Opponents call hospital rate-setting a backward approach to cost control, a practice that fell out of favor in the 1980s. Those critics dub the practice socialist, a desperate move by healthcare providers to limit costs while sacrificing profits.

While the Massachusetts Hospital Association and the Federation of American Hospitals say improving cost-control is a necessary endeavor, they worry about limiting profitability. The federation's mission statement makes that apparent: “We are staunch advocates of a market-based healthcare system, which benefits consumers by continually improving the quality, safety and value of care through competition and innovation.”

The American Hospital Association lacks an official position on the issue, deferring inquiries to individual state agencies, contending that what works for one state might not work in another.

Meanwhile, California and Massachusetts are exploring their own rate-setting programs, a practice popular in the early 1970s when as many as 30 states had their own versions of the practice. Now only two states remain: Maryland and West Virginia.

Carmela Coyle, president and CEO of the Maryland Hospital Association, says she understands why rate-setting could be attractive: “There's the frustration that everybody is facing and that is a shortage of funding in the states, especially for Medicaid.”

West Virginia's program covers only private payers. In contrast, Maryland's program applies to all payers. The distinction with Maryland's program is a waiver with the CMS allowing the state's Health Services Cost Review Commission to set the state's Medicare and Medicaid rates.

Coyle says the state is proud of its system and happy to be a model for the rest of the country: “We have been able to control costs and to hold costs at or below the national average.”

Maryland legislators created the program in 1971, and its seven-member commission has set hospital rates since 1977. The panel convenes monthly and sets rates annually, with the governor-appointed commissioners serving four-year terms, consisting of a mix of administrators, policy experts and healthcare professionals. Its goals are to constrain hospital costs, ensure hospitals have proper resources for high-quality services and to increase the fairness of hospital financing.

Coyle says financials prove the program's success. Over 32 years, from 1977 to 2009, the state's cumulative growth in costs per admission ranked lower than any other state, and since 1981, Maryland's rate of increase for average admissions payments is 315% versus the national rate of 358%. That's a stark difference from 1976, when costs per admission were $1,458, or 26% above the national average of $1,165. Had that rate continued through 2010, Maryland officials say hospital spending would be at $3.2 billion in 2010 alone.

For fiscal 2010, the equivalent inpatient admission was $10,410 and the average amount for a hospital stay in Maryland grew by 2%, compared to the national average of 3%. Rate-setting also saved Maryland patients $113 million compared to what they would have paid if the state's hospital rates grew at the national level in fiscal 2010 alone.

“We have been able to control costs and to hold costs at or below the national average.” —Carmela Coyle, president and CEO, Maryland Hospital Association

Hospitals can appeal the commissioners' rulings by asking for a special rate order. Since fiscal 2006, five such appeals were submitted and four were granted.

Massachusetts officials are pondering revisiting rate-setting, despite protests from hospitals. “The hospital industry here in Massachusetts is very concerned about government trying to intervene in the rate-setting process that is the relationship between payers and providers,” says Lynn Nicholas, Massachusetts Hospital Association president and CEO.

An independent commission set hospital rates in Massachusetts from 1975 through 1991, and during those 17 years, hospital costs remained 2% below the national rate. The program ended in 1991, when hospital costs in Massachusetts matched the nation's average rate, according to the state's Special Commission on Provider Price Reform. Nicholas sits on the 10-member group, which recently formed to re-examine rate-setting and other cost-control measures. They presented a report in November to Massachusetts legislators.

The Massachusetts rate-setting plan would be reviewed after two years if enacted, but lawmakers remain in the preliminary stages of discussion. No target date has been set to implement any of the proposals. Rate-setting was among six recommendations in the report, which included increasing transparency on price variation and to offer a variety of plans to increase consumer enrollment.

Massachusetts lawmakers see rate-setting as a temporary solution, but that's not good enough for Nicholas. She cast the only vote on the commission opposing the report, specifically because of the rate-setting recommendation. She made no secret she was on the panel to represent the best interests of hospitals: “As a strategy to reduce costs, (rate-setting) takes the focus away from the real issue, which is cutting medical spend in all respects.”

She also wondered about the other factors leading to increased spending. She reiterated Coyle's concerns about the federal government falling behind on Medicare and Medicaid payments to doctors and hospitals, and says rate-setting should represent a “minor piece of the puzzle.” The report also mentioned New York and New Jersey as states with significant experience with rate-setting. Their programs were among those that vanished in the early 1980s.

Chester “Chet” Burrell is familiar with the Maryland and New York rate-setting programs. Since 2008, he's served as president and CEO at CareFirst Blue Cross and Blue Shield of Maryland. Previously, he spent a long career with the state of New York as an administrator, where he helped run its rate-setting program in the mid-1970s.

There's a predictability and uniformity in Maryland's program that providers can trust: “With any system, there are up- and downsides, from time to time changes are considered,” Burrell says. “And I think that will continue that way at least through federal reform. And then we'll see.”

Communication between providers and regulators is also critical, and Maryland's process allows hospitals and insurance companies to communicate directly with the state rate-setting board. There have been discussions in other states to use a mediator to help set rates, but Burrell doesn't see the benefit: “There's no such thing as effective mediation.”

Insurance companies in Maryland support the system because of its stability, and because they don't sustain the brunt of rising costs from providing services to the uninsured, Coyle says: “Where do they get shifted? They get shifted to the privately insured patients to make up for the unfunded societal costs.”

Maryland's size also makes it unique. “This may not work in other states, it really depends on the system, how it's set up, how the partners work together,” Coyle says. “Maryland has 46 acute-care hospitals and the rate-setting commissioners need to be intimately involved and knowledgeable of the circumstances of each and every one of those 46 hospitals.”

Maryland's program also allows flexibility, Coyle says, as the state's law doesn't specify how rates should be set. There's no specific formula, but members must adhere to three principles: To keep costs reasonable, ensure “aggregate revenues are reasonably related to aggregate costs,” and to ensure equity between all purchasers.

West Virginia officials don't receive as many inquiries regarding their program as Maryland does, says Joseph Letnaunchyn, West Virginia Hospital Association president and CEO. That state's rate-regulation program, governed by the West Virginia Health Care Authority, covers only private payers and self-payers. That's about 30% of the state's patients, Letnaunchyn says. The remaining 70% fall under public payer categories, including Medicaid, Medicare and the state's employee insurance program.

Rate-setting has helped ensure West Virginia has kept a balanced state budget through the years, and is proof of the program's success, Letnaunchyn says, but state officials continue to consider tweaking their procedures for the future: “We're looking at refining the program and trying to apply the appropriate changes in the current environment as we move into the components of healthcare reform,” Letnaunchyn says.

In California, a ballot initiative involving rate-setting and requiring insurance companies to make records available to the public is slated to appear on California ballots in November 2012. Consumer Watchdog, a not-for-profit organization based in the state, is spearheading the ballot initiative. California has more than 430 acute-care hospitals, which could make communication between stakeholders a lot more difficult compared with the smaller populations in Maryland and West Virginia.

The California Association of Physician Groups immediately went on record in opposition to rate-setting. President and CEO Donald Crane sees the proposal as a political ploy, not a way to improve healthcare or cut costs. Much of what he says echoes Nicholas in Massachusetts, calling rate-setting a “power grab” that ignores the problems with the delivery system, saying he also worries about provider profitability: “I don't think we want to run hospitals and doctors into bankruptcy.”

Profits in Maryland have taken a dip, Coyle acknowledges. But there are benefits, as the system also regulates hospital performance, with the commission using metrics to help determine rates. That limits the disparity in care offered at different facilities.

“What does that mean?” Coyle asks. “It means you'll see much less of the high profits that you'll see in other states, but you'll also see much less negative profits—losses—that you see in other states.”

But that doesn't mean profits are a bad thing. “Costs need to be constrained under the terms allowed, but profits have not been a dirty word in Maryland,” says John Colmers, chairman of Maryland's Health Services Cost Review Commission and vice president of healthcare transformation and strategic planning at Johns Hopkins Medicine in Baltimore.

Despite worries about provider profitability, representatives from other states for years have been curious about the Maryland system. So what are the top questions Colmers hears?

“How do you keep the politics out of this?” Colmers says. “How do you keep hospitals from practicing the political game in the state capitol?”

One way Maryland avoids politic influence is through who makes up the Maryland Hospital Association, Colmers says. Unlike most state hospital associations, the MHA consists of hospital trustees instead of hospital administrators. That's what gives the MHA a broader perspective when it comes to addressing problems, he says: “If you look at the history (of rate-setting), when it came along in the early 1970s, it was in many ways the hospital industry that was as supportive of it as anyone.”

While Coyle lauds the cost stability in Maryland, the healthcare reform law clouds her forecasts for the future. She's shrewd in saying that rate-setting isn't a one-prescription-fits-all solution.

“I think they're really looking for states to experiment,” she says. “It might not be in the area of rate-setting, per se, but for all of this, there will be experimentation in great effect and great cost control.”