HSC's 14th Annual Wall Street Comes to Washington Conference

Conference Transcript
July 8, 2009

P R O C E E D I N G S

PROCEEDINGS

Paul Ginsburg: I’d like to welcome you to HSC’s 14th Annual Wall Street Comes to Washington Conference. The purpose of this conference is to give the Washington health policy community better insights into market developments that are relevant to policy. And discussing market developments and their implications for people’s health care is the core activity of the Center for Studying Health System Change. Here we have an opportunity to tap a different source of information, specifically equity and bond analysts on this topic. Equity analysts advise investors about which publicly traded companies will do well and which ones will not. And bond analysts advise on the likelihood of debt repayment.

The good analysts develop a thorough understanding of the markets that the companies they follow operate in. They also follow public policy, which often has important implications for these companies.

This meeting is an opportunity for equity and bond analysts to take a break from their day jobs of assessing the outlook or the profitability or solvency of companies, and bring their understanding of market forces to bear on the questions that those involved in health policy have on their minds.

And we also include on the panel a Washington-based health policy analyst. They’ve made contributions to these sessions by tying the market development more closely to health policy.

Our format this morning will be roundtable discussion of a series of questions that had been shared in advance with the panel. We have two sessions, each with a separate panel. The first is on health insurance issues, and the second is on delivery system issues from the perspective of providers of care, such as hospitals and physician organizations.

We’ll have audience Q&A opportunities after each panel, and I believe there are question cards in your packet.

And please note that the analysts are not permitted to answer questions about the outlook for specific companies.

I want to thank the Robert Wood Johnson Foundation for funding this conference. I want to briefly introduce the panelists. All of the panelists today, except one, have participated as panelists in this conference in the past, although some have changed jobs since their last appearance.

The Wall Street analysts with the panel on insurance are Christine Arnold with Cowen and Company and Matt Borsch with Goldman Sachs. And since a large part of the hospital industry is non-profit and raises much of its capital from bonds, the second panel has both an equity analyst who’s Gary Taylor of Citigroup and a bond rating analyst, Jeff Schwab of Fitch Ratings.

And Joe Antos of the American Enterprise Institute and Bob Berenson from the Urban Institute will comment on the discussion as policy analysts rather than trying to be equity or bond analysts.

The initial topics for both panels are health care reform and the economic crisis.

So I’ll turn to my first question on health reform, and let’s get right into it. Let’s talk about the public plan, and I want to ask the panelists to discuss the implications of a public plan, the type in which providers who participate in Medicare are required to provide services to its enrollees at 105 percent or something like that of Medicare rates. What are the implications for -- what will the health care system, the financing system look like should that be enacted? Who’d like to start?

Matthew Borsch: Sure if I can just take a quick stab at it?

Paul Ginsburg: Okay.

Matthew Borsch: I think

Paul Ginsburg: You’ve never thought about this before?

Matthew Borsch: I know. That’s the first time, so I’ll just just shoot from the hip here.

No, I think that the conclusion that I come to is probably one that you’ve heard from many other sources that a public plan priced close to Medicare on provider rates would certainly have a strong price advantage, if presuming that was translated into premium costs on the front end, and would take significant and ever-growing market share.

And so, for the critics of a public plan to point to that as a Trojan horse towards a single-payer system, I think that criticism is valid, and, that, in fact, that’s probably what the outcome would be over time.

It’s interesting on Wall Street the reaction I often get from institutional investors is, aren’t the hospitals and doctors up in arms about the idea of a public plan that would pay them at Medicare or Medicare plus five percent in this example.

And, I don’t want to speak for those groups, but it’s not necessarily clear to me that they are given that with a public plan initially covering many of the previously uninsured.

Obviously, it’s a lot better to be paid at 105 percent of Medicare and to be paid -- whatever the self-pay collection rate is something very, very small. That’s particularly true in the case of the hospitals. So I’ll turn it over to any other comments.

Paul Ginsburg: Actually, before Christine speaks, I want to say that I’ve spoken to some physicians, and in certain areas, physicians in small practices would see 105 percent of Medicare as a raise. I think the big price difference would come for hospital care more than from physician services. Christine?

Christine Arnold: So a couple observations. I’d just like to throw out a few numbers. Matt’s correct. The Lewin Group estimates that Medicare pays hospitals 30 percent less than private plans and that the Medicare fee schedule is 20 percent less for doctors than private plans. And, according to Lewin, a public plan at Medicare rates would reduce costs by about 39 percent for a single person and about 22 percent for a family.

Milliman similarly concludes that the operating margin is a negative nine percent for hospitals on Medicare. So hospitals lose nine percent, according to Milliman, on Medicare; and has similar statistics suggesting that Medicare pays hospitals about 23 percent less than commercial and doctors 25 percent less.

So the issue here is very real. Our understanding is that the hospital sector did as part of what’s going to be announced today at the White House in their concessions of $155 billion to $160 billion contribution over 10 years did, as part of that, insist that the public plan not be linked to Medicare rates.

Now at this point, that’s unconfirmed. We don’t have paper on that, but the hospitals that cover both sectors are very opposed to linking this.

And the question is the law of unintended consequences here, and because we will have erosion to the public plan if, in fact, the public plan can pay doctors and hospitals 20 to 30 percent less than private health insurance, and we commoditize the insurance market with an exchange; right? Then think of any other commodity product. Like why would you pay 20 to 30 percent more for a box of Cheerios; right?

So they all look the same. So we will be going to a single-payer system in my opinion if we move down this road. And then the question is how many doctors are going to drop Medicare, if, in fact, this is what we’re going to do?

We’re asking doctors to take 20 to 30 percent less for the commercial health plans for the 180 million Americans who get coverage now. So will we be eroding the benefit of Medicare for seniors? And is that really what we intend to do?

Paul Ginsburg: Joe?

Joseph Antos: The hospital deal, so-called deal that may have been struck at least, it seems to have been announced is kind of interesting when you realize what they’re talking about. They said that they’d be willing to take a hit of $155 billion over the next 10 years. The disproportionate share component, $50 billion worth, according to them, wouldn’t kick in until 2015 and only if certain enrollment targets are met.

Now that compares to what was in the Obama budget, a $220 billion cut.

So they are hoping that they made a deal that’s better than the deal that was put before them. The only problem is that these negotiations don’t turn into law very easily, and the other problem is that they know they were going to get a big cut anyway, even if we weren’t having health reform.

So it’s really kind of an interesting problem. The hope that they can make it up on volume, clearly, this deal suggests that they’re not so confident.

Paul Ginsburg: Good. Let’s say following this the policy discussion, let’s say it were possible to create a level playing field in which the public plan would be a significant competitor, but would not, in fact, dominate the insurance markets. Is this feasible?

Christine Arnold: I don’t know what that means so here’s the question: A level playing field. I coached soccer when I was between jobs, and they were six- and seven-year olds, and the level playing field had to be downhill for my team, with the sun in the eyes of the other team. And that’s what we’re talking about here -- seven-year-old soccer.

So is the government plan going to pay taxes; right? That would be a level playing field. Is the government plan going to have the same cost of capital as these health plans, because even a nonprofit has a cost to capital. They don’t print money; right? So they have to make decisions.

If I’m going to try this out over here and take a chance and invest in this system over there, I need to raise some capital for it, and I need to get a return on that capital, because my investors are going to expect it, whether I’m for profit or not for profit.

So what’s the cost of capital going to be for this public plan? Are we just going to print money and hand it to them? Are we going to expect a return? And then are they going to pay the same to providers as health plans currently do?

Because if they’re not paying the same to providers, then it’s not a level playing field. And if they are paying the same to providers, then there’s no cost savings.

So it feels like we’re spending a whole lot of energy on the public plan when there’s so much else that I think reform could address; that the public plan option when you really think about it is going to have a hard time solving for.

Paul Ginsburg: Matt?

Matthew Borsch: I guess I would just I mean I agree with much of what Christine has said that the idea of a level playing field is a very murky one, and I think on a number of fronts where it’s hardest to envision is exactly how you would have a mechanism to pay providers that would be at a level playing field relative to commercial payers. It would be very complicated at a minimum, but presumably you could come up with something on that front.

And what you would have ultimately if you put something like that together and it truly was a level playing field is a test of the value of private-sector managed care, not in terms of provider network rate negotiation, because you’ve taken that out of the equation you’re all paying the same unit costs somehow, presumably but in terms of care coordination and driving care to certain access points on the network versus the administration and profit that comes with private-sector plans.

So, in theory, if you built it the right way, you would be testing the value of those things against the public plan that presumably had the same benefit structures, but had a much smaller overhead for administration and profit and presumably did not really have any managed care value-added capabilities.

Now the experiment for that that you can look at in some ways is Medicare Advantage. Now I know people would say, well, right now, it’s not a level playing field, because Medicare Advantage is getting whatever it is, 12 percent premium per capita. And, that’s a fair criticism. But if you look at it in terms of Medicare Advantage in periods of time when it did not have that premium, I think what you saw is that there were areas where Medicare Advantage could drive enough savings to fund the administration and profit of private sector plans, and there were areas where they couldn’t.

They could do it well in areas where there was high utilization, in areas where there was significant competition amongst providers, and it was much more difficult to do it in usually less urban areas where there’s fewer providers and arguably a lot less overutilization, maybe even underutilization.

Paul Ginsburg: So, Matt, in this sense, the public plan would somehow still have to form a network, but would, in a sense, get the right to pay not at 5 percent above Medicare, but maybe 15 or 20 percent above so that it wouldn’t dominate, but it would be a very different model. It would be like traditional Medicare in relation to Medicare Advantage, except it would be the opposite, because here the more traditionally managed plan would not be the large one. It would be the newcomer.

Joseph Antos: I think that’s a debatable point, Paul. A lot depends on the rules that come along with this. In fact, I think I agree with all the panelists that the words public plan are pretty much a red herring, put up primarily because of Democratic politics and not much else.

So the real question is what are the rules in the marketplace? And so, for example, if the public plan became the default insurer that would be a gigantic change in the way the market works.

After all, people are essentially lazy, and they don’t understand insurance, and so the default is going to be the winner. If it’s the default insurer, then no matter what you say, it’s the dominant payer. Even if it’s not the default insurer, I think there’s likely to be a perception that that is a favored plan -- that you can’t mess with that plan.

And so the idea of hospitals, for example, to name a particularly vulnerable provider group, acting as if they were negotiating on the same basis, whatever that is, with a private insurer, I think is incorrect no matter what their rules are. I think the political consequences of not participating could be very substantial for hospitals, in particular.

Paul Ginsburg: Yes, Matt. Sure.

Matthew Borsch: Could I just make one point on that. I agree with what you’re pointing to, although I would just add that in theory what you could have is a mechanism where the public plan did not negotiate per se with any of the hospitals and physicians, but it was really treated like Medicare and all providers who accept Medicare would be required to accept the public plan, and the public plan would pay at some determined average of what the commercial payers are paying.

So you would not actually be having negotiations it would in essence piggyback on the negotiations of the private carriers. I’m not advocating that, but that, in theory, is one way you could get at.

Paul Ginsburg: Yes. That’s a good point. In fact, I’ve seen some discussion about somehow finding out what the private plans are paying, which is not an easy job. And that’s what the public plan will pay. Actually, if you had a "level playing field" public plan, gave the plan some capital, but basically it still had to negotiate its own rates, my perspective on insurance markets is that they’ve been very hard to enter in recent years, so on the surface that might look level, but how can it be level when the outsiders have never succeeded in breaking into insurance markets?

Matthew Borsch: Well, I would just add on that front we are talking about a different category of new entrant

Paul Ginsburg: That’s right.

Matthew Borsch: If it’s a government-endorsed plan that is simple to understand and has some perhaps status as a default plan in some way. I think it would very significantly offset the you’re right the entry barriers are very high today but I think that could easily be taken care by the way the legislation is crafted.

Paul Ginsburg: Sure.

Christine Arnold: The key question is how will this plan deal with losses? So I think the insurance market is pretty cyclical. That’s my personal view; but cost trends rise unexpectedly, as they did in 2008; right? And then the health plans respond by raising price in order to recoup any losses.

And if the public plan can just forgo -- kind of get a do over and ignore the losses and this goes to the cost of capital issue then they will at times when medical trend upticks get a disproportionate share of membership because even if it is as close to a level playing field as possible, if they’re not earning a return on that capital, then they will be underpriced egregiously when cost trends rise.

Paul Ginsburg: Yes. Now if the public plan were instead a cooperative, would that make any difference in what we’ve said so far?

Matthew Borsch: Well, again, I mean, the problem is these concepts are being thrown out, and the devil is definitely in the details; and we don’t know how they’re really being established. I mean a co-op could in theory be very similar to the public plan in structure. , what do we mean when we’re saying a co-op? Is it a co-op that is sponsored, enabled by some new legislation that authorizes the co-op to do what or is it just we’re just saying we’re going to grant some seed money for co-ops to form in states if they want to.

Well, if you did that, you probably wouldn’t really have accomplished very much. And, but if you did the former and it was enabled by a number of provisions in legislation, then you probably have something similar to the public plan that we’re talking about, even though the idea seems to be more palatable in a sort of bipartisan sense.

Paul Ginsburg: Right. Some advocate a public plan on the basis of needing greater market power to deal with providers. Has provider market power vis-à vis health plans been increasing in recent years?

Christine Arnold: Yes. I think there’s probably four reasons why market power has been increasing among providers. First of all, right now, we’re at 60 percent of the commercial market with PPOs versus about 40 percent 10 years ago. And what we’ve done is we’ve reduced the HMOs’ presence.

So when you had HMOs, the doctors and hospitals were at risk of being out of the network. If you’re out of the network, you don’t see patients. So that threat is gone, and we also favor breadth of network.

If you talk to employers, what do they look for? I want all the doctors in the PPO network.

So there’s no real threat of being thrown out of the network if you’re a provider, and that means the providers have the negotiating leverage.

Point number two: Provider consolidation. We’ve seen the public companies, like LifePoint and Community, each increase leverage, borrow to buy other publicly traded hospital companies, and that’s been replicated in the non-public market. Hospital consolidation in the ’90s has increased pricing by at least five percentage points according to the Robert Wood Johnson Foundation. So, and if hospitals close to each other geographically consolidate, prices increased about 40 percent according to the Robert Wood Johnson Foundation.

And 1990 to 2003 was a huge wave of consolidations. And the FTC really only started challenging some of these very large hospital system consolidations in 2005. So we’re behind on the consolidation front.

Point number three: Hospitals are building a lot. They’re building service lines, and it’s making it tougher for these hospitals to be out of network because if the hospital is providing all these services, right, then this really is a one-stop shop and makes that hospital tough to dump out of the network.

There’s a long lead time, so we’re seeing an increase in hospital construction-related costs by about 20 percent in 2006 and 2007, according to MedPAC; and a 20 percent increase in capital costs at the hospitals translates into about a two percent increase in costs that the hospital has to pass on each year.

So these 20 percent increases in capital expenditures in ’06 and ’07 are still increasing hospital costs today because construction starts and takes a couple years.

They’re adding cardiovascular, imaging, office buildings, the whole nine yards. And the fourth reason is we’re into prevention and coaching and transparency and steering loosey goosey medical management versus more aggressive medical management that we had in the ’90s with health plans like pre-cert, prior-auth -- just saying no.

Paul Ginsburg: Thanks.

Matthew Borsch: Could I?

Paul Ginsburg: Sure. Go right ahead.

Matthew Borsch: Just add one point on that, which is if you look at the consolidation of market share and consolidation of market power, I think you can argue it’s happened on both sides. In other words, the hospitals have greater market power and the insurers have market power. Now maybe that doesn’t sound like you could have both but we’re talking about one relative to the other. , one relative to the other, I agree with Christine that probably the hospitals have somewhat greater leverage today than they did 10-plus years ago relative to the payers.

But I would also argue that both the hospitals and payers have greater market leverage and what that leads to is what we’ve seen for most of this decade, which is much more of a pass-through environment, where the hospitals demand rate increases that at least meet their minimum sometimes more than minimum cost needs, and the payers pass those along to the purchasers, and the employers purchasers, mostly employer groups, simply absorb those costs, and to the extent they can’t, they adjust benefits where they drop benefits. But in terms of making hard purchasing decisions and doing things that would actually change the way care is delivered, employers pretty much put up the white flag and surrendered on that front back in the late ’90s.

There’s some talk now that that’s changing in light of the economic climate that we’re in with health care premiums climbing even more rapidly now. But it’s not clear. We haven’t really seen it yet.

Paul Ginsburg: Good. Let’s say there’s no public plan. Health reform passes. Cost continues to increase rapidly. Provider market power continues to grow. Any scenarios as to how that might be resolved?

Matthew Borsch: So this is a scenario in which you have health insurance exchanges for the individual and small group business?

Paul Ginsburg: Well, actually maybe I wasn’t thinking about the details, but thinking almost like put health care reform aside.

Matthew Borsch: Aside. Okay.

Paul Ginsburg: , let’s just say hypothetically still, most people have insurance.

Matthew Borsch: Right.

Paul Ginsburg: But it looks like this pattern of growing relative provider market power, and I think hospitals have few limits other than now when they can’t raise more capital to raising their costs as to what kind of scenarios of what might the private sector or what might government eventually do to respond?

Matthew Borsch: Well, you can kind of think about two potential outcomes. And, the first is that trends that we’ve seen for much of this decade continue, and the reality of insurance risk sharing has gotten steadily weaker and weaker, certainly over the last decade. And I think it goes back further as more and more people figure out ways to get out of what is in effect the community insurance pool so that pool then gets worse and worse, and it’s what’s referred to in the insurance industry as a death spiral now. , that’s we’re not there yet, but it’s been a gradual process. It will probably continue, bringing the system ever closer to really collapsing as the growth in the number of uninsured accelerates and as the health insurance industry and employer purchasers sort of give up on anything that would be able to stem that cycle.

Now I guess the other scenario is something else happens. When I say something else, if you go back to the Clinton reform push in the early ’90s, the view was if we don’t get this done, the system is going to collapse. And, I think what the Clintons were trying to do was to push really managed care through a very heavily regulated mechanism, but to push managed care.

And that was a period of time when employers were ready to embrace managed care, and, in fact, there was a lot of low-hanging fruit to be wrung out of the system and cost trends dropped to I guess a forty-year low in the mid-’90s.

And, seemingly for a while, the private sector had the solution. So I just hold out there that while it would seem and I think the former scenario of continued erosion makes more sense. It’s possible there’s something out there that we’re missing and that employers might in the wake of a failure of health reform perhaps return to tighter forms of integrated delivery systems or really push for change on their own behalf, although I’m skeptical.

Christine Arnold: So, I mean, this might be a segue into kind of what’s missing in the reform effort. Is that kind of what you’re thinking, Paul?

Paul Ginsburg: Okay. Let’s well, actually, why don’t we hold that?

Paul Ginsburg: Joe, do you have anything to add at this point?

Joseph Antos: Well, just we should remember that the really the history of employer involvement with cost containment. So in the early ’90s, as you said, they were ready to embrace managed care. The only problem is the economy got better. Now we won’t have that problem going forward. (Laughter)

Joseph Antos: But the economy got better. And so as the lines outside the HR department grew with disgruntled employees about that blankety-blank health plan we have, employers all figured out, well, we can’t have that kind of managed care.

So now what we call managed care isn’t really very strongly managed care in most cases.

I think that story suggests to me that absent federal action, that employers will figure that out again. I mean there aren’t any there aren’t really new ideas here as far as I can see. There aren’t any miracles to expect, but going back to the old ideas that did, in fact, work for a few years. If you’re pushed up against the wall economically, you’ll probably do it, not out of the goodness of their heart, but because, after all, this is part of production.

Paul Ginsburg: Sure. Let me finish up this public plan section. As some of the advocates of public plans speak of the need for additional competition in the health insurance business, so when I hear additional competition, I want to ask the Wall Street analysts are health plans earning rates of return on equity, that is, that are above normal either overall or on particular business segments?

Christine Arnold: I wish. I mean I look at it this way: managed care stocks have been trading at a discount to the S&P as long as I’ve been following them. If they were earning superior rates of return, would they be trading at a discount to the S&P? Probably not. Right? 2006 is the only time we saw the multiples of managed care companies even approach that of the S&P. Managed care operating margins are about 6 percent.

So we have a six percent operating margin for managed care. Large-cap drug companies, 30 percent. And the same thing for medical device companies.

Now managed care companies do have the full premium rolling through. They’re arguably not the best innovators; right? Arguably not coming up with anything unusually lifesaving here. Right? So we could argue this kind of cost-benefit, but from a purely financial perspective, we’re not dealing with big margins here.

And so even if we eliminated those, that’s a pre-tax margin. So after tax, you’re dealing with what a four percent margin. So even if you elim. and somebody’s going to have to administer something. So even if you eliminated the HMOs, right, some of that four percent would have to be allocated to the government, to an exchange, to a whosy whatsy out there, and you’d only save four percent in the end.

So my view is looking at managed care as a process challenge is absolutely appropriate, but as the solution to our health care cost problem, eliminating managed care profits, not so much.

Matthew Borsch: Well, I would definitely agree with that last point that that is , obviously everything comes under examination if you’re making an earnest push at comprehensive health reform, but that when critics point to the profits of the managed care companies, it’s disingenuous given how small a slice that is of everything else, although I would say, it’s not necessarily clear to me that we can conclude from the valuation discount that the rates of return in the managed care industry are unattractive. I think part of I mean you can operate at attractive, perhaps above economic normal rates of return in an industry and still attract a pretty significant valuation discount from the market, because the market isn’t so much looking at what rate of return you’re earning now. The market’s thinking, "what’s going to happen in the future?"

And the market is always factoring in things like the risk of change to the health care system, which is very much in play now and coming up, potentially even an outcome of extinction for the economic returns of the industry in the extreme scenario as well as the cyclical nature of the business.

So I would just add on that point. And one also, Christine, just to take issue with the margin question. I think that can sometimes be you need to look at the bigger picture there, because the 30 percent margins on drug products, I mean there you’re talking about a product that a company manufactures, and that’s the price of that product. They have a patent on it. As opposed to

Christine Arnold: I agree. That goes to the whole lifesaving point.

Matthew Borsch: But I just wanted to make the point that when you look at a four percent profit margin on a fully insured premium, well that may equate to something like, let’s say $20 per member per month in pre-tax profit. Well, if it happens to be a self- insured employer, then your revenue stream is less than one-tenth the size.

Christine Arnold: Right.

Matthew Borsch: The margin might be 25 percent, but now you’re getting $5 pre-tax per member, and you’ve got a 25 percent margin. You’d much rather get the four percent

Christine Arnold: But can we agree that taking that $5 per member per month to two and half isn’t going to solve our health care crisis?

Matthew Borsch: Absolutely. No.

Christine Arnold: Which was kind of the point.

Matthew Borsch: Right.

Paul Ginsburg: That’s right. I think we can all bring this together.

Christine Arnold: Two and a half bucks a person. Yeah.

Paul Ginsburg: This is an industry where even if it has very high returns on equity, that its margins on sales are very low. So if it were made more competitive just on a static basis, it wouldn’t lower premiums very much.

So let me get into health insurance exchanges, that this seems to be a fairly important part of the proposals and so one question I’d like to pose to you -- do you expect that exchanges will reduce the costs of health insurance and, in a sense, they could reduce costs because they’d be less expensive for health plans to market or distribute to individuals and very small employers or would exchanges wind up increasing costs because there’s another layer of administration, and it’s not replacing enough existing activities?

Matthew Borsch: It all depends, of course, on how it’s set up. , if they if, through exchanges, there is a mechanism where benefit offerings are standardized, as happened years ago in the Medicare supplemental market, and if it’s set up in the right way where you no longer need as much of the intermediary function, I think you could clearly save money. If you set it up in the wrong way that could lead to a new layer of redundant costs. And just a related thing to touch on, I think you could make the argument that the individual market for health insurance has really failed, and I think that the free market doesn’t work and I’ll make that comment. I’m sure at the end of the table I’ll probably get a different opinion on that one.

But the here’s the thing: the reason the free market doesn’t work is because as a country, we’re not willing to let people die of heart attacks on the street. We have a backstop, and that backstop of at least some access to care on an emergency basis, and it makes more and more sense ,as health care costs the cost of insurance grows ever higher, that as a healthy 25 year old your decision to be uninsured becomes more and more economically rational.

Paul Ginsburg: Christine or Joe, do you want? Actually, I was going to say that in economics, there’s something called market failure.

Joseph Antos: Well, no, no. Absolutely. I think the question isn’t whether there is market failure. The question is why is there market failure? By the way, I might add that employer-sponsored coverage is in the competitive market as well. It’s just that you don’t generally have choices. But so you can trace this back potentially to World War II the tax treatment of health insurance. You can certainly trace it back to the ’50s, when there was an era big unionization, and they smart people they recognized that health benefits were going to become increasingly important, that hospitals weren’t just going to be a place where you’re going to go to die; that it would actually be useful to maybe visit the hospital once in a while.

And so we had we basically set into motion a process that’s still in motion today that pushes us towards employer-sponsored coverage and pushes us towards more generous benefits, and, of course, higher premiums. Why? Well, the tax treatment calls for lower cost sharing, higher premiums. That’s where you get the tax break. And the bargaining process in the ’50s, ’60s, and ’70s basically said let’s add more.

And in that era that made sense. The marginal additional dollar added to health insurance probably, I would guess, be more than a dollar’s worth of value to most people.

That isn’t true anymore. So when you talk about market failure, and there’s a market failure all over the place, including in the group market.

Christine Arnold: Well, I think something we haven’t touched on is kind of the broker commission structure, and what happens there. So in the individual market, brokers earn about 20-25 percent of the premium the first year, and about half that the second year and every year thereafter. So 12 to 15 percent of the premium is going to the selling broker in the individual marketplace and that is linked to the price of the premium.

And so I mean that’s something that I think the that the exchange is looking to deal with. Right now, in a world where we don’t have guaranteed issue, where we don’t have community rating, where we do have a lot of disputed claims, where we do have a lot of retroactive rescission, it’s worth having that physical broker in the minds of many individuals to say, hey, which health plan would be best for me, given who I am and what’s likely to happen to me and having someone in your camp if there’s a problem.

But if there’s heightened regulation of the insurance industry and the exchange or whoever takes that on, then the question is what’s the role of the broker? Is that their function? Or do they transition and do other things like help with care coordination or other things that we decide we need feet on the street for in terms of folks out there.

And also, we have about a four-eight percent commission in the small group marketplace, where it’s primarily outsourced HR for that small employer.

So, and most state laws now prohibit if you buy directly on Aetna.com or United.com, you go straight to the health plan you don’t get a price break, because that broker is not getting that 20 to 25 percent commission.

So it’s no cheaper and the costs are built into the product. So that’s I think a cost within the product that the exchange could help to deal with.

Paul Ginsburg: What about the degree of, say, standardization in products, say, if each carrier has to have a gold, a silver, a bronze version and that’s it. It creates a version according to the actuarial value. If there’s more standardization, if there’s a central place, does this actually make the individual health insurance market a more competitive market?

Matthew Borsch: I think it does. I mean I think because you have such an information disconnect between the seller of the product and the end purchaser.

You probably make should make a big distinction between health insurance purchasing in the exchanges where we’re talking about individuals and small group employers versus the middle market and particularly the large and jumbo employers where you have very sophisticated purchasers and there should be where you really wouldn’t need to impose that standardization.

But again, we’re talking about the exchanges, and I think you can look at the example of the Medigap market as what I believe is a successful model for this type of regulatory intervention.

Paul Ginsburg: Well, good. Let’s go to the individual mandate. And if the federal government expanded Medicaid to all people, say, up to 133 percent of poverty, and then subsidized those with incomes above that but up to 300 percent of poverty, what percentage of the latter group would be uninsured? So I guess I’m really saying what degree of compliance with an individual mandate should we expect?

Christine Arnold: Well, I’m taking a stab at some of the math here.

So it obviously depends on how much we subsidize, and the strength of the individual mandate, but if we equalize the burden of insurance for those over 300 percent of poverty and those under, so we make the people who are under 300 percent of poverty look like those that are over 300 percent of poverty, the math looks something like this: Now we have about 121.6 million people who are under 300 percent of poverty, and 27 and a half percent of those people are uninsured.

Only 8.3 percent of people over 300 percent of poverty are uninsured. And so if we took that 27.5 percent uninsured on 121.6 million people bear with me here, I’m almost done and we take that to just 8.3 percent, then 23.3 million of those 121.6 million who are currently uninsured would no longer be uninsured. So we’d reduce the number of uninsured by 23.3 million. What do you think of that?

Matthew Borsch: You lost me there.

Christine Arnold: So did I lose everybody?

Paul Ginsburg: Okay. So actually, it’s a the other thing how what proportion of the people under 300 percent of poverty will be uninsured after the subsidy?

Christine Arnold: Okay. So if we’ve got 23.3 divided by 121.6, then we’re insuring 19 percent

Paul Ginsburg: What will be the residual of people who continue to be uninsured?

Christine Arnold: Oh. Okay. So 100.5. Okay. So right now, 72.5 percent have insurance, and we are going to add another 19 percent let’s see if I can hang on 100 minus 27.5. Okay. 72.5 have insurance, and then we’re going to add another 23 million 23.3

Joseph Antos: It’s about 10 million people I think we have insured.

Christine Arnold: divided by 121.6. So we’re going to add another 19 percent, so then we’ll have 72 plus we’ll have about 10 percent uninsured. You’re right.

Paul Ginsburg: Okay. So

Joseph Antos: Let me just add that I think dynamic scoring is called for here. This is a calculation that Christine did assuming that behavior doesn’t change, and that, of course, isn’t true. If you have a mandate, then the people above 300 percent some of them will also pick up coverage.

Depending on the rules of the market, depending on other rules, you could have further up, a little bit down. It’s a little hard to know. But a good insight into this is the latest CBO estimate for the HELP Committee bill. As , they keep putting up partial bills, and they keep getting partial estimates. I don’t understand that myself.

But by 2019, Title I of the Affordable Choices Act would leave 34 million people uninsured.

Matthew Borsch: That is the CBO just came out I believe last night, though, to update that, just speaking of dynamic scoring, because they scored the $611 billion cost was tied to the number that you just gave.

Paul Ginsburg: Right.

Matthew Borsch: And now the CBO has I believe just came out last night, I believe, and said that if you did the Medicaid expansion, now you add on some $500 billion of additional costs on top of the $611 billion, and get down to I think 15 million uninsured by 2019.

Joseph Antos: Right. So 15 million is a pretty big number.

Matthew Borsch: But that’s out of a but just to be clear, I mean the CBO projection is that you have something close to 60 million uninsured if you do nothing.

Paul Ginsburg: Of the current lot. Right.

Joseph Antos: 54, yeah.

Matthew Borsch: 54; okay.

Christine Arnold: And the 10 percent of the full population remaining uninsured also assumes that everyone under 300 percent of poverty I mean my eight percent uninsured kind of rate being maintained eight to 10; we can round it is assuming that everyone under 300 percent of poverty behaves like everyone over 300 percent of poverty, which includes people who have millions of dollars. I mean my 10 percent is probably underestimating how many will remain uninsured, because we’ve included very high income people in this calculation, and because we don’t have data closer to the 300 percent data.

Joseph Antos: I’d like to think that those millionaires are self insured.

Paul Ginsburg: Now let’s say we had an individual insurance market with guaranteed issue, no medical underwriting, and compressed rating by age, and would this type of compliance that you’re talking about be enough to avoid a serious adverse selection spiral?

Matthew Borsch: They clearly have to strike the right balance here. I would say there’s maybe early evidence, and, Paul, you may know more about this than I do, but there’s some early evidence that sort of so far so good in the Massachusetts experiment. Obviously it’s going to need more time to roll through. I would say was something like that, you’re going to have to fiddle with the mechanism. It can’t be too onerous, but on the other hand, if you’re getting significant adverse selection, the balance isn’t set right and you’ve got to tighten it.

Paul Ginsburg: Yes.

Christine Arnold: I mean the industry sources suggest we need 97 to 98 percent compliance in order to avoid kind of any kind of adverse selection. And I think Matt’s right about striking the balance. Massachusetts is about, I think, a $1,000 penalty per year right now

Paul Ginsburg: Mm hmm.

Christine Arnold: if you choose not to have coverage, which is only about 83 bucks a month. But the problem is Massachusetts is over budget.

Matthew Borsch: Well, that’s a separate issue. Yes.

Christine Arnold: But they’re linked. If you don’t have the healthy person contributing the premiums, and only the sick people show up when they’re sick, then insurance coverage is going to cost more for the people who are sick.

And so the cost goes up and so if you’re subsidizing people, then the cost of your subsidy goes up. So I think it’s a big circular issue, and the question is how much are we willing to subsidize, and that will determine how much adverse selection we’re willing to take, because if we are just allowing people to show up when they’re sick, why show up when they’re healthy, and then obviously the price per person increases.

So I think we need to evaluate risk pools as we’re implementing guaranteed issue and community rating if we’re phasing them in.

So as the Senate Finance Committee currently envisions, which seems like the most kind of business savvy proposal we’ve seen to date, you have guaranteed issue community rating hitting in 2013, which means you can’t turn sick people down and you can’t price them more.

Right now, the rating bands from sickest to healthiest or from youngest and oldest and the rating bands are about 12 to 1 in terms of like the 64 year old who’s not in great health versus the 25-year-old who is. It’s a 12 to one ratio. And Senate Finance wants to go to seven and a half to one - HELP starts it at two to one.

So I mean if it’s going to cost you only double in premiums to wait until sick, why wouldn’t you?

So, I think the important thing we have risk pools and if we’re not going to be phasing in the guaranteed issue and community rating, and we are phasing in the individual mandate. If everyone doesn’t have to be in day one, then the risk selection day one will be pretty bad.

Matthew Borsch: Yeah. I’m not necessarily going to disagree with you on that, but I think you just make the argument that and it’s not a simple matter, but again you’ve got to find the right balance between people who are going to rationally respond to the incentives that are out there, and if you give them a strong enough incentive to do one thing or the other, you’re going to get a response to it. I’m not pointing to Massachusetts as a miracle. What Massachusetts has done, though, is I think you can point to it and say, well, a lot of the access and participation problem have been addressed.

Now they have a second problem, which is a big cost overrun, which has not been addressed, and that’s no small problem, so we’ll see where that goes and I think that bears a lot of parallels to the current health reform push, which is really about access and cost containment, because it’s there isn’t the political ability to deal with it right now. It’s really getting kicked down the road a few years. Sorry to drift off the topic.

Paul Ginsburg: That’s okay. We’re going to get to that. But actually, a comment on Massachusetts is that I think the anecdotes about individual mandate had been somewhat favorable given how there’s been an increasing take-up rates for employer-provided coverage and the like, but I think what Massachusetts has done is basically buried the risk of a selection spiral because they have joined the much larger small group market with the individual market. So if you have some significant adverse selection in the individual market, it’s not going to drive it down in a spiral the way it would if it was by itself.

Matthew Borsch: Right.

Paul Ginsburg: So, in a sense, it’s the people in the much larger small group market that are taking the hit, and it’s spread fairly widely.

Matthew Borsch: Yeah. I spoke to a group of small employers out there. They’re really steaming mad about that right now.

Joseph Antos: And there’s we’ve been talking here about selection as a system problem and, of course, that’s a concern. But even if that was solved, insurers still have to be smart about how they design their plans, if they’re allowed to be, because you can always go out of business, because of selection on a company basis.

Paul Ginsburg: Absolutely.

Matthew Borsch: Right.

Paul Ginsburg: That’s right. Okay. Let me get into cost containment. Now if you look at the legislative ideas that have emerged from the different congressional committees, what, if any, aspects of those ideas are most promising in the area of cost containments?

Matthew Borsch: I can I just build on my

Paul Ginsburg: Right.

Matthew Borsch: because I just , I think this is where I really am surprised at sophisticated economists and institutional investors on Wall Street who mistakenly seem to think that this health reform push and the direction of legislation is about cost containment. I mean I guess I’m just very cynical on this point, but I think I have a lot of company. It’s not about cost containment.

And we had somebody from the White House come speak to us recently, and this person basically said, well, look. What the Obama administration is not doing is, what we’re not doing is putting in place a plan that’s going to get to universal coverage and create a huge cost problem that’s going to necessitate health reform part two.

That is exactly what’s happening. Now, I think you can defend it on either end of the ideological spectrum because you could say, well, the Obama administration can’t come out and say that’s what they’re doing, but that’s the only thing they can do, because if you try to do what the Clintons tried to do 15 years ago, and come up with a plan that attacks both cost containment and universal access in one big bill, no matter how politically savvy and strong you are, it’s just not going to get through Congress.

Paul Ginsburg: Okay. Christine?

Christine Arnold: I mean I guess I’m in total agreement, but what has shocked me is kind of what we’ve done wrong on the cost containment spectrum so far. And let’s just talk about that. If you enter the doughnut hole as a senior, the branded drug companies are going to pay for half your drugs. Wow. Isn’t the doughnut hole there so that people start thinking about generics?

Joseph Antos: No.

Christine Arnold: That was part of I mean that was part of the reason for the doughnut hole is to get people thinking about generics. Now if more people enter the doughnut hole, get through the other side, guess who pays? The federal government, because the health plan only pays 15 percent of cost on the other side of the doughnut hole. Is this cost saving? I don’t know. It doesn’t sound it to me. Hospital market basket. We cut the hospital market basket. The hospitals are getting zero rate increase in 2010, administratively. This is before Congress even acts.

And we’ve already talked about the fact that there’s cost shifting, that the commercial health plans have to pay hospitals more, and now we’ve got the federal government deciding to pay less, administratively, and increasing the cost of private health insurance coverage. Wow. Is that cost containment? Is that making health care more affordable? Probably not.

And it’s not even scoreable savings, right. If we let the federal government do it, we’d have scoreable savings to pay for reform, but we did this administratively by slashing code creep at the hospitals. We still have a very fragmented IT system, right? So we’ve got the IT department in the doctor’s office, in the hospital, and then within the hospital we’ve got 10 different IT departments.

So we haven’t really tackled that. And we haven’t really worked on how doctors and hospitals practice medicine; right? We’ve still got Mildred in the front office with paper instead of hiring somebody else who is going to contact patients and say, hey I saw you haven’t been in for a while. You’re a diabetic. Come on in. When was the last time you got that kind of call from your doctor’s office?

Or hey, I know I prescribed this medicine. Did you it’s really important that you take it. Did you actually take it? Taking that from something that the health plan is supposed to be doing into the physician’s office because I mean, let’s face it, I mean I screen my calls. If my health plan’s calling, no way, right?

And those health risk assessments? I mean you’ve yeah. , we’ve been through this before. I mean everyone who’s ever seen one of my health risk assessments thinks I’m a 110 pound runway model. It’s a good time playing with the Mayo people.

So I mean I think this is where if we’re really going to contain costs, we probably need to go. And we’ve seen just in the last few months from our federal government things that I can definitively point to and say, like, cutting hospital payments administratively for Medicare and this whole drug thing are going to increase costs.

Paul Ginsburg: Okay. Did you want to add some, Joe?

Joseph Antos: Well, I mean this question of magic bullets and finding easy ways to get out of hard problems this is a this is classic Washington. We all know that. We live here. And we do believe in Santa Claus and the Easter Bunny as well.

I think Paul’s original question was is there are there any good ideas out there, and I think the my answer is, yeah, there are plenty of good ideas. We’ve had most of those same ideas for the last 20 or 25 years.

And the hope that this is the year when all those good ideas are really going to come to fruition or next year or in five years from now or 10 years from now I think is a false hope.

What it says is, first of all even the terms we use biases against action cost containment. Wow, what does the word cost mean? It means something you must spend your money on. That’s what cost is.

But this is really spending containment. And nobody wants to face that reality that it’s spending, that a lot of what we do is, in fact, optional.

A lot of the processes of medical care are speculative at best, but very expensive. A lot of what insurers do really don’t address the fundamental cost drivers in their own plans because, well, they don’t have to. The employer is happy to pass those costs on to their employees in ways that the employees don’t understand.

So it’s a pretty depressing picture, it seems to me. But fortunately, Washington is right there hoping with the best of us that something miraculous will happen. And CBO is saying on a regular basis, we’ll give you a little here and a little there, but when you look at the track record, it doesn’t look good.

Paul Ginsburg: Okay. Let’s move on to I’ve got a question about Medicare Advantage and then want to get into commercial insurance.

With the proposal to essentially put Medicare Advantage payments on the same level as those for traditional Medicare, how will the Medicare Advantage industry evolve? I mean what types of products or market share could we look to presuming that there’s success in having the cost to the government being about the same to those who enroll in Medicare Advantage compared to staying in the traditional Medicare program?

Christine Arnold: Well, I mean analysts have been around forever. But I’d kind of like to change the debate. Can we do an audience participation thing?

Paul Ginsburg: We’re going to get to that soon.

Christine Arnold: Okay. Well, in terms of kind of from my perspective, how many of you have an issue with subsidizing low-income seniors? Anyone have an issue with that? Okay. How many people think it’s okay to subsidize low-income seniors? All right. You’re awake. Okay. Good. So here’s the idea here: If we’re paying 114 percent of fee for service for Medicare Advantage members, then why isn’t anyone talking about enhancing the benefit package such that that extra 14 percent goes to better benefits, and allowing lower-income seniors to be in these products? We got, like, bipartisan support for this out there, and it includes some Republicans probably, too.

So if we were to tax people who are, say, not low-income, who choose those incremental benefits, then we could achieve the same fiscal objective without hurting lower income seniors who need those incremental benefits. And that seems to me to be I don’t know a better solution than just taking away with a chopping block the 14 percent in incremental benefits, so that’s my first observation.

And then I kind of object to the idea that we just take away the 14 percent without thinking about how it impacts seniors. Why are we taking away from old people, right, to give to people under 65 to have health insurance coverage. It just doesn’t seem like the right equation.

Matthew Borsch: If I could take it from a different angle, which is leaving aside the policy question, assuming that does happen and that you simplistically let’s think about and this, in fact, it is in some of the proposed legislation you just take that that 14 percent or 12 percent subsidy down to zero in the order of a few short years, and you get $177 billion or however much it is over 10 years. I mean it’s going to be a very painful transition from the standpoint of the participating Medicare Advantage plans.

You are going to I mean there’s a big question here on whether you leave in place the current geographic formulas that are tied to the local costs of care. Under Medicare, traditional Medicare, if you do that, then Medicare Advantage is going to go back to probably looking a lot like it did in the ’90s, which is it’s going to be much more concentrated in urban areas, much more concentrated in areas where there is significant provider competition, significant overutilization, and it’s going to be offered in the form of HMO products tight network, tightly managed HMO products because those are the only ones where you can enable enough cost savings to pay for administration and profits, and also all of the Part A and B benefits and also some supplemental benefits, because you’ve got to do something to attract seniors to want to be in a Medicare HMO as opposed to traditional Medicare.

Now we can make arguments on both sides of the policy question. I will say, though, that you could make an argument that that’s actually rational, that it should be in those geographic areas where private-sector plans can drive savings is where they should participate the most, and in areas where right now you have a lot of private fee-for service plans that don’t do very much at all, and in many cases those are in rural areas that those plans shouldn’t be there in the first place.

Paul Ginsburg: Okay. Joe?

Joseph Antos: There is, of course, the big political angle on all this, which is senators from largely rural states, and what they see is they think of the family farmer. This is probably not necessarily the right picture, but it’s the easiest one to think of the family farmer didn’t work for General Motors, General Electric or any of the Generals and didn’t get a retiree health benefits program. So they’re stuck buying a commercial Medigap policy.

And so, in a sense, whether this was really intended back after ’97 or not, what we’ve sort of gradually worked our way towards is a system of providing federal subsidies for what is essentially Medigap for people in largely rural states.

Now I think what Christine said really nails it, but I would make a distinction here between subsidies and payments to plans. Let’s separate those things out. What we want are the health plans to act efficiently. So we want to have a payment system for health plans that rewards efficiency and rewards smart benefit design and smart marketing and smart everything else about health plans.

That’s separate from the question of how you subsidize people. And I think that’s a lot of what health reform is allegedly about. It’s too bad that we don’t talk about this directly when we talk about Medicare, but that’s sort of the principle health reform that I get when I read the newspaper, and I think it’s a reasonable principle.

So if we’re going to make some changes here, let’s think about promoting efficiency in the Medicare program also with traditional fee for service Medicare. But let’s not forget that there are people, not just people in rural states, that could use more help.

Matthew Borsch: The context to bear in mind here is when you look at the Medicaid program for the poor, there the majority of beneficiaries, if not the majority of spending, are in quasi-private sector managed care plans, and that is a contrast to Medicare, where the penetration of Medicare Advantage right now is about 25 percent, and if we go to parity, it’s probably going to go down to something between 15 to 20 percent. Well, do you have that difference in the first place? Because politically we can’t mandate managed care plans for the Medicare population. So I mean that’s the context to all of this and why one of the ideological reasons or policy reasons for driving that big subsidy to begin with was not only to secure a political base for the Medicare Advantage program in more than just the high cost urban areas but also the idea, well, you can’t mandate it like you can in Medicaid.

So you’ve got to get people in over time with this additional subsidy, and then gradually, we’ll have to ratchet back the benefits as Medicare becomes more and more of an unsustainable cost burden.

Paul Ginsburg: I’d like to talk next about the impact of the severe economic decline on commercial health insurance -- things like enrollment, benefit buy downs, other product changes, premiums. I’d like to ask the analysts what they have seen so far or what they expect to see.

Christine Arnold: Obviously enrollment is down because of the economic downturn, and we’ve seen much more price sensitivity on the part of small employers and individuals. So we’re seeing a lot more churn I think in the books of business.

So small group and individual members will move for as much as little as a five percent differential on pricing.

We saw this year entering the so 2008 I think medical trends upticked a bit and that caused health plans to increase pricing. So pricing before benefit changes we think is up about 100 basis points in the individual and small group segment, which means prices are a little bit higher this year than they were last year because of the increase in medical trends that we saw last year.

We’re also seeing an increase in benefit changes. So we had thought we had reached largely kind of the end of the road on benefit design changes in ’08, but we saw a pretty big uptake in benefit design changes more cost shifting to the consumers entering 2009, and what we’re seeing is increased deductibles, increased in upfront deductibles, higher out-of-pocket costs.

Next year we’re expecting large employers who did not make these changes entering this year because the economic downturn happened in October of ’08, and their benefit design changes were largely set. Next year we’re expecting benefit design changes to be much steeper in the large group segment of the market. We’re also expecting those large employers to have to bear the price increases they didn’t get entering ’09, because they renewed too soon.

So we’re expecting things to get kind of tougher for the larger employers. The large employers are, in turn, kind of going back to the health plans and trying to get a guarantee on their insured medical trend.

And so we’re seeing a bigger trend towards large employers setting their medical cost trend by saying I’m going to give you this ASO fee of $15 to $20 per member per month, but if my medical trend is not below X, then I expect you to give me about half that back.

So we’re seeing a much more aggressive large employer in terms of maintaining the trend on the ASO, but if that large employer is fully insured, they’re going to pay a price increase.

Paul Ginsburg: Yes. Matt?

Matthew Borsch: Well, just a couple comments from a different maybe a different angle here, which is when you think about medical spending inflation and the impact that the economy has had there, I mean you need to parse it into a couple of different questions. First of all distinguish between the absolute level of spending and per capita insured spending, because with the recession, the insurance has contracted and the impact per insured member has been subject to some offsetting factors, because, on the one hand, you have people who are facing significant cost sharing and now are feeling much more economically squeezed and, therefore, have reason to delay or not seek care. And there seems to be evidence that there is a lot of that, in fact, that’s happened this year.

The flipside of it, though, is you have dynamics like people taking advantage of their insurance benefit or using it because they expect to actually lose their job, and so they want to use the benefit while they can. You also have the dynamic of hospitals seeking to cost shift to private carriers, which translates into medical inflation, and their costs hospitals are seeking to cost shift because they’re facing a more sharply rising uncompensated care burden and lower volumes in light of the economic backdrop.

And the last angle of this is adverse selection. We actually haven’t seen as much of this as at least I was expecting earlier this year, but we’ll see what happens over the remainder of this year into 2010. But adverse selection resulting from the fact that, as a simple example fewer healthy 25- to 30- year-olds actually taking up employer-subsidized, employer-offered coverage because in this economic environment it’s a significant chunk out of take-home pay.

But those are some of the dynamics to watch, and the COBRA option and the COBRA subsidy come into play there as well.

Paul Ginsburg: Good. Matt, here’s a question for you and I’m asking it to you because I know you’ve done work on this before this is about investment losses for insurers on their reserves; that there certainly were some losses as asset prices, including bonds, sharply declined. And has this been substantial enough to actually lead plans to change strategies, to do more than just absorb the loss?

Matthew Borsch: I think you want to distinguish between the public and non the publicly traded, which is about half of the industry market shares with the publicly traded plans and the non-public, mostly not-for profit plans. And the reason to distinguish there is because the publicly traded plans don’t hold as much capital. They generally seek to pay it back to shareholders either by repurchasing stock or less frequently these days paying a dividend or doing acquisitions.

And they also the publicly traded insurers tend to hold more of their investment portfolio in more fixed income, shorter-term duration instruments.

So, therefore, just to make a point, the publicly traded insurers, while they’ve definitely taken a hit from the market last year, I don’t think it really has had a substantial impact on their behavior.

The contrast, then, though, with the non-public, not-for-profit plans, which holds more of their investment portfolios in longer duration and they don’t have access to the capital markets, and so they’re holding more capital, and they’re holding it more in longer duration, more equity-oriented holdings, the impact has been somewhat more pronounced there, and from anecdotally, from a lot of different sources, it does seem like it’s made a difference in the pricing behavior of those nonpublic companies.

They’ve gotten in in the parlance of the public companies, they’ve gotten more price disciplined. They’re putting through higher health insurance rate increases than might otherwise be the case to offset the fact that their capital ratios actually went down for the first time in about six years last year.

And I think that pricing discipline, if you will, has carried through for the whole industry and employers are facing stiffer rate increases than they were a year ago as a result.

Paul Ginsburg: Thanks. Let me turn to some question from cards and if others would like to get up. How will changing health care financing alone, without changing the fragmented, dysfunctional care delivery system fix anything? The question is supposed to be for me, but I’d rather the analysts answer it.

Matthew Borsch: Just one point I want to make is that that the pushback to that question again could be that if you have an agenda where you say we can’t do both cost containment and access at the same time and you can’t do cost containment until the problem is even worse than it is today, then the rational approach is to put forth a health reform plan that is mostly about expanding insurance access, which will necessitate an even bigger cost problem a few years down the road, which will be so big that we’ll have to deal with it by reorganizing the health care system.

One could defend that as the only rational way to go because no other approach is politically feasible. So I’d just offer that up.

Paul Ginsburg: Okay. Good. I’ve got these two questions, both on the same topic. Let me read both. What about administrative costs? The public plan is supposed to cut costs by eliminating all that wasted overhead. And there’s another question, which is directed at Christine, administrative costs. The New York Times reported last week that private insurers spentt 17 percent on administrative costs, including marketing, as compared to about three to five percent for Medicare, even though health plans only earn six percent margins.

Why isn’t the relative cost of administration a greater part of the debate between public and private plans? Why isn’t the debate about costs rather than profits? Actually, I think the debate is about costs, but go ahead, Christine.

Christine Arnold: Okay. So a couple points here. Of the $2.6 trillion in U.S. health care costs about seven percent, or $200 billion, is administration and profit of insurance companies. So including the profit margins plus administrative costs of the health plans, we’re dealing with about seven percent of the $2.6 trillion. That’s financing, distribution, regulatory costs.We’ve talked about the individual and small group market where we’re paying brokers an average of 15 percent of the premium in order to distribute the product. That’s clearly an opportunity to eliminate some costs. We also have a four to eight percent small-group commission.

I think the reason that Medicare is perceived to be so much cheaper is because there’s huge standardization in Medicare and pretty much all claims are paid. So there’s no pre-certification. There’s no prior authorization. There’s no disease management. There is no nurse calling. There is one standard system that the claims go through, and they have these adjudicators and so we’ve very much standardized how we pay doctors and hospitals.

So, for a doc for hospitals, we’ve got a DRG. For doctors, we’ve got RVUs. And the health plans have attempted to contract with providers, and they’ve gotten very sophisticated in their contracting. But it also means that the administrative costs are higher.

Keep in mind that the health plans are dealing with this cost shift. Right? If Medicare is paying 20 to 30 percent less to doctors and hospitals than the health plans, they’re paying more. They’re trying to get creative with their strategies with doctors and hospitals and disease management and contracting, which increases complexity, and increases the administrative costs, because they’re dealing with a situation where they’re being cost shifted to.

And doctors and hospitals, as they continue to be pressured on the Medicare and Medicaid side, are increasing costs to the health plans. A natural outgrowth of that is that administrative costs are going to rise with the health plans and they’re going to be larger than Medicare.

Paul Ginsburg: Thank you. I’ve got a question about actually, most of the questions were about cost containments.

What opportunities are there for cost savings that you see, not necessarily in the bills, but this is really a question about what actually could be done if you wanted to address costs now, and this question was focusing on particularly provider payments, whether bundling payments, hospitals and doctors or tightening post-acute payment systems.

Matthew Borsch: Just a quick one on that -- my observation and this is certainly not unique but is coming out, that you can do some things with bundling payments. The more you bundle, the more you encourage integration in the health care system by doctors working together in larger practices, working across specialties, working with facilities.

And if there’s a key piece of evidence out there it’s that integrated delivery systems where the economics are on a much more shared basis deliver better outcomes at substantially lower costs.

But you probably need more than just bundling some of the Medicare payments to get there. In fact, you probably need a lot more to get there.

Paul Ginsburg: Yes. And the question is what should, if anything, government be doing to foster the movement of resources. Christine?

Christine Arnold: I’m not sure if it’s the role of the government to kind of to come up with innovation; right? That’s why I mean look at Medicare. Like how innovative is it? Not really.

So I think this is kind of a role for the private sector, and what we need is a bunch of maybe pilot programs organized by the private sector in order to get back to where we were heading in the mid-’90s kind of post-Hillary care. Remember those physician practice management companies?

And that was an effort to get doctors organized together like Matt is talking about in multi-specialty practice organizations.

Now the challenge was that we didn’t necessarily execute very well, and the physician practice management companies are gone and kind of extinct, because instead of really incentivizing doctors and hospitals to work together to lower medical costs, we bought the doctors’ practices; right? And then they went out golfing. And, lo and behold, we lost money.

So it wasn’t and now we’ve got issues with the way we pay doctors and hospitals in terms of Stark rules, in terms of antitrust, in terms and so I think what the government can do is bring down some of those barriers that are keeping doctors and hospitals from working better together in order to manage care. The medical home model is one thing that they’re talking about, but also bundling payments alone like, if we just hand hospitals and doctors bundled payments before they’re organized, I mean we’re just setting ourselves up for huge disaster.

Even back when we did capitation and, by the way, bundling is capitation. Right? That’s what it is. We’ve seen this before. We had this all in the ’90s, and it works great when you continue to increase what you’re handing them. It works not so well when you’re reducing what you’re handing doctors and hospitals.

Matthew Borsch: Christine, could I just I really don’t agree. , I think private sector based incremental efforts first of all, I worked for one of those physician practice management companies for six years. My golf game did not improve.

Christine Arnold: Well, you’re not a doctor.

(Laughter.)

Matthew Borsch: No, but seriously, I think I just I don’t think I don’t think the private sector has the answer with innovative pilot projects. I think you need to go back to something like, frankly, what the Clintons proposed 15 years ago. And you either have to go to single-payer or you’ve got to go to something like a system of managed competition where you take the employer out of the purchasing function, and that type of system is actually pretty simple in its design, and what it looks like, ironically, is the Medicare Advantage system does today. That is exactly what was put on the table.

Now the problem is we are just not politically willing to accept that kind of change

Christine Arnold: Right.

Matthew Borsch: in the health care system. So it just ain’t going to happen until the problem gets worse.

Christine Arnold: I think we’re going to have to agree to disagree on this, because I would point to Mayo and Kaiser as private sector examples where we have superior outcomes. We have integration. We have this practice model that we could deploy.

Matthew Borsch: I no, no, no. I’m not saying that the integrated delivery system shouldn’t be private sector. But I’m saying you can’t the private sector isn’t going to get us to where Kaiser and Mayo are the dominant systems. In fact, they’re leading us in the other direction. And that’s where you need government intervention.

Paul Ginsburg: Yes. I could actually say many of these prominent systems are prominent despite all of the market forces that are going against them, and that they’re truly outstanding organizations. But the real question is how do you get more normal people to form more normal organizations and go in that direction because forces are pushing them there.We’ve got a question at the microphone there.

Linda Truman: Yes. My name’s Laura Truman, and I’m following on what you’re discussing now and that is on getting it bending the cost curve. The president is touting the Mayo-like system regularly. Peter Orszag has in the hat that he wore before at CBO before saying that addressing the regional variations on costs could save 30 percent on what we spend on health care. People tout the Geisinger system in Pennsylvania. They point to North Carolina’s Medicaid reform. So these are all areas where we’re seeing some results and the medical home model. I’m wondering if you were seeing things like that being supported in the legislation that is being talked about now or are we spending all our time talking about a public plan and not enough about how to address the cost?

Matthew Borsch: Yes. My answer is that the legislation that’s on the table does not really meaningfully push us towards those types of models far from it.

Christine Arnold: And the whole discussion has been hijacked by the public plan. I agree. I mean they do have grants to support the medical home model, but I mean I really think that we need to change the way the physician’s office and that we need to pay them differently in order to do that. And that gets to kind of Mildred versus somebody else and then the doctors working together.

Paul Ginsburg: Yes. And we have a question here, which will have to be the last question before the break. Much of the cost of health care today is due to personal lifestyle choices. Is it realistic at all to think that reform should or could include some sort of mandate around personal responsibility for your health, for example, smoking cessation, weight reduction. Would an affordable public plan just exacerbate people’s apathy towards managing their good health?

So really this question where does better personal choices fit in the whole reform debate?

Matthew Borsch: I think that’s a distraction. I hear this frequently. Clearly you can legitimately point to problems that arise from obesity, from smoking and all those things. And yet if you look at the availability of affordable health care in other industrialized countries I don’t see any evidence that that is somehow encouraging unhealthy lifestyles. And I think that really while steps to encourage wellness and prevention, I don’t think as a society we’re willing to go too far in terms of coercion. And there’s more than enough to be done with huge rates of over utilization before we get to that question.

Christine Arnold: I mean who’s not aware we shouldn’t be smoking; we should lose weight, and we should exercise. Like who doesn’t know that?

So what? We all know that. I mean I don’t know I struggle with it now, because ever since you guys passed that TARP thing I look at a cheese Danish and think that’s my bonus.

You feel the same way? Yeah. Sorry. So I mean I think we can have penalties in terms of higher premiums and build that into kind of how we’re going to have our minimum benefit package. So if you don’t meet these expectations, then your premium then we could widen the premium range. I mean that’s the way we could tackle it in order to encourage changed behavior. But I just think that changing behavior is an incredibly difficult thing for a government to try to impose, or even a health plan, on individuals, and that gets back to this whole issue of it needing to be coming from the physician’s office and changing the way the doctor’s office practices medicine so they’re not just wandering around with claims forms spending 10 minutes. So we’ve got somebody else allocated in that office to say, look, here. I’m looking at you as a person, and I’m saying these are the things I’d like you to work on. Here are some programs I’d like you to enroll in, and someone is going to call you and follow up on your progress.

And so we bring in kind of I don’t know , Weight Watchers in, SilverSneakers and nutritionists and other kinds of folks in disease management into the physician’s office, and that becomes a part of what they do, because I don’t think it’s going to come from the government. And I probably speak for everyone in saying I don’t want to hear it from my health plan.

Paul Ginsburg: We’re going to take a break. The next panel will start at 10:45, and please join me in thanking the panelists.

(Applause.)

Paul Ginsburg: O.K., let’s start the second session. I introduced the panelists before. Gary Taylor from Citigroup, Jeff Schaub from Fitch Ratings, and Bob Berenson from The Urban Institute.

This panel is going to be about providers, particularly hospitals and physicians, and I’m going to start this off as the first panel did, on the subject of health care reform and ask hospitals are watching health reform and what perspective do they have on proposals for a public plan. Do you want to start Gary?

Gary Taylor: I’ll go first. Good morning, well I cover all the for-profit hospital companies and Jeff covers a lot of the nonprofit providers. So, our perspectives may be a little bit different.

But I think hospitals are watching development of reform very nervously, because there’s always a lot of unintended consequences when the government changes things. And even though things aren’t great now burden of the uninsured is a substantial burden, I think there’s a little bit of fear that what could come out of this process could actually be worse. So, I think there’s some caution, but with that caution there’s obviously also some opportunity. The companies I cover somewhere between 6 and 7 percent of their total patient volumes are uninsured. So they get paid essentially nothing for 6 to 7 percent of their total volume. So, a plan whether it be a public plan, or whether it be commercial plans as part of an exchange with that would actually allow more folks to have coverage could be a substantial positive for the hospital industry.

And of course they know that if they get a positive they’re going to get things taken away, and I’m not sure if they’ve officially put out their proposal yet. But they’re proposing a willingness to take a $150 billion of payment cuts over the next 10 years to help support this reform effort.

So, I mean hospitals are very nervous, but I think they’re really excited if something really can get done on this uninsured burden.

Paul Ginsburg: Jeff?

Jeff Schaub: Yes, well I would pick up on one thing in particular. They think they could get something under insurance reform, but they know they’re going to get something taken away. And from our perspective as a bond-rating agency, I think for the bulk of insurance reform it’s going to be a wash.I mean the 46-48 million people that are not insured right now don’t stay away from health care. They’re in the system; they just don’t have a direct reimbursement mechanism to sponsor them. So, but the cost is paid for, the nurses and doctors, and supplies are paid for, they’re just paid for through subsidy payments, and other types of programs designed to partially fund uncompensated care.

So, in a it could be a wash. There will be slight positives, slight negatives. But with insurance coverage instead of getting the $.02 on the dollar that an uninsured person pays a hospital, they’ll get several cents. $.30, $.60, it’s tough to pick a number. But on the other side we do expect to see reductions in payments for uncompensated care. DSH, various state level, and even local taxation subsidy programs.

So, most of the hospitals that we rate are pretty neutral on whether they think there’s going to be a plus or a minus to reform. There certainly is a lot of effort spent right now in qualifying folks for charity care, and in trying to collect on bad debt expense. So, some of that administrative cost goes away. But again, hospitals are fearful of the change, but they don’t see a great benefit or disadvantage to moving towards a more insurance-like mechanism for those patients.

Paul Ginsburg: Yes, so they say the real reward is patients that aren’t insured being insured, and they’re not too concerned about doesn’t sound like terribly concerned about getting lower payment rates for some of their patients who are already insured? And is this their political call or that they could handle the lower reimbursement?

Jeff Schaub: Well, they’re not enthusiastic about lower reimbursements and from a bond holder prospective neither should be bond holders. But they feel they can handle the types of pressures that might come about through reform.

Paul Ginsburg: Okay. Bob?

Robert Berenson: I assume you’re going to in a moment ask about the public plan and the perceptions of that?

Paul Ginsburg: Well this really is getting in to that. That’s right, so go right ahead.

Robert Berenson: Okay. So, I won’t you want me to do that now?

Paul Ginsburg: Sure.

Robert Berenson: Because I wanted to get some comments out about some of the observations that were in the first panel

Paul Ginsburg: Okay.

Robert Berenson: Which I think are relevant to this panel as well, about the public plan. I thought there was some data cherry picking going on, and so I want to just make a few points. It will take a few minutes probably.

I mean the argument seems to be that government insurance is inherently inefficient, tolerates fraud and abuse, tolerates McAllen, Texas, it uses Soviet-style price controls as the Wall Street Journal would characterize them. Wall Street Journal editorial that produced lousy quality And well, the threat is that a government bureaucrat will show up in the doctor’s office, and start making medical decisions. And yet everybody’s going to pick the public plan if it’s offered.

I think what’s really going on is some savvy people actually believe that Medicare works pretty well, and that so would a public plan. And so if it actually was given an opportunity, it might actually attract people. And therefore it is a threat to private insurance.

But a couple of other points I want to make. The assumption that the private plans can’t compete with a public plan. I don’t quite understand those assumptions that came out of the Lewin analysis. Seemed mostly to be based on price, assuming all the difference was in prices, and I agree with the data about 20 percent, and 30 percent for physicians and hospitals that private plans pay more. And clearly hospitals would rather have 30 percent more than that.

But I would want to ask how then do you explain the Medicare data, which shows that HMOs and Medicare Advantage produced the Part A and Part B premiums at about 98 percent of the cost to traditional Medicare, and PPO’s at about I think it’s 105 or 107 percent. Clearly plans that have an advantage are able to do something on volume utilization that the public that Medicare can’t do. They’re fairly competitive in the Medicare I think it is clearly a tilted playing field currently in Medicare, because the plans get the subsidies. But in fact, they’re relatively competitive and I assume that’s what would happen if there was a public plan, especially I don’t think the public plan could start at Medicare rates. It would have to be paying somewhere between Medicare rates, and current rates.

And I guess the third thing I would want to say is that I think it’s a mistake to just talk about, and this will get us into I think some more discussion for this panel, into sort of the aggregate spending differences on prices. I mean the aggregate price differences for hospitals and physicians, and not look at the distribution of those differences. So, if physicians overall get 20 percent more from a private plan than Medicare I’m not sure that that means that we have an access or quality problem, if we paid them all at Medicare rates.

So, a radiologist coming out of training can command $600,00 or $700,000 with 10 weeks vacation to start in a practice. So, if Medicare pays 20 percent below that I’m supposed to have a problem if they’re making $500,000.00 and 8 weeks vacation?

On the hospital side there’s huge geographic variations. Geography is destiny and there are have and have-not hospitals. And so clearly, some hospitals would not be able to tolerate a significant reduction in their prices. Others are doing quite well, thank you very much. And so I think a public plan and Medicare in fact should be bringing a little more sophistication to distinguishing across provider types, and their financial well being in terms of how it structures its payment.

So, I guess those were some of the points I wanted to make up front. The bottom line here let me make the final point is related to the level playing field. And you heard some comments about advantages that a public plan would have. It doesn’t have the cost of capital, there were some other points made. But a public plan would presumably have to be an any willing provider plan as Medicare is. If it wanted to start eliminating people or not contracting people because of quality problems, it faces government due process requirements, whereas a private plan can simply terminate without cause.

And so, if anything I think Medicare and what’s likely to happen for a public plan is that it will be under funded in administration, and can’t do medical management like private plans can do, for various reasons. So, if we really wanted to have a fair scorecard of a level playing field I think we’d be adding up on both sides of the ledger. I’m not sure you can create a level playing field, but I would say that private plans and a public plan would have different advantages and disadvantages that haven’t fully been articulated.

Paul Ginsburg: Thanks Bob. Actually getting back to a comment that Matt Borsch made. I think your notion of the public and private plans would be different. Which is, he used the example, well maybe the public plan will start looking like Medicare with less medical management, and access to lower prices. And so in a sense we’ll have, although with the shifting somewhat of a replay of Medicare Advantage versus traditional Medicare, if we had a public and private plans for the under-65 population.

Robert Berenson: Yes, I think that’s right. I think it’s clear that it may be that certain kinds of private plans wouldn’t be able to compete. But those are the ones that are mostly Medicare look-alikes. They’re sort of open fee-for-service plans, all providers. I guess the prototype would be a private fee-for-service plan, and Medicare Advantage that would no longer be able to deem rates on some providers.

I don’t know that the system would be hurt very much if those plans disappeared. The tightly managed good HMOs would should be able to compete quite effectively, and if that’s the result you have a public plan that’s efficient, but it’s an all provider, any willing provider plan, and while it should be allowed to test new payment models. It’s not going to be as innovative as what a good private plan can be. You’ve got I think the makings there of a reasonable competitive environment, and people can choose which plan they’re more comfortable with.

I don’t the basic point I’m making here is I think the cost advantage that’s been assigned to the public plan in some of the modeling is pretty exaggerated.

Paul Ginsburg: Good. What about the impact on hospital utilization of the coverage expansion, presuming we do get the number of uninsured down to 10 or 15 million. Do hospitals have the capacity to handle the increase in utilization?

Gary Taylor: From my prospective I think they do. I think we’ve done some work on that. If you look at the uninsured population, it’s about 15 percent of the total U.S. population, but it represents only about 6 percent of hospital utilization. Part of that is logical, because the uninsured are disproportionately a younger, healthier population. But we’ve done some work just on age stratification of the uninsured population. We think that it’s 15 percent of the population; it should be in the ballpark of 10 to 11 percent of total utilization.

So, our math would suggest you probably would see hospital utilization nearly double in the uninsured population. But that only constitutes about a 4 to 5 percent increase in total hospital days, and the industry is running about 60 percent occupancy. So, the physical capacity is certainly there. There would be some incremental staffing efforts, but we think they can handle it.

Paul Ginsburg: Okay.

Jeff Schaub: Yes, I agree with that. I mean the industry has gone through a tremendous building boom since the beginning of the decade, late 1990s. And there has been an awful lot of new capacity brought online, especially in the second half of the decade. It’s not unusual or wasn’t unusual a few years ago to look across any city skyline and if you counted eight cranes, six of them were hospital construction projects.

And that capacity that new capacity it’s not necessarily inpatient beds. It’s reconfigured capacity to reflect what’s happened in medicine since a lot of these institutions were built following World War II. A lot more ambulatory facilities, a lot of stuff in suburbs, urban areas where the population is, and where hospitals have gone to follow commercial payor mix.

Paul Ginsburg: Good. I would imagine there’ll be a change in payor mix in hospitals with reforms. Such as more Medicaid patients, and more privately insured patients, and as you mentioned fewer uninsured. Likely too it’s just like they’d have a significant effect on margins, or is this going to have a balance out?

Jeff Schaub: Well, our outlook on this sector is negative, and we’re looking, or expecting, lower operating margins for the next 24 months or so. And quite possible beyond that. For a lot of different reasons, I think shifts in payor mix are probably a smaller component of that outlook then other factors.

Paul Ginsburg: Okay.

Gary Taylor: I’ll make a couple comments. I’m actually in an interesting position. I haven’t recommended a hospital stock since 2003, I’m kind of known to be the bear on the street about the hospital sector, but we actually upgraded the sector in the last few months. Part of which because the valuations have come down so dramatically, because of their balance sheet positions, and because of investor concerns over health care reform.

But I’m actually optimistic that what we could see done this year could be at least a modest net positive for the hospitals. Because I just I don’t ultimately believe we’re going to have large public plan, paying Medicare rates that sucks tens of millions of people out of the private health insurance market. And I think that’d be a net positive for the hospitals.

But the key issue, just the way we think about the math. Hospitals make 20 to 25 percent margin on commercial patients, they roughly break even on Medicare, they lose 20 to 30 percent margin on Medicaid. And then on the uninsured not excluding some of the subsidies that are built into their total Medicare rates that take them to just a break even margin, on the uninsured they collect $.08 to $.10 on the dollar.

So, the big concern would be anything we can do that would provide payment for the uninsured, is great. But if it does it in a way that it pulls people out of those commercial profit margins into break even type Medicare profit margins, is going to be a negative. And there’s a crossing over point where it’s good up to a point, but then if we get 50 to 60 million people move into this public plan it would be a net negative.

So, so much of the devil is in the details, but I think it really depends on if we get a public plan, what does it pay, and what incentives or what disincentives are in that public plan to keep people that are in private insurance today in private insurance, and that’s really important to the industry.

Paul Ginsburg: Okay let me pose a question to this panel that I posed to the first panel. Which is will the health care reform proposals on the table today succeed in slowing the rate of spending growth. And follow on of what’s missing from them. Jeff, do you want to start?

Jeff Schaub: Well I don’t know. There are an awful lot of elements being talked about who’s strategy is to take dollars out of the system. There are an awful lot of there’s an awful lot of pressure just to take dollars out of the system. So, if less money goes in, even without any kind of meaningful reform happening that will slow spending growth.

But I think that the biggest concern we have from an investor prospective is on reimbursement rates. Government set reimbursement rates being paid to hospital providers, and the outlook for that is substantially lower than what the history had been through the middle part of this decade. So, I see pressure there.

Paul Ginsburg: So in a sense that’s where you see the most clear cut let’s call it cost containment that the system as a whole is going to pay hospitals less, without necessarily changing the payment system -- just paying lower rates?

Jeff Schaub: Absolutely, I mean the kind of take backs or reductions in Medicare update factors are very significant. We could be back to the kind of reductions that were put in place with the BBA of 1997, which caused a lot of stress in the industry.

Paul Ginsburg: Okay. Gary?

Gary Taylor: Well, how much time do we have? I think this

Paul Ginsburg: Yes, take as much as you want on this question. I’m sure Bob will have a lot to say too.

Gary Taylor: All right so about I could do about two hours on this, I think but I won’t. But a few thoughts I had kind of listening to the first panel. I mean the first is the very basic premise of what we’re trying to do this year is really flawed I think, in that is we have 40 to 50 million people with no insurance coverage in the U.S. that receive very limited health care. They primarily receive that in the hospital emergency room, they don’t receive that in physician offices, because physicians don’t take care of people generally that can’t pay them anything.

So, the premise is we’re going to try to expand coverage, which is an important moral imperative that most of us probably agree with. You shouldn’t go bankrupt if you have the misfortune to have some episodic illness. I think we agree with that, but we’re going to try to cover 40 to 50 million people, but it’s not going to cost anything. We’re going to make it budget neutral, so who here has the resources to try to fund care or expanded care for 40 to 50 million people, but not do it in a way that cost even one dollar.

So, what Congress is trying to do here is really a challenge to say the least, and maybe it’s putting two things together that are both very difficult in and of themselves. I think what’s on the table this year is primarily about coverage expansion and that’s great. I think it’s only a little bit about cost reduction, and that’s not good, and in the future we’re going to deal with that more.

I think anytime the government does something you always have these unintended consequences, and a clear one here to cut hospital payment rates is just going to drive more cost shifting to the private sector, it’s absolutely going to drive private sector hospital rates up to commercial payers, it’s going to drive our own premiums up. This is just a replay of the last 30 years.

There’s a couple of things in the bill, or in some of the bills that we think are interesting, but way too small to matter right now. But there’s this concept of accountable care organizations, which presumably would either take physician groups, or physician-hospital groups and bundle them or capitate them in some way to provide less incentive to provide fee for service medicine, which I’m getting off track a little bit. But I would say that is the single largest issue that we have to deal with in this country, if indeed we have a cost issue. And that’s just a perceptional issue. We spend a lot of money on health care but we’re the richest country in the world. Maybe we should spend a lot of money on health care.

But I think the fee for service incentive for physicians to provide care is the single largest factor driving excess costs in health care, because every time you go to the doctor why does the surgeon always want to cut, and why does the cardiologist always want to stent when all the studies say, take Plavix. So, and those doctors 99.9 percent of them absolutely believe they’re doing the right thing, but I think we have to change that and maybe I’ll save my ideas for how maybe we can change that. But very little of that is in this bill. I think this bill is about expanding coverage, and then cutting rates in a way that are going to provide pretty perverse consequences.

Paul Ginsburg: Yes, actually let me clarify something before going on to Bob. I think the attitude among policy makers now is that health reform shouldn’t increase the deficit. Now, that doesn’t mean that offsetting the costs of increased Medicaid enrollments, and subsidizing individual’s needs to come out of the health care system.

In fact, it didn’t go anywhere, but the President initially proposed some tax increases as far as charitable deductions outside of health care. But there probably is a tendency to focus mostly on health care and I think that’s what you’re getting at.

Gary Taylor: There are some tax increases built in so it’s not entirely coming out of the back of the providers

Paul Ginsburg: That’s right.

Gary Taylor: But a big chunk.

Paul Ginsburg: Bob your take on it?

Robert Berenson: Yes, let me make some points. One is I think it was Matt in the first panel who did make the point, or somebody did that you probably can’t do both significant system reorganization, and redesign, and cost containment, and universal coverage. That sort of forces would align against that kind of change. You probably if you can, should get the coverage expansion done, and then we would come back down the road. I hope the legislation would have some specific language as to when we would be getting serious on cost containment, rather than leaving it open ended with some kind of triggers or something.

But I think in this case, even though I agree with a number of the panelists about the desire to have primary care docs take over much greater responsibility for chronic care management, for having real accountable care organizations, for fundamentally moving away from fee for service, to some population-based payment method, which used to be called capitation but we can’t call it that anymore.

I think we need some time to sort out how to do that. We clearly it didn’t work very well the first time around, and so let’s make a virtue out of necessity. And I’m encouraged that some the bills are calling for fairly active demos. I don’t think we’re ready to - on any kind of wholesale basis completely change how hospitals and doctors are paid. I do think over the next five to 10 years we can figure that out and be able to start bringing those into this system as we learn more about it.

I do want to say one thing about cost shifting and here I disagree somewhat. I do think there’s been an argument amongst the economists as to whether cost shifting happens, and why would the hospitals be leaving the money on the table in the first place if they could have gotten that money out of the plans.

I actually think some cost shifting does happen, but sometimes is exaggerated. But I want to point to an interesting analysis that MedPAC did, which found that in markets where hospitals have more negotiating clout with health plans, and therefore feel and are able to cost shift and get higher rates from health plans, and therefore feel less financial pressure, they have negative Medicare margins. And in places where hospitals have less clout, feel more financial pressure, they tend to have positive Medicare margins and suggesting that they actually reduce their cost structures, and are more efficient when they have to be.

But if there’s a safety valve, which means they can cost shift, they do. So, I think the end it’s not a straightforward story as to whether if Medicare reduced rates more. It would just automatically result in higher rates to private plans. It’s a little more nuanced then that.

That does bring up the issue, which hasn’t been discussed very much, about ultimately what do we do about market power for increasingly hospitals, some single physician groups who are able to ask for and get 170 percent, 190 percent of Medicare. I mean we’re going to need a public policy response to that problem, which I think is increasing, not decreasing. I don’t think anti-trust enforcement is able to deal with that problem, and I think until we sort of figure out what the response is we’re going to have ongoing pressure, and some cost shifting.

And let me make the final point on this topic, that I am concerned that some of the deal making that is going on essentially will result in reduced updates but basically, a preservation of the current system, and as I said at the beginning that may be inevitable to make the political deal to get this done.

But if in five or 10 years we are still in a situation where hospitals have no incentive to be concerned about 20 percent 30-day readmission rates, where they would just as soon have that patient come back, because it’s a whole new DRG, rather than having some reason to be involved with the community physicians and others in reducing those readmission rates, we will not have achieved very much in health reform.

Again, I understand the reason to cut such a deal, but I think we need to be clear open eyed about the fact that we are not restructuring the health system as part of this health reform.

Paul Ginsburg: Yes, any further comments on the deals that are being made, such as the various what some of the major trade associations are negotiating with the White House for cost containments. And then to what extent is this real cost containment? Or to what extent does this actually put cost containment on hold, while generating some scorable savings?

Gary Taylor: Well, maybe I’ll start. As a Wall Street analyst that has to compile numbers and make decisions based on numbers, just kind of looking at the initial offering from the AHA and the AMA about how they could sort of bend the cost curve in the out years. I guess I’m I’d kind of be like the CBO, I don’t see a lot there that would be very easy to put any hard penciled numbers to.

So, I would say that initial effort was pretty unimpressive in terms of anything that looked really quantifiable in terms of savings. Now, this next deal out of the AHA and the Federation of Hospitals, which keeps being rumored but is supposed to be official today, and who knows if it’s official or not. But that’s $150 billion over 10 years, looks to be it’s an offer, but it looks to be very real dollars. It’s a willingness to take some reductions in market basket updates, willingness to take some reductions in disproportionate share payments, which makes a lot of sense, it’s very good policy.

Some of the other things from industry, I share some of the skepticism that that’s that those are really hard penciled saving type numbers, but I think we’re moving a little as the deal making gets a little closer to the end game, it seems like we are actually moving a little closer to having some real numbers that are meaningful.

Paul Ginsburg: Yeah, Jeff or Bob any comments?

Jeff Schaub: Well, I would say that the proposals that are out there really don’t break any new ground. My perspective is I work with the top 10 or 15 percent of the not-for-profit hospitals systems in the country. They do have positive operating margins, very strong debt coverage, a lot of money in the bank. Which all of which means they have the resources to be pursuing the kinds of initiatives that are outlined in the various proposals for in a lot of cases measurable but incremental, moderate improvements in cost and quality. So, again they’re not breaking new ground but I think what’s significant about the proposals and the level of organizations that they’re coming from is that it finally puts these types of items and initiatives at the top of the industry. And assuming that there’s resources and direction and examples to be following and possibly even mandates, it at least provides a framework for some of these initiatives that we’ve seen success with being pushed down to the bulk of the not for profit sector that maybe has not had as much experience or success with them.

Paul Ginsburg: Bob, anything else on this?

Robert Berenson: No, I think I’ve said my piece.

Paul Ginsburg: Okay. Let me talk about how the weak economy has been affecting hospitals and ask you to speak about the impact on hospitals as far as volumes of elective procedures, as the emergency room volume’s growing or decreasing, etc..

Jeff Schaub: Well, the economy has certainly had an effect on the entire sector, and the end of the sector that I deal with has not been immune. But we have just wrapped up taking a look and parsing the 2008 results, some of which were year-end 2008, some with fiscal year ends during 2008.

And I guess I would characterize what I’m looking at as saying it’s not as bad as expected. I mean operating margins are down, utilization is down. But hospitals have had have demonstrated a pretty good ability to adjust to the changes in volumes, and implemented operational improvement strategies on both the expense side, and the revenue side to maintain operating margins.

Five months ago I would have told you that our median operating margin would have moved from plus three percent down to negative one percent for the year 2008. And that’s not the case; we’ve gone from maybe three percent down to two percent. Some individual facilities have suffered more than that, but overall we haven’t seen the kind of deterioration in the core business of hospitals that we had expected.

On the non-operating side though, investment income being the biggest thing, we have seen just a blood bath. The investment performance of hospital portfolio’s took a big hit, really starting at the beginning of 2008, but just a tremendous devaluation; October, November, and even into the first quarter of this year. We certainly run numbers reflecting that but we also acknowledge that those are really one-time returns and volatile returns. So our focus is, I think, is to emphasize the core operating business over the bottom line.

And hospitals, at least at the end of the spectrum that I deal with, are dealing with the stress. They’ve made adjustments and we haven’t seen a lot of reason to move hospital bond ratings. We do continue to see our downgrades a little bit higher than our upgrades but both upgrades and downgrades are far outweighed by the number of affirmations, rating affirmations that we do.

And in our bond rating is an expression of our opinion of whether a hospital is going to pay back money that it’s borrowed. And to affirm a significantly greater number of hospitals than we downgrade or upgrade means we still see a lot of stability and financial strength in the sector.

Paul Ginsburg: Yes. Now if you talk about the investments and beyond just, what kind of return they’re booking but what about hospitals that were going to be using that capital to fund new projects, to continue ongoing projects, are there are problems with hospitals not being able to access the capital market to fund an ongoing project? So if you could discuss the affect on the capital projects.

Jeff Schaub: Well, it’s put a freeze on capital spending. For not for profits, the debt markets are the major source of funds to finance construction projects. And hospital bond issuance is down about 40%; first half 2009 versus first half 2008. Part of that was just a freeze, a lack of funds for hospitals to access to borrow. But as credit loosened up, interest rates went up so projects that had been feasible all of a sudden were not feasible.

So higher capital costs, more limited access was one thing. The reduction in hospital portfolios, though, has also had a very chilling effect. That if you have 30% less cash on hand than you did six months ago it motivates a desire to hoard cash, especially with the uncertainty that’s in the investment markets right now in the world of finance.

So we have seen, and this goes back to the fall, we have seen hospitals delay, suspend, reduce capital projects across the board. It’s a seven floor hospital tower that had been planned to be fully built out last August might be built out to seven floors but with three floors just shelved in without being finished off.

So , I guess I would say that of hospitals’ five year capital spending plans, they’ve been reduced by 30 to 50% across the board. And those reductions are really contingent on what actually happens with investment returns and operating cash flow. If things improve in their portfolios, or they stay they maintain a strong operating platform, we do expect to see resumption of more typical capital spending.

Paul Ginsburg: Yes. So hospitals might be in a good position today to say voluntarily we’re going to cut our rate of cost growth two or three years down the road just from the effect on investment that has already been slowing.

Jeff Schaub: Run that by me again.

Paul Ginsburg: I was just thinking about the implications on the cost trends a few years down the road from this sharp reduction in construction activity.

Jeff Schaub: Oh, yeah; yeah. That’ll play out sure.

Paul Ginsburg: Yeah; that’s right.

Gary Taylor: Can I share a couple of things?

Paul Ginsburg: Sure, Gary.

Gary Taylor: I think just the whole concept of how hospitals are doing right now there’s two I agree with almost everything Jeff said if not all of it. But two real paradigm shifts that we’ve seen just in the last year or so in the hospital industry, I think - one, two years ago hospitals were paying nurses $20,000 signing bonuses for 18 month commitments and in the fourth quarter when the world was falling apart, at least in New York it felt that way, and the hospitals thought volumes were going to be down 5%,

they started laying off nurses and they started freezing wages and low and behold, just like Jeff said, so far things haven’t been as bad as expected in our for-profit universe. Admissions volumes were down 2% in the first quarter. That was against a tough flu comparison and a leap year so actually it was a pretty decent quarter.

But the reductions that the hospitals have made on the labor side of the equation have helped them pretty much maintain their profitability and that’s a little better than we expected. That’s not good news if you’re a nurse that got laid off, of course, but it has helped preserve the financial position and Jeff’s nonprofit sector is 85% of the industry. The for profit I cover only 15% and the nonprofits are doing layoffs and wage freezes too. So they’re providing political cover for the - for profits to be a little more aggressive on labor. And then what he said on capital spending is absolutely true.

I think the market funds more than half of all of the capital spending in the hospital industry. And if I’m not I don’t think we’ve seen a noninvestment grade deal since September and I think maybe two triple B deals

Jeff Schaub: And I’m not sure we’ve seen a triple B minus deal.

Gary Taylor: Yeah. I think so maybe a couple triple B deals since September. So we’re really this is a big paradigm shift because if you go back to the late ’90s nonprofits weren’t spending much on capital. From 2000 to 2007 we’ve documented capital spending growing about 20% a year and now we’re off 50%. And most of that is because of lack of access in the municipal market. But that paradigm shift is also playing out for the for profit companies I cover because if the nonprofits aren’t spending it to buy that to jump from that 64-slice CT to the 128 then the for profit guy doesn’t have to spend it and they’re tending to their balance sheets a little bit.

So the technology spending, which has been historically robust, probably 2000 through 2007, has dropped off dramatically in ’08 and ’09. Now, whether that actually carries through and bends the cost curve down, I don’t know. I think it depends on depends on what happens on the government side and what hospitals are at least they’re going to try to seek on the commercial side. But there’s definitely less spending.

Jeff Schaub: Yeah; , I’d also add to that. The capital costs for hospitals are a pretty small part of their overall expense budget. So to the extent that somebody reduces their capital expenditure by 30% in one year, it’s not going to have a huge effect on the bottom line. I mean debt service for an investment - for hospitals it’s typically 4 or 5% of their total expenses. So a reduction of part of that isn’t going to solve all of the world’s problems.

Paul Ginsburg: Yes; well, Jeff I think the cost implications of capital spending aren’t just the debts. It’s really the fact that they’ll be doing things, admitting patients, doing high tech they wouldn’t have done if they didn’t

Jeff Schaub: If they didn’t have the

Paul Ginsburg: That’s right.

Jeff Schaub: machines; sure.

Paul Ginsburg: Yes; so I think that’s the big thing. So it sounds like some resemblance potentially to the mid- to late-1990s, although a very different driver because that was driven probably by tight managed care and this is being driven by very tight capital markets. So it may not come out that - it’ll probably have very different implications for different hospitals according to their dependence on the capital markets.

Okay; the next thing I’d like to get into is hospital pricing, and changes in leverage between insurers and hospitals, and particularly what role competing physician-owned facilities have been playing, and the role of close affiliations of physicians with hospitals.

Gary Taylor: Actually this whole issue of specialty hospitals, physician-owned hospitals, gets a lot of attention in Washington, it gets a lot of attention in Texas because that’s where they all are. But broadly, nationally with the exception of maybe outpatient surgery centers, which we had maybe 2,000 of those built in the last five years nearly doubling the industry’s capacity.

It’s a particular issue in the of the AHA and they want to curtail growth of that but I don’t know that the outside of market by market situations I don’t know that nationally I could really say the specialty facilities are having a heck of a lot of impact.

The other issue mentioned, which is increased employment of physicians by hospitals, I mean this is back to the ’90s all over again. This issue seems very predominant, again in Texas, pretty predominant in Florida, and we’ve really viewed it as a defensive behavior for hospitals. So in a market where patient volume trends have been slowing, hospitals have gone out and tried to lock in utilization, or referral patterns, referral sources.

I don’t know that I can think of an instance where that’s become big enough or large enough that it’s really able to drive the pricing discussion say for the way it for like a and how dominant they are in Northern California. So I think these issues are kind of at the fringe of the larger issue that’s shifted pricing power between providers and insurers.

And I think that the primary issue was when Dickie Scruggs sued the HMO industry in ’99 it was kind of the end of the HMO and everything went to open panel. And it’s taken hospitals 10 years to figure out that discounting your rates for no volume isn’t a very smart business decision. And I think that has slowly empowered the industry to do better on the rate side.

Jeff Schaub: The industry has done very well on the rate side through say 2002 through 2007 five-year period - increases rom commercial payers for rates paid to hospitals where it wasn’t unusual to see double digits.

That has pared back in the last couple of years. I think a lot of it is due to some stress of acquisition and then merger on the insurer side. So, we’re back down into single digits. But, somewhat healthy. We are negative on the sector of commercial insurance so we do see a lessened ability for insurers to pay large increases, which also has implications for the ability to cost shift some of these reductions that might be coming from the federal level.

As far as who’s got the power right now in insurer-hospital negotiations, and I think it’s shifted a little bit to the hospital sector as the hospital sector has consolidated, hospitals have shut down smaller hospitals merged into larger systems, some larger systems are being very aggressive to contract on a state-wide or a national basis.

The information that’s out there and available to hospitals about what the other hospitals are paying has improved. So from that I think there is some more power on the provider side. But there is probably a little bit lessened ability of resources on the insurer side for the hospitals to take advantage of that slight shift in leverage.

Paul Ginsburg: Yes; Bob.

Robert Berenson: I think there are some sort of long-term trends too which would move in the direction of employment of physicians by hospitals. One would be just younger physicians coming out of training, wanting shift work rather than being an entrepreneur in their own small practice or even a new employee in a small practice. That doesn’t seem to be where younger docs want to go. They like the "systemness" that a hospital might provide. If there were ambulatory multi-specialty groups around, that would be attractive, but where that doesn’t exist I think they wouldn’t they’re more willing to consider working in hospitals. And sometimes that will align with the hospitals interests.

There’s the service-line strategy which, in some cases, would have a hospital recruit and hire specialists rather than primary care physicians to promote whether it’s a cardiac service or an oncology service or something to promote a service-line strategy. Some hospitals have actually gone to sort of closed medical staffs where they’re closing off to the what’s traditionally the community physicians to have a tighter alignment of their docs. That still is rare but is happening.

In a few cases some to simply be able to carry out the emergency room- requirements for trauma care; requires hospitals actually to hire rather than to pay bounties, essentially, to doctors to take call. They may decide that it’s in their interest actually to just bring in on staff the trauma team. So these are various things happening.

I agree it’s sort of not a dominant phenomenon right now, but I think the trend would be towards more employment. And that leads to the second point I wanted to make. The view that some have that accountable care organizations, which have various meanings in various peoples’ minds, might be a hospital medical staff-kind of an organization.

I guess one of the concerns that I have heard articulated in the purchaser community, the large employers and some health plans, is that aligning the docs in the hospitals would concentrate market power even more powerfully than it is right now.

And that in fact, I’ve had in some sort of public discussions heard employee benefits managers say they don’t want to see this integration happen because they just feel they have no ability to resist the price demands that such an organization would ask for. Whether that’s different from what’s currently nonintegrated hospitals and single-specialty groups are able to do I think deserves a little discussion.

Paul Ginsburg: Actually, if I could add something. I see Bob and I were interviewing in California and it’s pretty much the norm now that California hospitals are moving to foundations to set up a vehicle for the hospitals to negotiate the payment rates for the physicians.

So you could have a situation and I think hospitals have learned from their disaster in the 1990s if employing physicians now physicians very much are in an environment that to me simulates fee for service private practice and very strong productivity incentives.

So in a sense, it’s very easy for a hospital to track physicians. You can make more money here because we can get higher rates for you. And when it comes to actually integrating delivery that’s the hard work. That probably doesn’t have to be done for that to be successful.

A few weeks ago I did a site visit in Milwaukee and found that all of the five hospital systems employ pretty much all of the physicians in the community. They have bought specialty practices, the primary care physicians around there. So I think it’s a growing phenomenon, although, it probably varies a lot community to community.

We have been hearing with consumer-directed health plans and greater patient cost sharing, the problems that hospitals have had is figuring out how to collect the patient cost sharing and that’s accumulated a lot of bad debts. If hospitals and the previous panel said that benefit buy downs are continuing and are likely to accelerate next year. Are hospitals getting more of a handle on how to deal with patients that have substantial deductibles in their policies?

Jeff Schaub: Absolutely. And it goes back to when the economy first started deteriorating with increases of bad debt being the initial phenomenon observed and on into doubling or tripling of charity care.

The hospitals have spent a lot of time trying to figure out how to get that two cents on the dollar because if you add up a lot of two cents, sooner or later it starts to be real money. The software, the databases that are available to research to try and find a financial sponsor for a patient are much better than they were even four years ago. And virtually everybody that we rate has moved some resources in that direction.

The most interesting thing that I’ve heard recently about was a system that came in to talk to us about their efforts to pay for a continuation of health benefits under COBRA for their patients that qualify for, recently terminated patients.

Checked it out with their legal counsel to see if it was permissible to pay for the patients insurance, but they made that expenditure because it was better than collecting nothing or trying to collect the bill from an uninsured patient.

Paul Ginsburg: Gary, when I see reports on hospitals they are always talking about collection of cost sharing.

Gary Taylor: Yes; I would agree. I think the cost sharing phenomenon, the buy down phenomenon really accelerated three or four years ago; caught the industry hospital industry a little bit off guard and I think the for profit companies have made some improvements on collections. But, really we’re still talking about if you come in the door and you have no insurance, they collect 8 to 10 cents on the dollar by sending you out to a collection agency.

If you have insurance and you have a copay or deductible they collect 50 cents on the dollar, maybe the best collect 60 cents on the dollar. That’s a pretty I mean that’s a little better than when this trend started but that’s pretty poor for a person who presumably has a job because they have insurance so they have a job or their spouse has a job and they have a liability, the copay or deductible, and you’re only able to collect at 50 or 60% of what that patient actually owes you.

So I think we’ve seen the hospitals doing a little bit better. I think there’s massive room for improvement on the copay side and there’s some investments being made to try to address that. But the complexity of our insurance system I mean a patient may come and go before you ever figure out what exactly it may be a month after they’ve left before you actually figure out what their final patient liability portion is.

And so somebody who’s been gone a month, that’s a lot harder to track them down when they’ve been gone that long. So it’s still a significant issue and buy down is if you look at the sources of bad debt, uninsured population growth, buy down, and then just collection rates deteriorating because of consumer credit, are all pressures on that bad debt line over the next couple of years.

Jeff Schaub: I would add that the way we measure it is on an overall basis and that’s bad debt expenses or percentage of revenue. And that number after going up somewhat significantly three, four years ago has stabilized and in some cases has come down. It varies by rating level but it really hasn’t budged much in the last two years.

Paul Ginsburg: We’re about five minutes away from going to question and answers from the audience. So if you can have questions on a card, please fill it out and send it down to the aisle; it’ll be picked up a question, a very specific question which you may or may not know on price transparency.

Discussions of price transparency sometimes raise concerns about the impact of additional knowledge by hospitals of prices that their competitors are negotiating with insurers. And the question that I’d like to take this opportunity for people that know the industry well, how knowledgeable are hospitals today about the prices that their competitors have negotiated with insurers? .

Gary Taylor: Yeah; I actually have a one of my college roommates used to work for Aetna and now he works for HCA and he negotiated payment rates on both sides of the table working for those companies. And , HCA is the largest hospital company in the U.S. and in their major markets I guarantee you they know what the payment rates are that other hospitals are being paid.

At some of the smaller companies I’m not convinced that they always know and I’d probably defer to Jeff, but I think for the nonprofits the very best do have resources devoted here and the 50 bed stand alone hospital in the middle of nowhere probably doesn’t have a very good idea of that.

Paul Ginsburg: They don’t have any competitors either.

Gary Taylor: Right.

Jeff Schaub: It’s like you said. The more sophisticated larger systems have tremendous databases, spies out there. I’ve seen advertisements for put out by organizations for paying a bounty for the coordination or explanation of benefit statements. So they collect that information and then it’s packaged and sold to hospitals. So there’s information out there.

There are some state-wide agencies that have collected and published some information on selected procedures and stuff like that. So hospitals have a pretty good idea of what their what their neighbors are getting and where they stand in relation to that. And the ones that are the loudest are the ones that feel they’re under paid compared to the hospital across the street, naturally.

Gary Taylor: And that that transparency has been a risk to the insurance industry. They’ve fought you’ve seen a lot in the news over the last few weeks about Ingenix, which is a division of UnitedHealthcare, which actually has a black box that develops physician payment rates that a lot of insurance companies use.

And as that black box got opened up there was some fairly sizeable liability for UnitedHealthcare in terms of how they were calculating what these market rates were. So I think the increased transparency is actually has probably helped the providers and hurt the insurance companies.

Paul Ginsburg: Okay. And the last question; well, before we turn to audience, is about hospital expansions into suburbs. I’ve seen a lot of strategies of hospitals opening up outpatient satellite facilities or hospitals in the suburbs and how we’re moving to the suburbs. And one of the implications for access to those living in the central city and also for the small independent community hospitals in the suburbs.

Jeff Schaub: We have seen a lot. And a lot of those capital dollars have funded construction and at times relocations from urban centers into where the demographics have shifted. It’s, I think much more often than not a development of a hub and spoke system or you put physicians or capital facilities out 50, 60, 100 miles from the mother ship. And in order to channel in those more advanced cases to the home facility.

That being said, it’s pretty unusual though where a major tertiary center will go out and battle for a suburban market share aiming to steal everything from the community hospital that’s out there. It’s much more common for tertiary facilities to develop clinical affiliations with the folks that are out there because if you’re a patient you don’t want to travel 50 miles into the urban center to get your routine health care needs taken care of.

It’s much more cost effective and a better use of capital for the urban center to leave those referrals out in the community and focus on the higher acuity, higher margin patients and bring those in. It’s a lot more cooperation I think in what’s going on than an outright competition, cutthroat competition.

Gary Taylor: There was a lot more passion and emotion in your last panel where some of these insurance analysts’ very livelihood is being threatened by the public plan than some of these questions fall. Not that they’re not good questions, but

Paul Ginsburg: Yes.

Gary Taylor: I wish I had more exciting things to say about it. I think the one issue that’s happening, I think the growth in the suburbs and capacity growth is contributing to more excess capacity growth in certain markets and that’s certainly an issue and there’s a cost to that that gets borne through the entire system. Again, there’s a probably a big difference here between Jeff’s hospitals and mine. His are going to be mission-oriented and may have a mother ship, flag-ship hospital that’s been there for 200 years and they’re and they have a mission that’s directed towards the community that they service. And the for profit companies that I cover are really all about portfolio management.

So , if looking at an inner-city hospital with a 20% Medicaid mix, going in the suburbs it’s all about chasing payer mix. And if the in the suburbs the Medicaid mix is five and in the inner city it’s 20, then they’re going to buy and sell portfolios of hospitals to try to maximize that mix. And you saw Tenet doing that, for example which got in big trouble with the government six or seven years ago and has gone from 110 hospitals down to 50.

Well, what were they selling? They sold Philadelphia; they had everything inside of Philadelphia. Sold that and got out of a lot of urban markets that they were in and really tried to focus on some of the suburban markets where the payer mix is better.

So again, going back to commercial; you make 20, 25% margin on commercial business and you lose 20% margin on Medicaid business. Anybody who’s not mission driven wants to be in a market that’s got a that has a better mix. So all of my companies are suburban hospital companies. Even the rural hospital companies really aren’t rural companies anymore; they’re suburban hospital companies.

Robert Berenson: And the only thing I would add to that is it’s you mentioned 20% Medicaid. As part of a HSC project, I’ve recently been doing side visits in L.A. County and there’s some central city L.A. hospitals that have less than 5% of their payer mix are commercial payers. It’s Medicaid or uninsured and they are playing very creative games to get funding, Medicaid and Medicare. And so at least one of my hopes is if we did coverage expansion we could sort of even out some of this cash flow problem.

Paul Ginsburg: Okay.

Jeff Schaub: The other point on your question. What happens to the folks that are in the city as hospitals move out? It’s pretty difficult to shut down a hospital. And for the multi-hospital systems that we have what a typical scenario is as the hospital struggles for years and years and years, the senior management of the system tries a lot of different strategies to stabilize it and get it to the point where it’s something that they can live with. But, ultimately, in order to preserve -- to pursue the overall mission, sometimes the hospital does have to be closed down.

But there are invariably a lot of different concessions that are made to preserve some footprint of healthcare services within that community. Turning the acute care facility into an ER and an ambulatory facility or clinics, but it’s pretty unusual for somebody just to pack up and leave and leave no trace of where they were.

Paul Ginsburg: Yes; I mean actually the way I see this is that there are a series of financial incentives in the hospital care system. And to the degree that both hospitals get better at responding to them or feel they have no choice but to respond to them. In a sense if there’s any blame it’s not for the hospitals following the incentives, it’s for the people that put the incentives up there, which is us and say policy makers.

Let me go to questions now. I’ve got one for Bob who is asking if this person asks do accountable care organizations seem to you like the 1997 PSO’s? I think they mean Provider sponsored Organizations and do they have the same embedded flaws and ability to take long term risk and long term lower productivity for employed docs, et cetera?

Robert Berenson: All right. I actually have been asked that question since I was around when we I showed up at HCFA just after the new negotiated rule making occurred to encourage provider sponsored organizations to come in. And the idea was that the provider organization wouldn’t have to get a state insurance license and could come into Medicare and nobody showed up.

Now I think I think over the history of the 10 years there’ve been three and a couple have been re designated. So it is a challenge to those of us who think there’s merit in considering Medicare-direct contracting with provider organizations on some kind of a risk basis to sort of consider that history.

It’s real clear that at the time a number of potential applicants did not come in because of the absence then of a risk adjustment system. That provider organizations would be much more likely to be recruiting their own patients and in the absence of risk adjustment they really were going to be taking much too great a risk.

We now have a pretty good risk adjustment system. I think that could change things. And again, I don’t know that by definition a PSO or a -accountable care organization has to adopt the model of paying physicians on salary and they become nonproductive.

Again, in California there are still successful IPAs in the California delegated model the market is moving away from that as HMOs are moving to PPOs. But at least for the remaining HMO business in California, there are medical groups and IPAs that seem to the ones who’ve survived, a bunch of them weren’t very good and have dropped out, but the ones who have survived do contracting with health plans.

They take risk; they sometimes take risk for hospital care. And so I think there’s some potential here in essentially trying to do right what we did wrong 10 years ago. But I would say that it’s I mean there’s a lot of different definitions of accountable care organizations. Is it a virtual organization with physicians being assigned to a hospital staff because that’s where their patients go? And a patient being assigned to the accountable care organization based on their claims history, which are some versions.

And at the other end it’s a real organization that has a business mission, has bylaws, has governance, and where patients know they’re in the plan. And so I think we have to sort out what we mean and what we want to test. But in many ways I think it is a revisiting of the PSO concept. And so the challenge for those of us supporting it is what’s what will

Gary Taylor: Can I say something?

Paul Ginsburg: Sure.

Gary Taylor: I just want to make one comment on that. There was a comment about this on the last panel. I think Christine had said just talked about how the whole physician practice management model failed. And from my standpoint, I think there’s a lot again, because I think fee for service medicine is kind of the crux of our health care cost issue. And I think capitation holds a lot of promise. Perhaps it’s the only thing we’ve ever seen actually work at all for a period of time. But I think I think I don’t think capitation was a flawed concept. It was flawed execution because you had actuarially competent organizations negotiating insurance rates with actuarially incompetent physician organizations, for lack of a better word. Doctors don’t go to actuary school, if such a thing exists.

So that I mean that was the problem, is that the insurance companies killed the doctors because they knew what they were doing actuarially and the doctors didn’t. But the concept again, I think is really good. And I think this accountable care piece holds some promise.

There are some really successful physician groups in California operating under capitation and all of us that live east of the Rocky Mountains don’t know a heck of a lot about it. But they’re they’re doing pretty well out there with that model. So

Paul Ginsburg: Thanks; gentlemen, the mic.

Henry Dove: Hi, my name is Henry Dove and I I’m a big fan of MedPAC and the work that they do. And several months ago Sen. Rockefeller made a proposal that would require Congress to either vote up or down on the recommendations that MedPAC comes up with. And I just wanted to ask I don’t know where that stands, but what would be the impact if that if Senator Rockefeller’s proposal was accepted?

Paul Ginsburg: Maybe this is a question for Bob.

Robert Berenson: Well, it’s a little difficult since I’m just now a MedPAC commissioner, and I don’t want to sort of interestingly I can say just as a matter of the record that Len Nichols and I had issued a report about a month before Sen. Rockefeller’s proposal, which promoted the same recommended the same kind of thing with the view that Congress really can’t make these can’t make tough decisions.

And it has real a lot of trouble making recommendations that would really cause any dislocation of existing sort of prerogatives that stakeholders have. And so the question and I mean it’s clear that I think MedPAC would have more expertise might if you had full-time commissioners, not part-time commissioners, in an independent situation, might be able to make tougher calls.

And at the same time, it’s sort of anti-democratic. You’ve got to ask members of Congress to sort of take a backseat on the largest domestic program I think we have. So I think we have to find a balance in there somewhere. I’m again, I’m going on MedPAC because I think it does a very good job and I probably won’t say too much more.

I think it’s going to take us a while to get some consensus around how this should work. I think there’s - Sen. Rockefeller has a proposal. I think others are introducing legislation in the House but I think what I expect this time around is that some decisions in health reform will be kicked to MedPAC and kicked to the secretary to come back to Congress but that they probably won’t take that leap at this point to actually diminish the authority of Congress.

So this is I think too new a concept and again it goes against the way we typically think our democracy should work, or our representative government should work.

Gary Taylor: Can I add one questions?

Paul Ginsburg: Sure.

Gary Taylor: I’ll just keep chipping away here. Well I know someone from MedPAC, or at least a few people are in the audience. I’m glad I know that before I respond to this question so I’ll be nice. Well providers generally don’t like MedPAC because a lot of times MedPAC makes some good calls that are going to cost providers some money. So they don’t like MedPAC; they wouldn’t be for it.

The concept is kind of similar to what Daschle has put forth to have sort of a healthcare Fed to help make some of these decisions. And I think as if we go down this if we agree as a country that we have to reduce cost, and I’m not sure we’ve ever agreed that we really need we haven’t agreed ever to do that in healthcare; let’s just say that.

But if we get to the point where we really agree that we need to do that then we do need something like that. The only suggestion I would have for MedPAC is that its charter I think is to recommend the Congress Medicare payment policy and of course providers don’t operate in the vacuum of Medicare payment policy.

You have Medicaid, which I keep saying you lose money on, and you have commercial that you make money on. So sometimes recommendations on the Medicare side are good for Medicare but they’re not good in the entire spectrum of what your payer mix looks like. So if we did go that route, I think MedPAC’s charter would have to be expanded to bring more inputs into it.

Paul Ginsburg: Yes; well I think it’s a fascinating question which I think we’ll have to end on. That basically what should be the governance and changes in governance mechanisms that we use in health care as far as the role of the Congress, the role of the Secretary of HHS, and the role for some type of independent or blended organization?

I’ve got a number of people to thank. I want to thank the HSC staff helping get the meeting set up. I want to thank the Robert Wood Johnson Foundation for funding the meeting and thank our afternoon our late morning panel for the interesting insights they have had.

Participant Biographies

Joseph Antos, Ph.D. - Wilson H. Taylor Scholar, American Enterprise Institute

Joseph Antos, Ph.D., is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at the American Enterprise Institute, where his research focuses on the economics of health policy, including Medicare reform, health insurance regulation and the uninsured. Antos is also a commissioner of the Maryland Health Services Cost Review Commission, a health adviser to the Congressional Budget Office and an adjunct professor at the Gillings School of Global Public Health at the University of North Carolina at Chapel Hill. He has written and spoken extensively on the Medicare drug benefit and has led a team of experienced independent actuaries and cost estimators in a study to evaluate various proposals to extend health coverage to the uninsured. Antos received his bachelor’s degree in mathematics from Cornell University and his doctorate in economics from the University of Rochester.

Christine Arnold - Managing Director, Cowen and Company, LLC

Christine Arnold is a managing director at Cowen & Co., LLC, where she covers the managed care and hospital industries. Previously, Arnold was a managing director at Morgan Stanley, where she started in 1999 as the senior managed care research analyst. Arnold has spent 17 years in investment research and has specialized in managed care and the hospital industry for the past 12 years. Before joining Morgan Stanley, she worked in research at Goldman Sachs; Furman Selz; Montgomery Securities; and in corporate finance at Burns Fry, a Canadian investment bank. Arnold earned her bachelor’s degree with a concentration in finance from Georgetown University.

Rober Berenson, M.D. - Senior Fellow, The Urban Institute

Robert Berenson, M.D., is a senior fellow at the Urban Institute and an expert on health care policy, particularly Medicare, with experience practicing medicine, serving in senior positions in two presidential administrations, and helping organize and manage a successful preferred provider organization. From 1998-2000, he was in charge of Medicare payment policy and managed care contracting at the Health Care Financing Administration (now the Centers for Medicare and Medicaid Services.) He served as an assistant director of the domestic policy staff in the Carter Administration. He was also national program director of IMPACS-Improving Malpractice Prevention and Compensation Systems-a grant program funded by the Robert Wood Johnson Foundation, from 1994-1998. A board-certified internist who practiced for 12 years in a Washington, D.C., group practice, Berenson is a fellow of the American College of Physicians and a graduate of the Mount Sinai School of Medicine.

Matthew Borsch, C.F.A. - Vice President, Goldman Sachs

Matthew Borsch is a vice president and senior investment research analyst at Goldman Sachs, covering the managed care and health care provider sectors. Before joining Goldman Sachs in February 2001, Borsch was an executive in the managed care industry for six years with Physicians Health Services, a health insurance company, and Telesis Medical Management, a physician management company. Previously, he spent seven years as a management consultant with Accenture. Borsch is also an adjunct professor at Columbia University, where he has taught graduate-level courses on the managed care industry since 1997. Borsch is a chartered financial analyst. He received two master’s degrees from Columbia University in 1994, an M.B.A. and M.P.H., and a joint B.A./B.S. in economics and mathematical sciences from The Johns Hopkins University in 1986. Borsch was voted Next Generation Analyst by Institutional Investor magazines in the 2003, 2004 and 2005 All-America Equity Research polls and is currently ranked among the top three research analysts covering the health insurance and managed care sector under the 2007 and 2008 Greenwich Associates investor polls.

Paul B. Ginsburg, Ph.D. - President, Center for Studying Health System Change

Paul Ginsburg, a nationally known economist and health policy expert, is president of HSC, a nonpartisan policy research organization in Washington, D.C., funded in part by the Robert Wood Johnson Foundation. Ginsburg is a noted speaker and commentator on changes taking place in the health care system. His recent research topics have included cost trends and drivers, Medicare physician and hospital payment policy, consumer-directed health care, the future of employer-based health insurance, and competition in health care. In 2008, for the sixth time, Ginsburg was named by Modern Healthcare as one of "The 100 Most Powerful People in Healthcare." He received the first annual Health Services Research Impact Award from AcademyHealth, the professional association for health policy researchers and analysts. He is a founding member of the National Academy of Social Insurance, a public trustee of the American Academy of Ophthalmology and served two elected terms on the board of AcademyHealth. Before founding HSC, Ginsburg was the executive director of the Physician Payment Review Commission (PPRC), created by Congress to provide nonpartisan advice about Medicare and Medicaid payment issues. Under his leadership, the PPRC developed the Medicare physician payment reform proposal that was enacted by Congress in 1989. Ginsburg previously worked for the RAND Corp. and the Congressional Budget Office. He earned his doctorate in economics from Harvard University.

Jeff Schaub, M.B.A. - Senior Director, Fitch Ratings

Jeff Schaub is senior director in Fitch Ratings’ public finance department, where he heads Fitch’s nonprofit health care ratings group. Based in New York, he is responsible for acute care, long-term care and senior living sectors, with analysts located in New York, Chicago, San Francisco and Tampa. Since joining Fitch in 1993, Schaub has also had responsibility for various operational aspects of the department, including budgeting, surveillance and compliance, analytical and operational systems development, pricing, electronic product support and training. Prior to Fitch, Schaub was a manager in Coopers & Lybrand’s New York consulting group, performing health care financial feasibility studies throughout the greater New York area. He also worked for the Hospital Association of New York State, where he was responsible for financial modeling and analysis, as well as the health economics group’s systems and databases. Schaub received a bachelor’s degree in engineering from Clarkson University and an M.B.A. in operations management from the University at Albany, State University of New York.

Gary Taylor, M.B.A. - Managing Director, Citigroup

Gary Taylor is a senior equity research analyst and Managing Director at Citigroup, covering the healthcare facilities sector. He joined Citigroup in 2008 after covering the sector for nine years at Banc of America Securities. In addition, he worked in the sector for three years as an investment banker and two years as a hospital reimbursement consultant. Taylor has been recognized as one of the best analysts in his sector for each of the last seven years by Institutional Investor magazine (most recently ranked #2). Over the same period he has also regularly placed as one of the top three sector analysts in the annual Greenwich survey (most recently ranked #2). Taylor is a graduate of the University of Missouri, where he received his M.B.A. (Finance), a master’s in health administration in 1994 and a bachelor’s degree in health sciences in 1992.