The Fiscal Health of Michigan Hospitals by Peter Pratt In the last twenty-four months, 150 of the nation's 6,300 hospitals have closed their doors-l 1 in Michigan. Almost half the nation's hospital executives say their institutions could close within five years-the same holds true of Michigan's executives. Half of Michigan's 102 hospitals with fewer than 150 beds lost money in 1986. The average operating margin-perating income minus operating expen- ses--of smaller hospitals has stayed below zero since 1984. On any given day, over one-third of the state's 35,500 hospital beds do not need linens changed; no patient has lain there. If the economic yardstick of manufacturing (percentage of plant capacity in production) were applied to hospitals, trade papers would scream "depression." The patient is not terminally ill and, in truth, has perlormed well. Few "industries" have been buf- feted by more radical declines in sales volumes, drastic changes in the products they deliver, tighterregula- tion, deteriorating prices, and stronger competition all while providing a public service to which most people believe they have a right. Looking back at the revolution in American health care delivery and i reimbursement, a revolution of barely ten years, our surprise is less that hospitals are at risk than that 98 percent of hospitals have survived. The fate of hospitals lies not only in the hands of hospital boards and administrators, many of whom accept the new "business of health care": diversification, repositioning, and cost consciousness. As the biggest purchasers of health care, federal and state governments, through regulation and price-setting, control much of hospitals' destiny. Business, through volume discounts, selective purchasing, and govcrnmental lobbying, holds a loaded gun to their head. Insurers and health maintenance organizations can broker contracts between consumers and hospitals that restrict hospital services and cut payments. Health care entrepreneurs (most particularly physicians) concentrate on the profitable lines of medical care and compete head-to-head with hospitals for myriad traditional hospital-delivered services. Purchasers of health care have endured years of inflation in medical prices that exceeds inflation in total consumer prices (see Exhibit 1). They argue that the sizeable gap is a sign of excessive health care costs. Hospitals respond that the high costs of the goods and services they must buy to provide health care account for the lion's share of the annual difference in inflation. Many purchasers of health care find this explanation unconvincing. In cutting their health care costs, they contend that they are paying fairly for all the health care that people need and that containing costs need not sacrifice quality or access. They cite growing bodies of research that (a) attack the premise that more medical care (and, therefore, more money) means better health and (b) show that many surgeries require fewer days of hospitalization than was prcviously thought. Hospitals retort that they have cut away the fat from their operations and adjusted L to the prevailing wisdom that less costly outpatient care and shorter hospital stays will often not com- 1 1W.I Public Sector Consultants, Inc. Knapp's Centre 300 S. Washington Square Suite 401 Lansing. MI 48933 (517)484-1954 EXHIBIT 1 Annual Percentage Increase in Index of Medical Care Prices and of Consumer Price Index, 1970-87 Year IMCP CPI Year IMCP CPI 1970 11.3 1971 13.5 1972 10.4 1973 6.1 1974 3.2 1975 4.3 1976 3.6 1977 1.9 1978 4.4 promise patient care. Inadequate payments for inpatient care, however, do threaten their ability to provide quality health care that patients need. One thing is certain: Purchasers' drive to reduce health care expenditures and cost-saving technologi- cal and medical advances that free patients from extensive hospital care will continue to change the role of the hospital from a facility where health care is provided to a facilitator of health care. As inpatient care becomes less the focus of medicine, hospitals will fill the breach with more outpatient treatment and surgery, primary care in satellite clinics, chronic and long-term care for our aging population, home health care, wellness programs, rehabilitation, and other programs. Much of this care will be coordinated by the hospital but provided outside its walls. This move in hospital care away from the hospital itself will be accompanied by a consolidation of our health care system. Small hospitals unable to diversify and survive continued pressure from purchasers will close their doors or merge with large health care systems. The flagship hospitals of these systems will maintain the latest technology and provide high-cost acute and critical care. The medium-sized and small hospitals in the system will provide limited acute care, concentrating on primary and outpatient care and the management of nontraditional hospital services cited above that are now performed largely by autonomous nursing home, home health care, and physician concerns. Big and diversified systems will control more of health care delivery and provide less of it in the hospital. While this consolidation may reduce health care expenditures, it is no guarantee that access or quality of care will be maintained. This paper will examine the forces behind the fundamental changes in the role of the hospital and the possible implications for access to and quality of care. FROM PUBLIC SERVICE TO BUSINESS There was a golden age for hospitals. The post-World War I1 economic boom and shortage of hospi- tal beds fueled federal government funding of hospital construction and modernization in communities throughout the nation. More than $4 billion was given to nearly 7,000 hospitals. Between 1946 and 1971, hospitals grew in number from 6,125 to 7,678. The spread of employer-based private health insurance, mmm Public Sector Consultants, Inc. with increasingly comprehensive benefits packages, guaranteed hospitals a steady source of revenues. In L the mid-sixties, Medicare and Medicaid-health care for the aged, disabled, and poor-brought govem- ment full-force into payment for health care. Government helped build and thcn pay hospitals. Few if any questions were asked by public and private payers, who paid most of hospital and physician charges. Nearly everyone-payers, providers, and consumers-believed we were well on our way to the ideal health care system, rich in technology and expertise, capable of providing anything from routine check- ups to sophisticated heart surgery at any time. With steady improvements in access to care, it was easy to call health care a right. Like public education, health care was a public service. In the late 1970s and 2980s, everything changed. The story of this change is familiar because it has been told, with only slight variations in plot, about Michigan's automobile industry. With agriculture and tourism, automobile manufacturing and health care are the state's biggest industries. In the seventies, a storm of international competition threatened automobile manufacturing in America. The automakers were forced to produce higher quality cars at lower costs if they wanted to survive. To do this, they af- filiated with other manufacturers and suppliers around the world ("outsourcing"); rid themselves of su- perannuated manufacturing plants and consolidated manufacturing in new plants, many overseas where labor and productioncosts are lower; reduced the white- and blue-collar work force; forged into high tech- nology with computers and robotics, aiming to reduce human error. The American automobile industry- a cause and beneficiary of the same post-WWII prosperity that fueled health care expansion-painfully reorganized in the seventies and eighties as outside forces buffeted it. Like the automobile industry, the hospital industry is struggling with change, but not as a result of in- ternational competition. Hospitals began to compete with each other for fewer and fewer patients, as the government and other third-party payers decided they cannot afford unlimited health care. Like the automobile industry, hospitals have steadfastly sought new markets to recover decreasing inpatient revenues, including outpatient services in and outside the hospital. Like the automobile industry, hospi- tals are "retooling," upgrading their physical plants and clinical equipment and eliminating unnecessary facilities and services with an eye toward greater efficiency. Like the automobile industry, hospitals have been and will be forced to consolidate. Mergers and closings are increasing in thc industry each ycar. Many jobs-with the equivalcnt of 127,689 full-time workers, hospitals are the fourth largest employer in Michigan-and a resource that many feel is essential to the community are in jeopardy. Hospitals, nevertheless, are not only businesses. They continue to provide a public service. Most people still believe that all Americans have a right to health care; few believe we have a right to a ncw mid-size sedan every two years. Because it provides a public service, a hospital idcally runs enough like a business to make sufficient profit on some services so that it can offer other unprofitable services that are necessary to its public mission. In the current health care financing climate, even the most efficient hospitals are having great difficulty accomplishing this. EMPTY BEDS AND LOW MARGINS The numbers testify to the struggling hospital industry, in Michigan and across the nation. In the past two years, 150 of the nation's 6,300 nonfederal, short-term hospitals [called "community hospitals" by the American Hospital Association (AHA)] have closed their doors. Michigan had 207 community hospi- tals in 1981; in 1987, it had 184, with 4,500 fewer beds. (See Exhibit 2.) Almost half of the 1,419 hospi- tal executives who responded to a nationwide survey by Touche-Ross in July 1988 said that their hospi- mmm 11- Public Sector Consultants, Inc.