Karen Wagner

At a Glance  

  • A state-regulated, all-payer system has saved Maryland an estimated $43 billion since 1976 while improving access to health care for state residents. It remains to be seen how healthcare reform will impact the system.  
  • Buy-in by hospitals, payers, and even the federal government is a must to keep the all-payer system working. In other states, similar efforts have failed.  
  • Uniform rate-setting takes some of the guesswork out of financial planning, but it has also resulted in lower margins and greater debt for Maryland hospitals.  

Maryland's all-payer system has lowered healthcare costs, but also has driven down hospitals' operating margins and driven up debt.

For nearly four decades, Maryland hospitals have operated under a state-regulated, all-payer system that no other state since has been able to successfully replicate. Instead of payment rates for healthcare services being negotiated between a hospital or health system and a payer, a state regulatory agency, the Health Services Cost Review Commission (HSCRC), sets them.

The HSCRC, created in 1974 and governed by seven volunteer commissioners appointed by Maryland's governor, establishes hospital-specific and service-specific rates for all inpatient, hospital-based outpatient, and emergency services. The HSCRC adjusts rates annually based on three criteria:

  • Medical cost inflation
  • Case mix changes or the degree to which hospital service use is increasing due to increases in the severity of illness of patients in the state
  • Policy

In 1977, the commission received a federal waiver to establish Medicare and Medicaid rates as well.

Over the years, the all-payer system has accomplished what it was set up to do: reduce healthcare costs in the state. In 1976, Maryland had a cost per case that was 25 percent above the average cost per case for hospitals in the country, according to the HSCRC. By 2008, the state's cost per case was 2 percent below the national average, resulting in an estimated savings of $43 billion for the state over that 32-year period. Annual updates in Maryland have consistently been about one to two points lower than national updates, according to the HSCRC.

But just how have individual hospitals and health systems fared in this deal? Does an all-payer system make operating a hospital even more challenging than it already is?

Leveling the Playing Field

Perhaps the greatest benefits of the all-payer rate-setting system for Maryland hospitals have been financial predictability and stability. Annual updates, generally equal to the rate of inflation, may not be as high as hospitals would like, but large rate discounting is off the table, too. That consistency allows for greater confidence in what hospitals will actually be paid and can help smooth out the bumps in the budgeting process.

"Stability gives you a greater ability to plan-and plan over longer horizons-than you would have if you're whip-sawed around by changes in federal and state budgets or a powerful insurer being in your neighborhood," says Stuart Erdman, senior director of finance and assistant treasurer for Johns Hopkins Medicine in Baltimore. Johns Hopkins operates four academic and community hospitals, four healthcare and surgery centers, and 25 outpatient sites.

The payment system also acts as an equalizer, says Carmela Coyle, president and CEO of the Maryland Hospital Association (MHA), which represents all of the state's 46 acute care hospitals in rate-setting and rule-making discussions with the HSCRC and payers.

"Because it is a state rate-regulated system, it tends to have the effect of floating all boats," Coyle says. That means, she says, that there are neither high-performing hospitals, financially speaking, nor hospitals closing due to financial hardship. She observes that inner-city hospitals in Maryland serving a large number of uninsured or Medicaid patients receive a fair rate for those patients, unlike similar hospitals in other inner-city areas. The system has also resulted in an equitable healthcare environment, Coyle says. Hospitals are able to more easily serve their mission of providing care regardless of who is paying.

A Smaller Bottom Line

Uniform rate setting may take some of the guesswork out of financial planning, but there's a price for that predictability-lower margins and greater debt.

"Margins are lower for Maryland hospitals," says Raymond Grahe, vice president of finance for Meritus Health. "They also have more debt because it takes margin to buy facilities and programs, and if you don't get it through the bottom line, then you have to borrow." The health system operates Meritus Medical Center, a 341-bed acute care facility in Hagerstown, plus various ambulatory care operations and medical practices in the tristate region of western Maryland, southern Pennsylvania, and the panhandle of West Virginia.

According to the HSCRC, operating margins at Maryland hospitals are about 0.5 to 0.7 percent below the national average.

Grahe says Meritus finished FY10 with barely an operating margin. He attributes the low numbers not to the payment system, but to a state assessment placed on hospitals to cover a state budget shortfall stemming from a higher-than-expected number of Medicaid recipients. Overall, he says, the all-payer system is doing its job. With an inpatient case mix adjusted cost per case of $9,173, Grahe says Meritus is one of the lowest-cost hospitals in the state.

One of the underlying issues, however-and what Coyle says hurts hospitals most-is the lack of capital funding. Hospitals say the annual update sometimes doesn't reflect the costs required to recapitalize-an issue that is especially apparent during tough economic times like these when payment increases over the last two years have not even covered inflation, Coyle says.

Over time, this lack of capital funding has resulted in aging facilities. The average age of healthcare plants in Maryland in 2009 was 10.3 years, slightly above the national average of 9.8 years, according to 2009 figures by the American Hospital Association, and above the HSCRC's target of 8.75 years.

Maryland hospitals also lag the HSCRC's financial performance benchmarks, which include such measures as total margins, operating margins, and days cash on hand.

What this amounts to is greater-than-average debt and threatened credit ratings.

Maryland hospitals, on average, have about 50 percent more debt than their peers in other states, according to Erdman. That much debt, he says, adds pressure to operating performance and gives cause for concern, even though operating margins at Johns Hopkins hospitals range between 2.75 and 3 percent, right at or above the HSCRC's 2.75 percent target. "We really can't have our profitability fall. We don't have a cushion," he says. "It doesn't leave a lot of room for mistakes or for bad judgment, not just at an individual hospital, but across this whole system."

Still, replacement facilities have been built and hospitals aren't using old equipment and outdated technology. Hospitals have been able to obtain additional capital by requesting larger updates. (Through the MHA, hospitals collectively negotiate an annual update factor with the HSCRC and payers.) The latest request for additional capital sparked somewhat of a building spree in the state, Coyle says.

Johns Hopkins built several new facilities in the past few years and is nearing completion of a $994 million project that includes an all-new hospital in east Baltimore, scheduled to open in 2012. Three years ago, when it was rated BBB2, Meritus sold bonds to help fund a new, nearly $300 million facility that opened last November. Last December, Mercy Medical Center in Baltimore opened a new, 700,000-square-foot, $400 million hospital.

"Overall, the rate-setting system is doing its job, and I think hospitals are supportive of it," says Tom Mullen, Mercy's CEO, who was involved in annual update discussions during his time as chairman of the MHA's finance committee. Mullen began working for Mercy in 1991 and became CEO in 1999.

Mullen acknowledges that recapitalizing hasn't been easy, but he says cost-efficient hospitals can make it work. At more than 5 percent, Mercy's operating margin is nearly double the HSCRC's target, one of the highest in the state over the past seven or so years, Mullen says. The medical center has been able to accomplish this the traditional way-by controlling costs and growing revenue through new programs. The new facility was financed through its operating margins, in addition to borrowing and additional capital provided in annual updates.

If the payment system has meant anything different for Mercy, it has allowed the hospital to remain independent, Mullen says. Mercy is a 244-bed teaching hospital that is part of Mercy Health Services, Inc., which includes a long-term care facility and various community health centers.

Although a lack of capital funding can deter expansion of clinical programs, that can sometimes work for, not against, hospitals, according to Mullen.

For example, as annual updates have lagged inflation and the state struggles with budget issues, Mullen says some hospitals may be putting off expansion plans and questioning the value of adding new clinical programs in bariatrics, orthopedics, or diabetes if the dollars won't be there to pay for these services. It is a kind of inherent check on expansion, which can run rampant in unregulated healthcare markets, Mullen says. "The HSCRC is looking hard at incentives to lessen hospitals' aggressiveness in expansion," he says.

And because capital is limited, Maryland providers face fewer problems with overbedding than other providers. Nationally, average utilization of staffed beds is 51 percent, while Maryland's average is about 71 percent.

All in all, the all-payer system requires a delicate balancing act.

"It's a mixed bag," Grahe says. "You don't have as much profit. You really have to prove yourself to get money and rates. But if you can do that, and run an efficient facility based upon the monies that are given, then you can still do those things that make the most sense for your community."

Impact of Healthcare Reform

Although Maryland's system has survived for nearly 40 years, just how the requirements of healthcare reform will affect hospitals in a regulated payment system remains to be seen. At first glance, the system seems to have built-in features and tools for adapting to and meeting the changes called for in reform. For example, Maryland hospitals are already accustomed to gathering and reporting financial and quality measures, essential in pay-for-performance programs, to the HSCRC.

In fact, the HSCRC has implemented several pay-for-performance initiatives. One gives higher annual updates to hospitals with lower risk-adjusted rates of hospital-acquired complications, such as central line infections, septicemia, and obstetrics complications. In the second year of the initiative, the frequency of hospital-acquired complications in the state decreased by 11.9 percent, resulting in an estimated savings of $62.5 million, according to the HSCRC.

Erdman suggests that a 2010 rate increase of only 1.4 percent provided the impetus for many hospitals to work harder to meet these and other pay-for-performance targets. "Maryland hospitals are looking for ways to take advantage of the pay-for-performance incentives to try to get another tenth or quarter of a percent of revenue increase," he says, adding that compensation for CEOs at all four Johns Hopkins hospitals is tied to such results. "Every one of those hospitals in our group is paying attention to those targets and has methods to monitor them and control the outcomes as best they can."

On the other hand, the MHA's Coyle believes the payment system first needs to be modernized before Maryland hospitals can achieve one of the tenets of healthcare reform: aligning physician and hospital incentives. She says the current payment system doesn't include hospital-based physician costs, a significant omission as more physicians are becoming hospital employees. Coyle also says the Medicare metric comparing Maryland's costs with national averages needs to be updated to include outpatient spending.

"This system continues to be, 30-plus years later, an innovative way to pay for healthcare services," Coyle says. "Right now, however, I believe our rate-setting system actually will hold us back from the goals and objectives of healthcare reform."

Payers, including the federal government, have generally been satisfied with the payment system. In fact, a handful of states have attempted to model Maryland's system, but those programs all failed because they weren't able to sustain participation by all stakeholders, particularly Medicare/Medicaid, Erdman says.

In Maryland, the federal government can opt out of the program only if it ceases to be an all-payer system or if the state doesn't keep its rate of increase for Medicare costs below the national average. Currently, says Erdman, the state has about a 10 percent cushion, so there's no reason for concern.

"It's like anything else in life: If it became unreasonable in any way, it would fall apart," says Erdman, surmising why Maryland's payment system has been working. "All the parties are getting what they want out of it."

Karen Wagner is a freelance healthcare writer, Forest Lake, Ill. (klw@klw.ms). 


Publication Date: Tuesday, November 01, 2011

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