"To my mind, it's kind of like the fall of Soviet Russia."
That's how Joseph Beck, a principal of Shattuck Hammond Partners, New York, describes the end of hospital rate control in New York state.
On Jan. 1, the state's 13-year-old system of regulating inpatient rates came toppling down. The old system used the same DRGs, or illness categories, that Medicare uses to pay hospitals for inpatient care.
The system gave Blues plans a break on DRG payment rates and allowed HMOs to seek discounts but required indemnity plans and PPOs to pay full DRG rates to New York hospitals.
Lawmakers replaced that system with a new law, the New York Health Care Reform Act, which freed hospitals and most payers to negotiate their own deals. It temporarily preserved DRGs for Medicaid, but Gov. George Pataki's budget blueprint for the fiscal year beginning April 1 authorizes the health department to begin negotiating Medicaid rates.
The new law also created a web of taxes to defray the cost of "public goods" like graduate medical education and charity care. Such subsidies previously were built into the state's DRG payment rates.
Market-based contracting may be a new concept to New York, but it's the engine driving healthcare delivery in every other state except Maryland. In New York, though, the transition already is stumbling along chaotically.
Hospitals that once operated behind the "iron curtain" of rate control have been thrust into a market that demands lower costs. While many hospitals have negotiated deals with payers, half or fewer have signed contracts. As a result, most remain tight-lipped about the terms.
"Nobody's claiming victory, that's for sure," said Izzy Kushner, a benefits consultant with Segal Co., New York.
Nobody says the new system is a piece of cake for payers, either. They must navigate a sea of tricky calculations and payment issues.
Some payers are questioning the legality of the tax-based subsidies and considering legal action. One group, the New York State Clinical Laboratory Association, already has challenged the new law in state court.
"Many organizations believe that the legislation is unconstitutional," said Ted Nussbaum, who heads the healthcare practice in the New York office of Watson Wyatt, a national healthcare consulting firm.
Providers, meanwhile, are crying foul. Even as they begin adjusting to the cost pressures of deregulation, new financial threats loom.
Just days into the new year, Pataki proposed a series of Medicaid cuts and other payment reductions totaling $3.4 billion, according to an analysis by the Healthcare Association of New York State. Hospitals would take a $1.9 billion hit in the fiscal year that begins April 1.
"The budget as proposed shows a lack of sensitivity and sensibility to the environment that hospitals are facing," said Daniel Sisto, president of the 450-member association. In recent testimony before state lawmakers, Sisto predicted hospitals and other healthcare facilities would be forced to cut more than 31,000 jobs if the governor's proposed cuts are enacted.
As Sisto pointed out, New York state hospital rates have been constrained by years of rate regulation. Overall, hospitals achieved a 1995 surplus of just $364.6 million, for a slim profit margin of 1.2%. How, he asked, are hospitals to absorb a $1.9 billion loss and give insurers their discounts?
"The budget sends a second clear message to the healthcare industry that we have excess capacity," said Watson Wyatt's Nussbaum. The spate of "mergers" among providers in the state hasn't wrung out inefficiencies, he said. "It's creating bulk, and bulk doesn't lower costs."
Shattuck Hammond's Beck sees a lot of fat, particularly in New York City. Data compiled by his firm show hospitals in New York's metropolitan area average just 8.9 adjusted annual admissions per full-time equivalent employee. That compares with 12.1 for hospitals in the San Francisco area and 10.8 in Chicago and its suburbs. The comparisons suggest that hospital workers in other markets are able to handle greater volume than in New York.
In dealing with cost pressures, "I think there's going to be more compulsion and pressure put on the hospitals to get people out even earlier," noted Charles F. Blum, vice president for legal and government affairs at the Visiting Nurse Service of New York, the largest not-for-profit home-care agency in the country.
Hospitals were thrown another curve ball from Washington last month when the federal Office of Management and Budget decided to "score" the Federal Housing Administration's mortgage insurance program in such as way that it would require a government subsidy. That would limit the FHA's ability to refund and finance capital projects.
In New York, the FHA insures more than $5 billion of mortgages on some 200 hospitals. Few hospitals in the state are able to issue bonds on their own credit.
Beck doesn't believe the loss of FHA financing would necessarily drive hospitals into bankruptcy. But, they may have to issue unrated or lower-rated bonds.
A report issued last week by Standard & Poor's Corp. gives some reason for optimism. Based on the experience of other states that have deregulated, the New York-based bond-rating agency said it doesn't believe deregulation is likely to lead to rating changes and, in the long term, "may result in some improvement in healthcare quality." The agency currently rates 16 New York healthcare credits with a total of $500 million of debt outstanding.
The bottom line, Beck said, is that "New York is going to look much more like the rest of the world in the next five years."