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Healthcare Retrospect Part 2: Skyrocketing Costs and the Emergence of Rate Setting [PODCAST]

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In part two of this three part series, John Dalton, Advisor Emeritus at BESLER Consulting, provides a look at the state of healthcare in America from the 1960s through the 1990s.
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Michael Passanante: Hi, this is Mike Passanante. Welcome back to the Hospital Finance Podcast. Today, I’m joined again by John Dalton who is an Adviser Emeritus here at BESLER Consulting and a longtime Board Member of St. Joseph’s Healthcare System in Paterson, New Jersey.

John joined us previously for a brief discussion on healthcare reform in the United States. And if you missed part one, we discussed the formation of Blue Cross plans in the ’30s, the growth of employer-sponsored health insurance in the ’40s and the 1965 enactment of Medicare and Medicaid.

Today, we’ll be covering the continuing evolution of healthcare coverage for Americans as well as the growing issues of access and affordability. So this is part two. John, welcome back.

John Dalton: Hi, Mike. It’s nice to be back with you.

Michael: So John, we’ve passed 1965 now and we’ve seen employer coverage for workers and their families begin. We’ve seen Medicare for seniors and Medicaid for the poor introduced. What issues rose as the system matured?

John: With the passage and implementation of Medicare and Medicaid, millions more Americans now had guaranteed access to healthcare, so as you can imagine, demand for services skyrocketed, but unfortunately, so did costs.

Medicare at the outset was pure cost-reimbursement. Whatever you spent on providing care to Medicare beneficiaries, you got back in reimbursement from the federal government. It didn’t take long for a lot of savvy financial types to figure out how best to make sure they were getting the most they could from the Medicare program. So with costs skyrocketing, the whole dynamics started to change.

In the 1970s, Richard M. Nixon was our President. He was elected in 1968. In 1971, as he finished his first term, he did propose a limited health insurance reform. What he was looking for at that time was a private health insurance employer mandate. A mandate to get insurance and that’s the term you hear again frequently as we move ahead through healthcare reform.

He also talked about federalization of Medicaid for the poor with the dependent minor children. In other words, we relieve the state of their burden for taking care of minor children of poor families. It got nowhere.

However, he was able to enact the Social Security Amendments from 1972, major legislation. He did two things. He had extended Medicare coverage to those under 65 who have been severely disabled for more than two years or who have end stage renal disease, so two very important changes to the Medicare program.

It also gradually raised the Medicare Part A payroll tax from 1.1% in 1972 up to 1.45% in 1986 and I believe it’s still at that rate today. So that was the funding for the expansion.

On the national scene, in 1974, Nixon again proposed more comprehensive health insurance reform, again an employer mandate to offer private health insurance and replacement of Medicaid by state-run health insurance plans. That proposal included income-based premiums and cost-sharing. However, again the AMA rose up with strong opposition and prevailed along with the seniors In 1976, the Democratic Presidential candidate Jimmy Carter proposed healthcare reform that included key features of Senator Ted Kennedy’s Universal Health Insurance Plan. Three years later, Carter proposed the more limited proposal to support employer mandates to provide catastrophic-only coverage and enhancement of Medicare by adding catastrophic coverage also. But that effort ended up being abandoned for a couple of reasons. One, the economy was starting to deteriorate, but costs were rising at an unacceptable rate. So that’s the 1970s on a national perspective.

The dynamics here in New Jersey were similar, but different. In 1971, under Republican Governor William Cahill, we were under pressure due to rising costs, and he enacted the Healthcare Facilities Planning Act. That did two things. It established the Certificate of Need Planning Process that only needed facilities would be built. And it authorized departments of Health and Insurance to set inpatient rates for Blue Cross and Medicaid. So it was a bifurcated program, they had two departments responsible for the rate setting and same rates for Blue Cross and for Medicaid. It’s somewhat paradoxical.

Initially, the Department of Health delegated the rate setting process to the New Jersey Hospital Association and a budget review process was set up. Basically the hospitals would submit their budgets to the Hospital Association. A panel of CEOs would review the budgets and then the budgets would be approved and implemented.

As you can imagine, there wasn’t a lot of cost-saving happening. So two years into that process, the New Jersey Public Interest Research Group issued a blistering report to briefly describe the process as “The fox guarding the chicken coop.” That lead to a public uproar and the state was then directed to take over the rate-setting process.

In 1974, Haskins and Sells, which is now Deloitte, was awarded the contract by the State of New Jersey to design and implement a hospital inpatient rate-setting system. I was assigned as the project manager to get it done and I was showed up in Trenton to work for Sister Kathleen Maloney, a Sister of Charity and a CPA who is chief of the rate-setting program. She was actually the first in the order to obtain a CPA and prior to joining the state, she had worked as controller at St. Elizabeth’s Hospital. St. Elizabeth’s is now Trinitas Regional Medical Center. Sister Jane Francis Brady, the long term CEO at St. Joseph’s in Paterson, was the second Sister of Charity to obtain a CPA.

So we had four months to get a system designed, train hospitals on how to fill out cost reporting forms, build a computer system to process all of their input and get rates out to the hospitals. It was a fast and furious four months.

The system was called SHARE, Standard Hospital Accounting and Rate Evaluation. It’s now chapter 160 of the laws in New Jersey. We set inpatient payment rates for 108 acute care hospitals. None of them were happy with the rates, but there was an appeals process. And at least, we got cash flow rates flowing by January.

Hospitals complained that the system did not adequately reflect their uniqueness. That was a common refrain. Every hospital claimed to be unique and you could really evaluate them versus other hospitals. But we developed peer groups and they were pretty reasonable and they are still in place today. But they advocated for change.

So we looked at some other options. As we had designed the first rate-setting system, we realized that it would not be the be-all and end-all. And one of the folks we talked to were the folks at Yale University.

I was in the room in 1976 when Professor John Devereaux Thompson and Robert Fetter from Yale came to talk to all of us in the Department of Health. And I clearly recall Thompson saying, “If General Motors can cost out cars, hospitals can cost out episodes of care.” Thompson by the way was a nurse, not a doctor and he was elected to the Healthcare Hall of Fame in 1997 for his work on the development of DRGs.

So then the great experiment began. We applied for Medicaid waiver, the Section 1115 waiver to implement an inpatient payment system based for all payers based on diagnosis-related groups.

The state got a $4 million grant, a medical waiver from the Federal Government and enabling legislation, chapter 83 to move the program forward. So New Jersey began implementing the country’s first ever inpatient prospective payment system where payment now is based per case and not on a per diem or other kind of rate.

So the DRG system really scrambled the cost data, clinical data and put it all together and looking at particular episodes of care. The initial system had 25 major diagnostic categories. That’s still the case today and a total of 383 DRGs. Today, with the MS-DRGs, I think the total number is well more than double the 383.

And for several years in the late ’70s early ’80s, New Jersey really was Camelot. The spotlight focused on New Jersey. That’s where all the innovation was happening in healthcare finance and financial reform.

So this was a major shift because now the hospitals had incentives to really look at how they deliver care or care protocols and payment per case. They still had the yin and yang with the docs being paid on a fee for service basis. So they still got paid for making rounds on a daily basis to see their patients while they are in the hospital. So our focus on trying to trim length of stay ran counter to the doctor’s focus on maximizing their cash.

I can vividly recall in the early ’80s working with some of the staff at St. Barnabas Medical Center in Livingston looking at some of the care protocols and lengths of stay. A total hip replacement at that time had an average length of stay of 18 and a half days. Ten years later, that length of stay was now four or five days. And today, for folks without complications or co-morbidities, actually the total hip replacement can be an overnight procedure.

Michael: Wow. So how did that DRG experiment work out?

John: Well, Medicare took it national in the beginning of 1983 and Medicare still pays based on DRGs. The New Jersey experiment had a flaw. As we developed the system hospitals advocated very, very strongly to include both charity care, which is the “can’t pays” and bad debt, which is the “won’t pays” in the elements of cost.

That was a fatal error. By allowing hospitals to include bad debt in their cost, cost escalated beyond what Medicare would have paid. The basis of the Medicare waiver was so long as Medicare is paying less on the New Jersey’s, then under its own reimbursement methodology, the waiver would continue. Including bad debt ended up blowing the Medicare waiver. And so in 1989, we lost the Medicare waiver and now it’s an all but Medicare DRG system.

And the uncompensated care add-on ended up being the subject of litigation by one of the unions in their ERISA plans. And then 1993, the entire all, but Medicare DRG system was blown away. In 1993, that was rate deregulation. Now all of a sudden, it was a free for all, hospitals are free to set their own rates and negotiations with insurance carriers, but that was the sad ending of the New Jersey’s stint as Camelot.

Michael: So John, Medicare has now taken DRGs national. What other developments occurred on the national scene that really impacted healthcare finance in 1980s?

John:  There were couple, one is rather bizarre and we’ll get to that in a minute. But in the early ’80s, there were a lot of allegations of patient-dumping and wallet biopsies as hospitals sometimes refused emergency services to patients. And 60 Minutes did a broadcast entitled The Billfold Biopsy documenting cases of patient-dumping at Parkland Medical Center in Dallas.

That provoked such an uproar that the Texas legislature passed a law requiring the hospitals to treat and stabilize a patient before any transfer to another facility. Twenty other states followed Texas’s lead and in 1986, the Congress enacted the Emergency Medical Treatment and Active Labor Act, EMTALA, which we are very familiar with today.

EMTALA had a couple of requirements. Among others, it required that the patient be evaluated and stabilized before any transfer, required that the hospital to which the stabilized patient was being transferred must accept the transfer. And it also required that adequate medical records accompany the patient. So EMTALA was a very important piece of legislation that’s still enforced today.

The other major piece that happened in the 1980s was rather bizarre. In 1986, Reagan, in the State of the Union Address, proposed expansion of Medicare to cover catastrophic illness. It’s a simple proposal. It blew through the Congress with near unanimous support. Congress enacted the legislation, so it would limit out-of-pocket payments to $2000 a year for seniors and the expanded coverage would be funded by a $4.92 per month Part A premium increase and higher premiums for seniors earning more than $35,000 a year.

It didn’t go over very well. A lot of well-off seniors—I coined the term whoopies, well off, all the persons in my newsletter that I sent to clients and colleagues—they rose up and with strong opposition to the bill, Congress did a complete turnaround and with the near unanimous ayes repealed the legislation a year later. For some reason, yuppies and DINCs made it into the vernacular, but whoopies never got any traction.

Michael: We’re now at 1992 and the governor who became president, Bill Clinton, made a big deal about healthcare during his campaign. Can you talk to us about what happened after that campaign?

John: Yes. In 1992, healthcare reform, broader access was part of the Bill Clinton’s promise to the American people and subsequent to taking office he appointed First Lady, Hillary Clinton to head up a multi-faceted task force to devise a plan to get America closer to Universal Healthcare.

Hillary Clinton convened a group of academics, executives from insurance, hospital and pharmaceutical industries, physicians, representatives of business and various policy makers, a group that came to be known as the Jackson Hole Group because the meetings were all held in Jackson Hole, Wyoming. And over a period of several months, these best and brightest developed a plan called Managed Competition To Provide Universal Healthcare For All Americans. It was extraordinarily complex. It makes what we now call Obamacare look simple.

So bogged down by complexity and by the opposition of America’s health insurance plans, the insurance lobby, the insurance lobby ran a very clever series of ads of a married couple at the kitchen table looking over the plan. And Harry and Louise became very widely known. They were more effective than Sarah Palin’s Death Panels in killing the legislation. That set back healthcare reform for a full generation.

Michael: John, great overview today. I appreciate it. We are looking forward to having you back for the final part in our series where you take us from the Clinton administration up to present day. It’s been a whirlwind probably for the last 20 years since then. So we’re looking forward to having that discussion with you.

John: See you next time.

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