  Five hospitals quantified annual costs associated with
universal precautions, which amounted to less than 1 percent of the hospitals'
fiscal year 1993 operating expenses.  Most hospital officials do not consider
these costs to be AIDS-specific because they also protect employees and
patients from other infectious diseases such as hepatitis B. 

Because many AIDS patients lack insurance, revenue is a significant concern of
hospitals treating large numbers of AIDS patients.  During the past 4 years,
over 60 percent of one public hospital's AIDS population was uninsured.  This
hospital is reducing the number of uncompensated AIDS cases through vigorous
Medicaid enrollment efforts.  As a result of these efforts, the hospital's
uncompensated care for patients with AIDS decreased to 55 percent in 1994. 
Correspondingly, the number of AIDS patients receiving Medicaid increased from
17 to 30 percent. 


   THREE OF THE HOSPITALS TREAT
   SIGNIFICANT NUMBERS OF AIDS PATIENTS
------------------------------------------------------------------- Appendix X:2

Only 3 of the 17 hospitals--all public hospitals--treat a significant number of
AIDS patients.  One hospital reported that it treated more than 40 percent of
its county's AIDS patients at a cost of over $22 million in 1993, which
represented about 6 percent of its operating expenses.  Another public hospital
treats approximately 60 percent of the known AIDS patients in its county, which
amounts to more than 4,000 patients annually.  This hospital projects AIDS
treatment costs of $69 million by fiscal year 1999.  The third public hospital
could not quantify its AIDS-treatment costs because its cost accounting system
does not segregate costs by medical condition.  This hospital treats
approximately 300 AIDS patients per month, which also accounts for a large
percentage of its county's AIDS population. 


   INPATIENT TREATMENT COSTS ARE HIGH
------------------------------------------------------------------- Appendix X:3

When the first cases of AIDS were diagnosed, the disease was treated primarily
on an inpatient basis.  Inpatient care is still typically required, especially
during the last stages of the disease.  However, the three public hospitals
treat most of their AIDS patients in outpatient settings and residential
treatment facilities, which are considerably less costly than inpatient care. 
Through discharge planning and case management programs, hospitals are
coordinating with community resources such as home health care and hospice
arrangements to minimize AIDS treatment costs.  One public hospital treats
approximately 95 percent of its AIDS cases in outpatient facilities.  Another
hospital established its own AIDS outpatient clinics to cost-effectively treat
its growing number of AIDS patients.  The third hospital, on average, treats
more than 80 percent of its AIDS patients in outpatient settings. 

However, when inpatient care is required for AIDS patients, it is more costly
than for patients with other medical conditions.  AIDS patients often require
longer lengths of stay, expensive drug therapy, and extensive laboratory
services.  For one hospital, the average length of stay for AIDS patients was 3
to 5 days longer than the average for patients without AIDS.  The hospital's
average cost per AIDS patient was $8,628 as compared to the next most costly
diagnoses with costs of $6,035 per patient. 


   INPATIENT COSTS MAY RISE
------------------------------------------------------------------- Appendix X:4

The three public hospitals may have difficulty controlling future AIDS-related
costs because of the changing demographics of the recently diagnosed AIDS
population.  According to one hospital official, a growing percentage of his
hospital's cases involve women and children, who currently have limited access
to community AIDS services such as medically managed day care and residential
care.  According to the official, a large network of alternative AIDS treatment
settings is currently available for homosexual males, but similar networks do
not exist for other populations.  Unless additional alternative AIDS treatment
settings are established, the hospitals may have to keep these patients
hospitalized longer because they may not be able to discharge them to
appropriate residential settings in the community. 


MAJOR CONTRIBUTORS TO THIS REPORT
==================================================================== Appendix XI

ACCOUNTING AND INFORMATION MANAGEMENT
DIVISION, WASHINGTON, D.C. 

Gloria Jarmon, Senior Assistant Director

DALLAS REGIONAL OFFICE

Ken Rupar, Regional Management Representative
Russell E.  Hand, Auditor-in-Charge
Claudine Scontrino, Evaluator
Dorothy Tejada, Computer Specialist

*** End of document. ***