Maryland's long-humming healthcare machine is showing its age after years of delivering accessible, efficient service at a reasonable cost.
Everyone agrees the system needs some maintenance and new parts, but they don't agree on what. And that has broken up the amicable co-existence of providers and payers.
As the last state in America regulating hospital rates, Maryland is trying to preserve the features that until recently made payers and providers equally content to operate within a benevolent bureaucracy.
But because of recent setbacks in cost control, the state's more than 20-year-old system is facing its sternest test of relevance.
Payers say Maryland cannot keep shielding hospitals from market forces and managed care; hospitals fear the effect of those forces on their finances and communities.
"We still have a long way to go to emancipate the free-market economy in Maryland from the interfering hand of state regulation," says David Wolf, executive vice president of Maryland Blue Cross and Blue Shield, one of the fiercest critics of the rate-setting system.
Too fast an idle. For many years, Maryland's hospital regulators achieved what other states are still struggling to do. For example, the state has held its hospital costs per admission (which were 25% higher than the national average in 1976) to comfortably below the national average since 1986.
At the same time, regulators managed to preserve indigent care by allowing hospitals to build in an allowance for indigent care in their prices to all payers. Elsewhere, hospitals often elevated charges to private-pay patients to cover indigent-care shortfalls, a move that triggered public outrage and managed care.
But in Maryland, hospital prices are the same for everyone, including Medicare and Medicaid.
That result is unparalleled access, says Larry Lawrence, executive vice president of the Maryland Hospital Association. "There is no disincentive for hospitals to treat anyone who walks in the door," he says.
But for all its accomplishments, Maryland now appears to be falling behind other states that have relied on the market forces of managed care. Recently Maryland's hospital costs have changed trajectory. The average cost per admission in Maryland rose 4.5% in 1996, for example, compared with a national average increase of 2.3%.
That's enough for some critics to question the point of regulation. Maybe managed care, which exists mightily in Maryland, could do better on its own. The state has an HMO penetration rate of 40%, among the highest in the nation. And in the densely populated corridor from Washington to Baltimore, about 80% of residents are covered under some type of managed care.
But while unregulated facilities are competing viciously on price, rate regulation for the most part has put hospitals off limits to the deep price discounts HMOs negotiate elsewhere.
When healthcare costs raced ahead at breakneck speed in the '70s and '80s, Maryland's pricing formulas acted like a governor on the engine of inflation.
Now critics say Maryland's formulas aren't slowing the engine enough.
Some want to tinker with the formulas, installing a brake of sorts on Maryland's system. Others would rather scrap the existing process for a more market-driven vehicle.
The Maryland Association of Health Maintenance Organizations has sued to eliminate part of the system: a longstanding rate-setting shortcut meant to ease the administrative burden on hospitals and the state. It says the shortcut is at the heart of excessively generous payments to hospitals.
Since Maryland actually went so far as to set up a commission to regulate hospital prices, payers have a right to better results than would happen without regulation, says Tom Barbera, president of the HMO association, which represents 21 HMOs with 2.1 million enrollees.
The Maryland Blues, meanwhile, wants a complete overhaul. Wolf says the state must create a less complex system "that exploits the best aspects of regulatory oversight while freeing the marketplace to perform its self-regulating task."
Hospitals, on the other hand, are fighting for less drastic measures. The regulatory system was crafted in part by the state hospital association.
"Clearly, the HMOs would like to have the ability to come in and extract deep discounts the way they do in all other places in the country," Lawrence says. But that leads to uneven and uncertain access to care, he says. "I don't think that's a system that stands the test of logic."
The spark. A key component of the system is the Health Services Cost Review Commission, which was set up by law in the early 1970s. It receives detailed cost data from each hospital, evaluates revenue needs accordingly and sets allowable revenues by local and national benchmarks.
Now the commission is caught in the middle of the debate. It's trying to freshen up its methodology and demonstrate it can do better than an unbridled managed-care company at controlling costs while maintaining access and efficiency.
"There's a crisis of confidence among the payers at this point that the commission can do better," says Barbera, executive vice president of Mid-Atlantic Medical Services, which owns two Rockville-based HMOs.
It was, in fact, an attempt by the commission to reduce excessive payments to hospitals that triggered cries for major reform.
An arcane but crucial adjustment to the rate-setting formula, called the "system adjustment factor," was implemented last year. It had the effect of taking back 3.9% of hospital revenues after they first were adjusted generously under the regular formula.
Howling that the correction was retroactive and too severe to absorb at once, a coalition of 39 hospitals tried to negotiate a lower adjustment.
The state's HMOs lashed back: The entire regulatory structure had become unbalanced in favor of hospitals, they said, and required a fundamental reassessment.
Despite protests about one regulatory tweak or another over the years, payers generally had been comfortable with the regulatory foundation. As long as it worked as planned, they perceived it as fair to all, Barbera says.
For most of its existence, the Maryland system steadily improved on the state's average adjusted cost per hospital admission compared with the nation.
In 1986 it beat the national average for the first time. The state's hospitals continued to widen the gap through 1992, when the Maryland average was 11% lower than the national (See chart, p. 100).
But the trend has reversed, as Maryland's costs closed to within 3% of the national average in 1996.
Payers griped that the state's 50 hospitals earned net income of $290 million in 1996 on $4.5 billion in revenues, while HMOs as a group lost $2 million on $3.5 billion in revenues.
Commission officials concluded that their formulas for inflation adjustments and other cost considerations, such as allowances for new services, were getting too generous. Commission Executive Director Robert Murray says an additional 2% to 3% was being built into every year's rates during a period of deceleration nationwide.
In early 1996, a special task force recommended the commission apply the correction factor to bring rate increases more in line with a national average. Hospitals were represented on the task force and went along with the scheme, Murray says. "Our perception at the time was, `Well, they've accepted it,' " he says.
Then reality hit.
Shock to the system. The correction factor was foreseen as a mild contingency, but its debut came in a year when Maryland's costs increased at double the national average. It meant the removal of $183 million from the operating revenues of the state's hospitals.
The cost-review commission saw that as ensuring hospitals didn't get more than they should, but the MHA saw it as "a major shock to the system," Lawrence says.
When the MHA agreed to the regulatory move, "the modeling was not estimated to be in this magnitude," he says. What's more, the trims from the correction factor came on top of about $200 million squeezed out by previous regulatory revisions since the early 1990s, he adds.
The MHA complained about faulty comparisons with national data and declared, "The work of the commission has resulted not in a `system correction factor' but in a `system crippling factor'-an error which Maryland hospitals now challenge."
Compounding the shock was its timing: The state Medicaid program is converting to a system of capitation through contracts with newly formed managed-care organizations. The MHA says it expects the Medicaid conversions to extract an additional $140 million annually from Maryland hospital revenues.
Meanwhile, enrollment in Medicare managed care is growing at a rate of 6% a month and now includes 80,000 of the state's 600,000 beneficiaries, Lawrence says.
The cumulative effect is half a billion dollars yanked from hospitals each year, the MHA says.
Hospitals launched a campaign to sound the alarm. The MHA charged the correction factor would crimp or cripple preventive-medicine programs and other community health services.
The kicker, it says, was the move wasn't even necessary: Hospital costs still are 3% below the national average. "The system is not broken, so let's not fix it," a position paper concludes.
A 39-hospital coalition materialized to negotiate a "compromise" rate with the commission, which agreed in May to entertain the idea.
Enter the payers. That small victory for hospitals turned out to be the beginning of a backlash that threatened to make the correction factor the least of their problems.
The Maryland HMO association had been fretting in the background about what it saw as a regulatory imbalance in favor of hospitals.
The correction factor was an overdue braking mechanism on hospitals, giving cost control the same priority as payment uniformity and incentives to treat the uninsured, Barbera says.
Hospitals' attempts to lobby away the hurt mobilized the HMO association. "We acted to counterbalance," he says.
HMOs not only pressured the commission to implement the correction factor as planned, but they also dug deeper and found fault with the underlying premise of much of the annual rate calculation-the Inflation Adjustment System.
The association determined "the Inflation Adjustment System itself was throwing the rate system out of balance" and in August sued the commission, says David Funk, the group's lawyer.
All Maryland hospitals underwent a comprehensive rate review when the regulatory system was launched in the 1970s. The process proved to be a considerable burden on the staffs of the commission and hospitals-impractical on an annual basis, says Murray of the cost-review commission.
To keep regulations from becoming too complex, the commission adopted a voluntary rate update based on inflation factors, Murray says. Operating in conjunction were yearly adjustments based on how far off a hospital was from the current target.
During inflationary periods, Murray says, the system provided incentives to lower costs while guaranteeing money for new services and tossing in a three-year rolling average to cushion year-to-year swings.
He acknowledges, however, that the formula's premises may not work anymore, and the commission has called for the inflation update system "to be recalibrated such that we don't need a separate correction factor at the end," Murray says.
But the HMO group's suit declares that "a comprehensive rate review is the only means of achieving the commission's statutory mandate and assuring the balance between hospitals and purchasers intended by the General Assembly."
A judge has thrown out the challenge to the inflation methodology, saying the commission was within its rights, but the suit has fueled the fight for change.
The inflation update formula is "a construct," Funk says. "It's an effort to approximate reality, not to reflect reality." And during the past 10 years, 90% to 95% of hospitals have taken the commission up on its voluntary offer and profited from it, he says.
Making it right. After months of presiding over the skirmish, the commission allowed a "technical correction" that slightly lowered the rate of reduction in revenues for most hospitals. Otherwise it did not back away from imposing the correction factor this year. It also made some adjustments that in effect clamped down on the 10 hospitals that had accumulated the highest rate increases allowed under the system.
Beyond that, Murray says, the commission has begun work on meeting two goals: changing the inflation formula to make an after-the-fact correction unnecessary and demonstrating it can do better than the national average in cost control.
"I think rate regulation can still achieve (those goals), and it's not going to be easy or pleasant for the hospitals," he says.
For its part, the hospital association now says it got irritated by the process by which the rates were set, not the rates themselves. "We were not opposed to having any adjustment, but the magnitude of it" took hospitals aback, Lawrence says.
The trade-off for regulation and full disclosure of financial data always has been the system's predictability and the resulting ability to set a prospective budget, he says.
That's why the MHA supports the commission's initiative to revise the Inflation Adjustment System. The move will assure the rate-setting formula calculates the right amount in the first place. "Take-backs are unpalatable to just about anyone in America," Lawrence says.
The MHA also is trying to win some flexibility for hospitals to compete in a managed-care climate, including financial incentives to encourage integrated delivery systems and the ability to negotiate with national and regional payers. If insurers want to bargain with hospitals, Lawrence says, they can't just transfer the risk to providers-hospitals must be able to share in the rewards, too.
At the same time, the association wants to make sure there's continued funding for uncompensated care and graduate medical education, he says.
It also wants added flexibility in outpatient services to compete with ambulatory surgery centers, which aren't rate-regulated and don't contribute to uncompensated-care provisions, says Nancy Fiedler, MHA senior vice president for communications.
It's a market out there. "The world has changed," Lawrence says. "The methodologies have to evolve."
Critics of the hospitals agree on the need for change. But they say the hospital industry is due for much of it.
"Hospitals have lived in somewhat of an artificial world," says Wolf of the Maryland Blues.
Warnings about crippled community programs and compromised teaching programs don't hold water for payers that operate far less profitably, he says. "There's enough excess to not only reduce costs to patients but also fund other things such as graduate medical education."
The cost-review commission also has come down on hospitals' allegations about the threat to vital community health programs.
"Nonprofit hospitals fund such programs out of their surplus," the commission wrote in response to objections raised in this year's debate. "Hospital profits are currently about twice their historical levels, and well in excess of agreed-upon targets, indicating that sufficient funds exist to support these programs if they are a priority to hospitals."
Besides holding hospitals accountable for community benefits, payers say it's also time for the state to create incentives to wring excess beds out of the industry. Current occupancy is about 56% statewide.
"The concern is that in the face of declining occupancy, there's a system in place that doesn't appropriately reflect the changes in the healthcare marketplace and particularly the problem of excess capacity," says John Picciotto, general counsel for the Maryland Blues.
As for the predictability issue, Murray says the rate-setting process, even with the correction factor, is "still a lot more predictable than what you'd encounter outside (Maryland)."
The commission writes: "In other states, rates are not predictable because a payer can demand renegotiation of hospital rates at any time."
That's all part of a marketplace economy Maryland may not be able to fend off much longer.
"Hospitals nationally are being forced to cut costs because of lower revenues due to reductions in payments negotiated by payers and due to the reduced need for hospital services," the commission declares.
"Maryland hospitals must be willing to adjust to lower revenues through cost-cutting as well."