Specialty Hospital Building Boom Threatens General Hospitals

Specialty Hospital Building Boom Threatens General Hospitals

Competition Intensifies for Lucrative Cardiac and Orthopedic Services

News Release
April 15, 2003

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WASHINGTON, D.C. -- Community hospitals are increasingly worried that a surge in physician-owned specialty hospitals will draw away their most lucrative patients, leaving them to care for sicker, higher-cost populations, according to a study published today by the Center for Studying Health System Change (HSC).

Proponents argue that specialty hospitals have the potential to enhance quality and lower expenses by boosting efficiency through a "focused-factory" model in which physicians carry out a high volume of a limited set of procedures. However, critics are concerned that these facilities and their physician-investors will cherry-pick the most profitable cases from community hospitals, eroding margins and jeopardizing the cross-subsidization of money-losing services like emergency departments and other vital programs.

"The rapid expansion of specialty hospitals and the fierce rivalry for profitable cardiac and orthopedic procedures suggest that reimbursement for these services may be too generous, while payment for other services may be inadequate," said Paul B. Ginsburg, Ph.D., a co-author of the research and president of HSC, a nonpartisan policy research organization funded solely by The Robert Wood Johnson Foundation.

"Public and private insurers may be inadvertently transmitting distorted signals to the market, fostering overcapacity in these high-margin services while underinvesting in less profitable areas such as emergency care," Ginsburg noted.

In principle, applying a focused-factory approach to health care could enhance quality, raise productivity, and reduce costs. But when the reimbursement system is skewed, specialty hospitals can thrive financially without delivering on the promise of better outcomes and greater efficiency.

Although the United States has a long tradition of certain types of specialty hospitals, such as children's and rehabilitation facilities, freestanding cardiac and orthopedic hospitals are a comparatively recent phenomenon that is expanding quickly. While comprehensive national figures on the number of heart and orthopedic specialty hospitals do not exist, 11 such facilities have opened since 1997 across the 12 local markets closely monitored by HSC investigators. Other estimates place the nationwide total at between 50 and 100 specialty hospitals, with additional ones in development.

"The worry is that when more hospitals vie for the same or a shrinking volume of procedures, quality could suffer and costs could rise because each facility handles fewer cases and surplus capacity is seldom eliminated," said HSC Researcher Kelly Devers, Ph.D., the study's lead author. "With excess capacity, there is a risk that unnecessary procedures may be performed."

The study identified three primary drivers behind the specialty hospital boom:

First, private and government payers may be overpaying for certain cardiac and orthopedic services while underpaying for others, which incentivizes investment in hospitals that focus exclusively on lucrative procedures.

Second, physicians want greater authority over their work environment, including decisions about staffing levels, scheduling, and equipment acquisitions.

Third, physicians seek to boost their earnings by generating additional professional fees through higher productivity and by capturing a share of facility profits when they hold ownership stakes.

The findings are presented in detail in an HSC Issue Brief titled "Specialty Hospitals: Focused Factories or Cream Skimmers?" The study was unveiled at an HSC conference featuring public and private sector specialists on the topic, with a conference transcript expected to be posted on the HSC Web site.

Community hospitals have adopted several strategies in response to the competitive threat from specialty hospitals:

Some have constructed their own specialty units to preserve revenue from high-margin services and retain physicians who might otherwise depart to launch a rival specialty hospital. By offering physicians certain advantages of a standalone facility -- such as better scheduling and staffing -- these hospitals aim to discourage physicians from establishing competing institutions.

Others have entered into joint ventures with local physicians to develop a specialty hospital, enabling the community hospital to retain some of the revenue that would otherwise be lost while giving physicians an investment opportunity.

Still others have revoked admitting privileges for physicians with a financial interest in a competing facility. Known as "economic credentialing," this approach has triggered litigation, with some courts ruling in favor of hospital restrictions on physician privileges.

The swift rise of specialty hospitals has attracted the attention of state and federal policymakers. Current federal law restricts physicians from referring Medicare and Medicaid patients to healthcare facilities such as clinical laboratories where they hold a financial interest, but it exempts physician ownership in entire hospitals. Recently proposed federal legislation would continue permitting physicians to refer patients to a hospital in which they have an ownership stake, provided that the ownership interest was acquired on terms equally available to the general public.

Beyond narrowing the exemption in federal physician self-referral law and adjusting Medicare payment formulas, additional proposals include: mandating that specialty hospitals accept Medicaid and uninsured patients; applying identical quality and patient-safety standards to both specialty and community hospitals; requiring specialty hospitals to operate full-service emergency departments; and passing certificate-of-need laws designed to curb excess capacity.

The Center for Studying Health System Change is a nonpartisan policy research organization dedicated to delivering objective and timely analysis of the evolving U.S. health system to help guide policymakers and improve health care policy. HSC, headquartered in Washington, D.C., is funded exclusively by The Robert Wood Johnson Foundation and is affiliated with Mathematica Policy Research, Inc.

Sources and Further Reading

Centers for Medicare & Medicaid Services — Inpatient Prospective Payment System — CMS details on the Medicare hospital payment system whose reimbursement structure incentivized the specialty hospital boom described in this study.

Health Affairs — Specialty Hospitals, Ambulatory Surgery Centers, and General Hospitals — Peer-reviewed analysis of the competitive dynamics between specialty hospitals and general hospitals, including quality and cost implications.

Robert Wood Johnson Foundation — Specialty Hospitals: Focused Factories or Cream Skimmers? — The full RWJF-funded HSC Issue Brief examining how physician-owned specialty hospitals affect community hospital finances and patient care.

American Medical Association — Physician-Owned Hospitals — AMA resources on physician self-referral laws, economic credentialing, and the policy debate surrounding physician ownership of hospitals.

Kaiser Family Foundation — Medicare Hospital Payment Policy — KFF overview of Medicare payment structures for hospitals, relevant to the reimbursement imbalances driving specialty hospital growth.