Specialty Hospitals: Focused Factories or Cream Skimmers?

Originally published as a Conference Transcript by the Center for Studying Health System Change (HSC), 2003. This event examined the rise of specialty hospitals from multiple perspectives -- health system leaders, equity analysts, and policymakers. HSC was a nonpartisan policy research organization funded principally by the Robert Wood Johnson Foundation.

Specialty Hospitals: Focused Factories or Cream Skimmers? Conference Proceedings

This conference, organized by the Center for Studying Health System Change and moderated by HSC president Paul B. Ginsburg, brought together hospital executives, physician leaders, equity analysts, and congressional staff to examine the rapid growth of specialty hospitals focusing on cardiovascular and orthopedic procedures. The event was structured in two panels: the first explored views from within the health care system, and the second addressed the policy perspective.

Panel One: Perspectives from Inside the Health System

The first panel featured William Greene, CEO of OrthoArkansas; David Kelleher of Health Care Options in Indianapolis; Gary Taylor, then principal of equity research at Bank of America; and William Petasnick, CEO of Froedtert Hospital in Milwaukee. The panelists offered contrasting views on whether specialty hospitals represented genuine innovation or a threat to community health care.

William Greene made the case for physician-owned specialty hospitals, arguing that focused facilities could deliver better outcomes through higher procedure volumes, more experienced teams, and purpose-built environments. He described how OrthoArkansas had designed its facility around patient flow and surgeon productivity, achieving shorter lengths of stay and high patient satisfaction scores. Greene contended that general hospitals had grown complacent with their profitable specialty service lines and that competition from focused facilities would ultimately benefit patients.

David Kelleher provided a detailed account of the specialty hospital building boom in Indianapolis, where the rapid proliferation of heart hospitals had been driven largely by cardiologists leveraging the threat of MedCath partnerships to extract ownership stakes from established hospital systems. He described how Community Health Network and St. Vincent each built freestanding heart hospitals under pressure from their own physician groups, setting off a chain reaction that led all four major systems in the market to develop cardiac specialty facilities in a metro area of just 1.6 million people.

William Petasnick presented the community hospital viewpoint, arguing that specialty hospitals cherry-picked the most profitable patients and procedures while leaving general hospitals to absorb the costs of emergency care, uncompensated care, and less profitable services. He pointed out that cardiology and orthopedic revenue often cross-subsidized money-losing services like psychiatric care, burn units, and trauma centers. If specialty hospitals siphoned off profitable cases, general hospitals would face painful choices about which community services to cut.

Gary Taylor analyzed the trend from the perspective of financial markets and hospital company valuations. He observed that specialty hospitals' ability to generate high margins on select procedures was largely a product of Medicare and private payer reimbursement formulas that paid the same amount regardless of facility costs, effectively subsidizing the creation of lower-cost niche competitors. Taylor noted that the investment community was watching closely to see whether the trend would prompt payment reforms that could alter the economics for both specialty and general hospitals.

Panel Two: The Policy Dimension

The second panel brought together congressional staff and policy analysts to discuss legislative and regulatory responses to specialty hospital growth. Maria Castillo from the office of Representative Jerry Kleczka of Wisconsin discussed proposed legislation that would impose a moratorium on physician self-referral to new specialty hospitals. The panel debated whether existing Stark law exceptions that allowed physician investment in 'whole hospitals' had created an unintended loophole that was driving specialty hospital development.

The policy discussion centered on several key questions: whether Medicare payment rates should be adjusted to eliminate the profit distortions that made certain procedures disproportionately lucrative; whether physician ownership in hospitals should face the same restrictions applied to physician-owned imaging and surgery centers; how to measure and compare quality outcomes between specialty and general hospitals; and whether certificate-of-need laws could effectively regulate specialty hospital development or would simply protect incumbents from competition. The panelists generally agreed that the data needed to resolve these questions was still inadequate and that the Medicare Payment Advisory Commission's ongoing study would be critical to informing future policy.

Key Themes and Takeaways

Several themes emerged across both panels. Payment distortions in the Medicare fee schedule were widely recognized as a primary driver of specialty hospital growth, yet fixing those distortions raised its own difficulties since reducing payments for profitable procedures could create access problems if general hospitals depended on that revenue. The tension between promoting competition and preventing cream-skimming had no easy resolution. Quality evidence was inconclusive -- proponents cited volume-outcome research and focused factory theory, while opponents pointed to the risks of splitting volume across too many facilities and the potential for overutilization when physicians had financial interests in the facilities where they practiced.

Sources and Further Reading

This conference transcript was published by the Center for Studying Health System Change. The companion publication, HSC Issue Brief No. 62 ('Specialty Hospitals: Focused Factories or Cream Skimmers?' by Kelly Devers, Linda R. Brewster, and Paul B. Ginsburg, April 2003), provides the research foundation for the conference discussion. Additional context on the focused factory concept and physician self-referral patterns can be found in MedPAC reports to Congress on specialty hospital issues.