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The 3 Pillars of the Medical-Industrial Complex and the Physician. Part 2. Evolution of The Hospitals and Insurers.

Posted on | June 27, 2016 | No Comments

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Mike Magee

In Part 1 of this 5 part series, I described the financial power and stakes of the pharmaceutical, health insurance and hospital industries, as revealed in the “givebacks” they granted to the Affordable Care Act in return for policy concessions to the Obama White House. In Part 2, I explore the immediate post-WW II evolution of the hospital and health insurance industries that set the stage for our current conditions.

The historical tracts of both the hospital and the insurance industry have charted intersecting paths, and drawn the active participation of employers who have been bearing, in large part, the costs of employee health insurance premiums since WW II. Employer based health care exploded in the US after the National War Labor Board, which regulated wartime wage and price controls, ruled in 1943 that health insurance benefits would be exempt from the controls. Their action was subsequently reinforced by IRS rulings that these fringe benefits would not be taxed as income. The net effect was that 77 million Americans had gained health insurance coverage by 1950 delivering massive additional cash flow to hospitals. This was further augmented by federal dollars in the form of construction grants from the Hill-Burton Act and NIH research grants.

Up until now, hospitals had been relatively stable, non-profit entities. In the first half of the 20th century, physicians dominated, with reform of medical education and hospital care following the clear directives laid out in the Flexner Report. On the date of the Wall Street Crash initiating the Great Depression in 1929, the country had committed $3.5 billion or 3 1/2% of of its GNP to healthcare. In light of the limited therapies available, this seemed more than reasonable.They relied primarily on a voluntary physician staff, functioning independently under their own set of Medical Staff rules, and were governed by an independent Board of Trustees made up of community luminaries with philanthropic zeal. The poor in the community were treated, to varying degrees, based on the beneficence of their local hospital and physicians. Those physicians, according to biographer Lewis Thomas, were committed to “a life of hard work and modest economic returns.” Physician wages averaged 2 1/2 times those of a skilled worker.

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The focus on “care” not “cure”, began to change with scientific advances during and after WW II. Out of that war came specialization, new therapies, the Hill-Burton Act and NIH research dollars. A decade later, the health sector exploded with growth as medical schools generated ever more physicians.  Medicare and Medicaid supported cost-plus reimbursement, which helped fill the massive number of new hospital beds that had been constructed. Test, treat, cure was now the mantra. Community hospitals controlled 82% of all in-patient facilities, over 50% of the nation’s hospital beds, and 92 % of the admissions. But at the top of the 7000+ hospital food chain, stood 40 or so Academic Health Centers, each with a premier teaching hospital, a medical school, at least one other health professional school, a biomedical research program which collectively received 75% of all NIH grants, a range of residency programs churning out ever more specialists and the latest in technology and treatment for the most complex, highly specialized cases. All of this was supported by prices that were roughly 30% higher than the local community hospitals.

By 1973, the national debate had reverted from cure to cost. The Health Maintenance Organization Act rewarded insurers which created Health Maintenance Organizations or HMOs to manage care and cost. Movement to managed care was further reinforced, when, as a byproduct of the Employment Retirement Security Act (ERISA), corporations could self-insure their own employees with protections from liability. Over the prior two decades, bed capacity had increased by a third. But once employers took control of their own health care, they invariably became very cost conscious, with a goal of dropping 15% of the cost of care. Almost immediately occupancy levels and length of stay dropped precipitously. The recession of 1980-1981 reinforced that trend, as did advances in technology which promoted ambulatory procedures and less invasive interventions in nearly every specialty field.

The National Commission on Social Security, in 1982, quietly inserted an innocent hospital payment reform proposal, and delivered the package to the Reagan White House and Congress in January, 1983. A month later, Reagan approved the measure. It all but eliminated cost-plus hospital reimbursement for Medicare patients, substituting in its place a Prospective Payment System. Episodes of care were bundled under 400+ diagnoses or Diagnosis Related Groups (DRG’s). Under the new system, a patient being treated for pneumonia would be paid a fixed amount for that diagnosis, regardless of how long he or she was in the hospital, and regardless of how many resources had been consumed. If you were efficient and careful, you made money. If not, you ate the difference. The American Hospital Association did not put up a big fight at the time because their analysis suggested this could be a winner for hospitals. Academic Health Centers were supportive because they were awarded extra payments in acknowledgement of their role as educators of medical students and residents, their treatment of more complex patients, their service to the poor and uninsured, and their over-utilization of resources that was part and parcel of an educational training environment.

But the law, along with the expansion of managed care, and employer self-insured cost containment, fundamentally changed the hospital balance of power. Clearly, physicians no longer received a carte blanche in managing their patients in the hospital. Cost now mattered, as did the numbers of ordered tests and therapies, standardization of equipment in and out of operating rooms, and length of stay. Suddenly physicians found themselves being evaluated for both the quality and the cost they were directing. As one analyst put it, “The quiet change in payment methods introduced a cascading set of changes – dramatically shorter hospital stays, fierce competition,among health care payers, and new limits on physician autonomy.”  Another remarked, “how, where, and for how long patients would be treated is being circumscribed by new rules, regulations, and protocols.”

By 1984, the business community saw little relief as their health premium costs exceeded $100 billion nationwide. In response, they experimented with more choice, and lower cost plans. Fully half of all employers changed their offered health plans between 1983 and 1985. Many went for restrictive networks that often limited use of expensive Academic Health Centers. The top 40 or so premier institutions had witnessed spectacular growth since the passage of Medicare and Medicaid, and the explosion of research funding from the federal government. The grants covered a wide array of services and facilities, including reimbursement for direct and indirect costs. They received financial rewards for managing Veterans Hospitals, for covering poor patients, for training federally approved residents, and for a whole lot more.

In the process, the power curve shifted in the large Academic Health Centers. Department Heads now controlled fiefdoms, and contributed money in the form of a “Dean’s Tax”, which the Medical School Dean could use at his discretion. But beginning in the 1970’s and extending into the 1980’s, there was a pull back in this open-ended funding, just as hospital occupancies were rising and managed care scrutiny was expanding.

By the time the 1990’s arrived, prospects for these premier institutions were looking questionable. In Part 3 of this series to follow, we’ll tract the changes over the following two decades that laid the groundwork for the passage of President Obama’s historic legislation.

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