also do not know if, in the longer term, they will damage community hospitals or unnecessarily increase use of services. The Secretary's forthcoming report on specialty hospitals should provide important information on quality. Further information on physician-owned specialty hospitals' performance is needed before actions are taken that would, in effect, entirely shut them out of the Medicare and Medicaid market. In addition, the Congress will need time during the upcoming legislative cycle to consider our recommendations and craft legislation, and the Secretary will need time to change the payment system. Therefore, the Commission recommends that the Congress extend the current moratorium on specialty hospitals until January 1, 2007. The current moratorium expires on June 8, 2005. Continuing the moratorium will allow time for efforts to implement our recommendations and time to gather more information.

Aligning financial incentives for physicians and hospitals could lead to efficiencies. Physician ownership fully aligns incentives; it makes the hospital owner and the physician one in the same, but raises concerns about self-referral. Similar efficiencies might be achieved by allowing the physician to share in savings that would accrue to the hospital from reengineering clinical care. Such arrangements have been stymied by provisions of law that prevent hospitals from giving physicians financial incentive to reduce or limit care to patients because of concerns about possible stinting on care and quality. Recently, the Office of Inspector General has approved some narrow gainsharing arrangements, although they have been advisory opinions that apply only to the parties who request them.

The Commission recommends that the Congress should grant the Secretary the authority to allow gainsharing arrangements between physicians and hospitals and to regulate those arrangements to protect the quality of care and minimize financial incentives that could affect physician referrals.

Gainsharing could capture some of the incentives that are animating the move to physician-owned specialty hospitals while minimizing some of the concerns that direct physician ownership raises. Permitting gainsharing opportunities might provide an alternative to starting physician-owned specialty hospitals, particularly if the incentives for selection were reduced by correcting the current inaccuracies in the Medicare payment system.

Chairman JOHNSON. Thank you very much. Dr. Gustafson? STATEMENT OF THOMAS A. GUSTAFSON, PhD, DEPUTY DIRECTOR, CENTER FOR MEDICARE MANAGEMENT, CENTERS FOR MEDICARE & MEDICAID SERVICES

Mr. GUSTAFSON. Thank you, Mrs. Johnson, Mr. Stark and distinguished Members of the Committee. I appreciate the invitation to testify today. I am here to present preliminary results from the technical analysis that will underlie the CMS report mandated by MMA that we expect to send to you shortly. I must emphasize that the quantitative findings that I will discuss here are tentative. The technicians are in the back room continue to twiddle the dials on this and the numbers may move around a little bit. But we believe that the qualitative nature of the results will not change materially, and the Administration will proceed to develop policy recommendations once this analysis is in hand.

Our study conducted a considerable amount of new data relative to the performance and impact of specialty hospitals. We made site visits to six market areas around the country. Included in these were 11 of the 59 cardiac, surgery and orthopedic specialty hospitals that were paid by Medicare at the end of 2003. These market areas were selected to represent a range of circumstances in which specialty hospitals now operate.

Within each market area we interviewed specialty hospital managers, physician owners, staff. We also talked with representatives of community hospitals in the area to assess patient satisfaction

which is one of the measures that Congress asked us to look at. We looked at patient focus groups of those beneficiaries who had been treated in specialty hospitals. We also examined referral patterns for all specialty hospitals, not just those that were in the six market areas I described, but all of the 59, using Medicare claims data for 2003, so it was a little bit later than the analysis, so the data was a little bit later than the analysis that MedPAC embarked on. And we also drew on information on financial relations based on information we acquired from the individual hospitals and for tax records.

One major conclusion which I think comports very well with what MedPAC discovered is that there are very clear differences between cardiac hospitals on the one hand and surgery and orthopedic hospitals on the other. Cardiac hospitals are larger, have a higher average daily census, about 40. They tend to have emergency rooms and other features that are usually associated with a community hospital such as community outreach programs. About two-thirds of the patients treated in these facilities were Medicare beneficiaries, which is higher than what you would expect in a community hospital. And in the hospitals in the study the ownership by physicians as a group averaged about 34 percent. Typically a national corporation or a not-for-profit hospital in the area owns the majority share of these hospitals. The average ownership share by an individual physician was about 1 percent. So, in other words, 34 percent in the aggregate, about 1 percent for each individual physician.

Turning now to surgical and orthopedic hospitals. These tended to more closely resemble ambulatory surgical centers. Their primary business appeared to be with outpatient services. They are much smaller than the other hospitals. Their average daily census is about 5. And physicians together generally own a comparatively large share. Our average showed that to be about 80 percent, and the average share for an individual physician was a little over 2 percent.

Medicare patients account for about 40 percent of the inpatient days in these facilities, which is more typical of the community hospital average. Unfortunately, the small number of inpatient cases at these hospitals, the surgery and orthopedic hospitals, prevented us from drawing very robust conclusions about this group on several of the dimensions that we were asked to look at. Turning to our preliminary results we discovered that the majority of Medicare patients in most specialty hospitals are referred or admitted by a physician owner. These physicians do not, however, refer their patients exclusively to the specialty hospitals in which they participate in the ownership. They also refer a similar, although slightly lower proportion of their patients to local community hospitals. Overall, the Medicare cardiac patients treated in community hospitals were more severely ill than those treated in the cardiac specialty hospitals in most of the study sites. There was a little bit of variation here.

Now, these results, the results I just described, held generally for patients admitted both by physicians with ownership in specialty hospitals and by other physicians in the area, indicating that we could discover no difference here in the referral patterns by physi

cian owners and non-owners. There was a little bit of variation again with cardiac hospitals in some areas having higher average severity than the community hospitals, but the general picture was of more severely ill patients in the community hospitals and no difference in referral pattern.

For surgery and orthopedic hospitals the number of cases involved was too small to draw definitive conclusions, but the preliminary results are suggestive of a similar pattern. We then turned to claims analysis. This involved all of the hospitals that I mentioned earlier, the 59 hospitals, not just the 11 in the study areas. And we examined the claims from these hospitals against a set of quality indicators from the AHRQ and their methodology. Our preliminary findings showed that the measures of quality at cardiac hospitals were generally at least as good and in some cases better than at local community hospitals. Complications and mortality rates were lower at the cardiac specialty hospitals, even when adjusted for the severity of the caseload in the two different hospitals. We were unable to make a statistically valid assessment, or at least have not yet been able to make a statistically valid assessment because of the small number of discharges relating to surgical and orthopedic hospitals.

We examined patient satisfaction, as I mentioned earlier. This was through focus groups of the patients at the specialty hospitals. This was extremely high for all of the hospitals in questions. The Medicare beneficiaries that we talked with enjoyed large private rooms and a number of other amenities, and seemed to enjoy their experience at the hospitals. We did not do a comparison group with the community hospitals in the same areas. We used proprietary financial information we had acquired from the specialty hospitals in the study to examine the taxes that they paid and the uncompensated care as a proportion of net revenues. This was again something that we were asked to do by the MMA. And discovered that relative to their net revenues, specialty hospitals only provide about 40 percent of the share of uncompensated care that the local community hospitals provided. Balancing this, however, the specialty hospitals paid significant real estate and property taxes as well as income and sales taxes. The nonprofit community hospitals-most of the hospitals in the communities we were looking at were nonprofit-of course did not pay these taxes.

If you added this up, the total proportion of net revenue that specialty hospitals devoted to the sum of uncompensated care and taxes significantly exceeded the proportion of net revenue that community hospitals devoted to uncompensated care. You have just heard from Mr. Hackbarth about the MedPAC report. I think it would be fair to summarize our reading of it so far. It is that we don't see any particular inconsistency. I think we are finding much the same, the same underlying reality. We are looking at some different things than they were, but I think the Congress can take some comfort that we are finding things that are very, very similar. We have MedPAC's recommendations under review and will be considering those as we form the administration's recommendations. That concludes my remarks and I look forward to your questions.

[The prepared statement of Mr. Gustafson follows:]

Statement of Tom Gustafson, Ph.D., Deputy Director, Center for Medicare Management, Centers for Medicare and Medicaid Services

Chairwoman Johnson, Representative Stark, distinguished committee members, thank you for inviting me to testify today about physician-owned specialty hospitals. At the Centers for Medicare & Medicaid Services (CMS), we remain deeply committed to improving the quality of patient care and to increasing the efficiency of Medicare spending. As you know, how Medicare pays for medical services can have important impacts on quality and medical costs, for our beneficiaries and for our overall health care system. By carefully examining interactions between physicians and hospitals, we can consider how the financial incentives created by the Medicare program might be redirected to improve quality. To that end, Section 507 of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) requires HHS to study a set of important quality and cost issues related to specialty hospitals, and to report to Congress on our findings. I am here today to present the preliminary_results from the technical analysis that will underlie the CMS report for Section 507.

CMS Study

Specifically, MMA required HHS to study referral patterns of specialty hospital physician-owners, to assess quality of care and patient satisfaction, and to examine the differences in uncompensated care and tax payments between specialty hospitals and community hospitals. CMS contracted with RTI International to conduct the technical analysis. At this time, we are reporting on the factual findings of the RTI analysis. Any policy recommendations on this issue will have to be developed once the report on the analysis is finalized.

While national data were used for some aspects of this analysis, some questions related to quality, cost, and community impact as mandated by the MMA required the detailed analysis of data that have not been previously available. Consequently, the analysis involved the collection of a considerable amount of new data related to the performance, and impact of specialty hospitals. The analysis included information about the environment in which specialty hospitals and community hospitals in the same geographic areas operate, and sensitive and proprietary non-public data on such issues as ownership. To conduct this detailed analysis, site visits were made to 6 market areas (Dayton, OH; Fresno, CA; Rapid City, SD; Hot Springs, AR; Oklahoma City, OK; and Tucson, AZ) around the country These markets included 11 of the 59 cardiac, surgery, and orthopedic specialty hospitals that were in operation as approved Medicare providers by the end of 2003. These market areas were selected because they were thought to represent a range of the circumstances in which specialty hospitals operate. Within each market area, specialty hospital managers, physician owners, and staff were interviewed. Executives at several local community hospitals also were interviewed, in order to evaluate their views and concerns with respect to the specialty hospitals. To assess patient satisfaction with specialty hospitals, the study used patient focus groups composed of beneficiaries treated in cardiac, surgery, and orthopedic hospitals.

Referral patterns for all specialty hospitals were analyzed using Medicare claims data for 2003. The inpatient hospital quality indicators developed by the Agency for Health Research and Quality (AHRQ) were used to assess quality of care at the study_hospitals and local community hospitals in the 6 study sites. Data obtained from Internal Revenue Service (IRS) submissions and financial reports, as well as from the hospitals themselves, were used to estimate total tax payments and uncompensated care for these hospitals.

Cardiac Hospitals Differ from Surgery and Orthopedic Hospitals

The empirical evidence clearly shows that cardiac hospitals differ substantially from surgery and orthopedic hospitals. Compared to surgery and orthopedic hospitals, cardiac hospitals tend to have a higher average daily census, an emergency room, and other features, such as community outreach programs. The average daily census of the 16 cardiac hospitals nationwide was 40 patients. All the cardiac hospitals that were operational in 2003 reported that they were built exclusively for cardiac care. Cardiac hospitals treated 34,000 Medicare cases in 2003, and Medicare beneficiaries account for a very high proportion (about two-thirds) of inpatient days in those hospitals nationwide. In aggregate, within our sample, physicians own about a 49 percent share in cardiac hospitals; typically, a corporation such as MedCath or a non-profit hospital owns the majority share. In the study hospitals, the aggregate physician ownership averaged approximately 34 percent for the cardiac hospitals in the study. The average ownership share per physician in those hospitals was 0.9 percent, with individual ownership share per physician ranging

from.1 percent to 9.8 percent, with a median of 0.6 percent and an average per physician share of 0.9 percent.

Surgery and orthopedic hospitals more closely resemble ambulatory surgical centers, focusing primarily on outpatient services. Their aggregate average daily census of inpatients is only about 5 patients. Physicians generally own a large share of the interest, averaging 80 percent in aggregate for the surgery and orthopedic hospitals in the study. The average ownership share per physician is 2.2 percent, with individual ownership shares per physician ranging from 0.1 percent to 22.5 percent, with a median of 0.9 percent. The balance is typically owned by a non-profit hospital or national corporation. Medicare patients account for about 40 percent of the inpatient days in these facilities. The small number of inpatient cases at surgery and orthopedic hospitals precluded the development of meaningful findings for this group on several of the dimensions of performance that we examined.

Preliminary Results

At this time, we would like to present the preliminary findings of our technical analysis. While we are still finalizing some aspects of the study, we do not expect the results to change significantly.

Our findings on physician-owner referral patterns indicate that the majority of Medicare patients in most specialty hospitals are referred or admitted by a physician owner, but that these physicians do not refer their patients exclusively to the specialty hospitals that they own. They also refer a similar but slightly lower proportion of their patients to the local community hospitals.

Overall, the Medicare cardiac patients treated in community hospitals were more severely ill than those treated in cardiac specialty hospitals in most of the study sites. This generally was true for patients admitted both by physicians with ownership in specialty hospitals and by other physicians without such ownership, indicating no difference in referral patterns for physician owners and non-owners. However, there was some variation, with cardiac hospitals in some areas having higher average severity than in the community hospitals. Although the number of cases was too small to draw definitive conclusions for surgery and orthopedic patients, the difference in the proportion of severely ill patients treated in community hospitals was greater for the surgery and orthopedic patients than for the cardiac patients. The analysis of patients transferred out of cardiac hospitals did not suggest any particular pattern. The proportion of patients transferred from cardiac hospitals to community hospitals is about the same, around one percent, as the proportion of patients transferred between community hospitals. The proportion of patients transferred from cardiac hospitals to community hospitals who were severely ill was similar to patients in the same diagnosis related group (DRG) who were transferred between community hospitals. The number of cases transferred from surgery and orthopedic hospitals was too small to derive meaningful results on this type of analysis.

Based on claims analysis using the AHRQ quality indicators and methodology, preliminary findings show that measures of quality at cardiac hospitals were generally at least as good and in some cases were better than the local community hospitals. Complication and mortality rates were lower at cardiac specialty hospitals even when adjusted for severity. Because of the small number of discharges, a statistically valid assessment could not be made for surgery and orthopedic hospitals. Patient satisfaction was extremely high in both cardiac hospitals and surgery and orthopedic hospitals, as Medicare beneficiaries enjoyed large private rooms, quiet surroundings, adjacent sleeping rooms for family members if needed, easy parking, and good food. Patients also had very favorable perceptions of the clinical quality of care they received at the specialty hospitals.

We also used proprietary financial information provided by the specialty hospitals in the study that allowed the calculation of their taxes paid and their uncompensated care as a proportion of net revenues. Relative to their net revenues, specialty hospitals provided only about 40 percent of the share of uncompensated care that the local community hospitals provided. However, the specialty hospitals paid significant real estate and property taxes, as well as income and sales taxes, while non-profit community hospitals did not pay these taxes. As a result, the total proportion of net revenue that specialty hospitals devoted to both uncompensated care and taxes significantly exceeded the proportion of net revenues that community hospitals devoted to uncompensated care.

Medicare Payment Advisory Commission (MedPAC) Report

The MMA also required a complementary MedPAC study of certain issues related to the payments, costs, and patient severity at specialty hospitals. Based on our ini