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May 19, 2005:

The Honorable Charles E. Grassley: 
Chairman: 
The Honorable Max Baucus: 
Ranking Minority Member: 
Committee on Finance: 
United States Senate:

Subject: Specialty Hospitals: Information on Potential New Facilities:

Beginning in the 1990s, there was a substantial increase in the number 
of short-term acute care hospitals that primarily treat patients with 
specific medical conditions or who need surgical procedures. Advocates 
of such hospitals, commonly referred to as specialty hospitals, contend 
that their focused missions and dedicated resources can both improve 
quality and reduce health care costs. Critics contend that specialty 
hospitals siphon off the most profitable procedures and patient cases, 
typically without providing emergency care or other vital community 
services, and thus erode the financial health of neighboring general 
hospitals. Critics also contend that the ability of physicians to 
invest in a specialty hospital and then refer patients to that hospital 
creates financial incentives that may inappropriately affect 
physicians' clinical and referral behavior.

In 2003, we issued two reports on the growth, characteristics, and 
performance of specialty hospitals.[Footnote 1] More than two-thirds of 
the 100 specialty hospitals we identified as being in existence in June 
2003 had opened their doors since the beginning of 1990.[Footnote 2] 
The specialty hospitals in existence in fiscal year 2000, the most 
recent year for which we then had data, accounted for about 1 percent 
of Medicare spending for inpatient services. We also identified an 
additional 26 specialty hospitals under development in 10 states. 
Approximately 70 percent of the existing specialty hospitals were 
owned, in part or in whole, by physicians.[Footnote 3]

Subsequent to our reports, Congress, through the Medicare Prescription 
Drug, Improvement, and Modernization Act of 2003 (MMA), established a 
moratorium which, in effect, temporarily halted further development of 
physician-owned specialty hospitals that focus on cardiac, orthopedic, 
or surgical procedures and mandated additional studies of specialty 
hospital issues.[Footnote 4] Specialty hospitals in operation as of 
November 18, 2003, are grandfathered under the moratorium and are 
allowed to expand within limits. Specialty hospitals not opened as of 
that date may apply to the Centers for Medicare & Medicaid Services 
(CMS) and request a determination of their development status. 
Hospitals not open as of November 18, 2003, but sufficiently advanced 
in their development may be grandfathered. The MMA moratorium expires 
June 8, 2005.

To help you consider the likely consequences of the moratorium's 
expiration, you asked us to provide updated information on the 
potential growth in the number of physician-owned specialty hospitals. 
This report responds to your request by presenting information that 
addresses the following questions: (1) How many applications for 
grandfather determinations has CMS received from specialty hospitals 
under development, what types of specialty hospitals applied, where 
were these hospitals located, and how many of the applications have 
been approved? (2) What information exists to indicate the likely 
number, location, and type of specialty hospitals not exempt from the 
moratorium that may be developed following its expiration?

We determined the number and characteristics of specialty hospitals 
under development that had applied for a grandfather determination by 
obtaining summaries of the applications from CMS. Facilities that 
submitted such applications included potential new specialty hospitals 
and existing specialty hospitals with expansions underway as of 
November 18, 2003. We included both new and expanding facilities in our 
analysis of the applications that CMS received and in that analysis 
refer to both types of facilities as "under development." To gather and 
assess information about the number of specialty hospitals potentially 
under development that are not exempt under the moratorium, we 
contacted representatives from national and selected state associations 
of community hospitals, including the American Hospital Association 
(AHA) and the Federation of American Hospitals (FAH); several large 
companies that own and operate specialty hospitals; the American 
Surgical Hospital Association; and the Medicare Payment Advisory 
Commission (MedPAC). Many of these representatives provided us with 
information about specific facilities that they had tentatively 
identified as specialty hospitals under development. Because MMA's 
moratorium applies only to physician-owned cardiac, orthopedic, and 
surgical specialty hospitals, our analysis focused on facilities that 
had been tentatively identified as such by one or more of the above 
representatives. We then sought to ascertain the characteristics and 
status of each facility by contacting a facility official or, if that 
was not possible, obtaining corroborating information from news reports 
or other sources. We also solicited the views of the representatives 
mentioned above regarding the potential for specialty hospital growth. 
Additional details regarding our methodology are contained in enclosure 
I. Our work was performed during April and May 2005 in accordance with 
generally accepted government auditing standards.

Results in Brief:

As of April 29, 2005, CMS had received 40 applications from specialty 
hospitals under development seeking determinations that they were 
grandfathered under MMA's moratorium. CMS received 38 applications for 
new specialty hospitals and 2 applications for specialty hospital 
expansions. Slightly more than half (22) of the 40 applications were 
from surgical hospitals, while the rest were from cardiac hospitals 
(9), orthopedic hospitals (5), or hospitals that did not indicate their 
specialty (4). Three-fourths of the applications came from hospitals in 
four states: Texas (19), Louisiana (6), California (3), and Oklahoma 
(3). Of the 40 applications it received, CMS issued 12 favorable 
opinions (approvals) and 2 unfavorable opinions (denials). One of the 
40 applications had been withdrawn.

Comprehensive information about specialty hospitals that may be 
developed when the moratorium expires is both difficult to acquire and 
verify, although what does exist indicates continued growth in the 
number of specialty hospitals--in California, South Carolina, and 
Texas. Of the 52 facilities tentatively identified by AHA, FAH, and 
others as specialty hospitals under development, and that did not apply 
for a determination on whether they were subject to the moratorium, we 
were able to obtain information corroborating that 6 of the facilities 
will be physician-owned specialty hospitals. One of the 6 new 
facilities is planned as a cardiac hospital; the remaining 5 new 
facilities are slated to be surgical hospitals. Four of the 52 
facilities had already opened as physician-owned specialty hospitals, 
while 4 others were no longer under development. We were unable to 
obtain sufficient information to determine the status and 
characteristics of 17 facilities. Finally, the available information 
for the remaining 21 of the 52 facilities indicated that they would not 
be physician-owned specialty hospitals. In short, the group of 52 
facilities could include anywhere from 6 to 23 specialty hospitals 
under development. Additional facilities, especially those in the early 
planning stages, could also be under development as specialty 
hospitals. Representatives of community hospitals are concerned that 
the number of specialty hospitals could grow rapidly following the 
moratorium's expiration. In contrast, most representatives of specialty 
hospitals said that continued uncertainty over future federal actions 
and other factors would cause any such growth to be both moderate and 
gradual.

Upon reviewing a draft of our report, CMS acknowledged the usefulness 
of our report and provided context for the scope of the specialty 
hospital issue.

Background:

Federal law, in general, prohibits physicians from referring Medicare 
patients for designated health services to facilities in which they (or 
an immediate family member) have an ownership or investment interest. 
In addition, the law prohibits such facilities from billing Medicare or 
the beneficiary for services rendered as a result of a prohibited 
referral.[Footnote 5] Before MMA, an exception to this general 
prohibition, commonly called the "whole hospital" exception, allowed 
physicians who have an ownership or investment interest in an entire 
hospital, and who are authorized to perform services there, to refer 
patients to that hospital. MMA's specialty hospital moratorium excludes 
from this exception those hospitals that are primarily or exclusively 
engaged in the care and treatment of patients with cardiac or 
orthopedic conditions, or patients receiving surgical procedures or 
other specialized categories of services designated by the Secretary of 
Health and Human Services.[Footnote 6],[Footnote 7] Therefore, a 
physician with an ownership or investment interest in a specialty 
hospital may not refer Medicare patients to that hospital, and the 
hospital may not bill Medicare or the beneficiary, for inpatient or 
outpatient hospital services or other designated health services while 
the moratorium is in effect.

MMA grandfathers specialty hospitals that as of November 18, 2003, were 
in operation or under development. Hospitals may apply to CMS and 
request an advisory opinion on their development status as of November 
18, 2003. In determining whether a hospital was under development as of 
that date, CMS is required to consider whether the following had 
occurred: architectural plans were completed; funding was received; 
zoning requirements were met; and necessary approvals from appropriate 
state agencies were received. CMS may also consider other evidence in 
reaching its determination. Specialty hospitals that had Medicare 
provider agreements in effect as of November 18, 2003, were considered 
to be in operation as of that date and thus grandfathered under the 
moratorium. During the moratorium, a grandfathered specialty hospital 
is not allowed to bill for physician investor referrals of Medicare 
designated health services if the hospital expands by increasing the 
number of its physician investors, changing the specialized services it 
provides, or increasing its size by more than five beds or 50 percent 
of the number of beds in the hospital as of November 18, 2003 
(whichever is greater).[Footnote 8]

Although MMA's moratorium specifically pertains to physicians' 
referrals of Medicare patients and any corresponding billing for the 
referred services, the moratorium in effect curtails further 
development of physician-owned specialty hospitals. Existing specialty 
hospitals grandfathered under the moratorium, although limited in their 
ability to expand, may continue to bill for services rendered to 
patients referred to them by physicians who have ownership or 
investment interests in the facilities.

Forty Specialty Hospitals Applied for a Determination of Their 
Development Status under the Moratorium:

As of April 29, 2005, CMS had received 40 applications for grandfather 
determinations from specialty hospitals that sought to continue to 
develop or expand under the moratorium.[Footnote 9] CMS had approved 12 
of the applications. Two of the applications were denied, although 1 of 
these 2 decisions is being reviewed by CMS at the request of the 
specialty hospital. Another of the 40 applications was withdrawn, while 
the remaining 25 applications are pending. The tables below provide 
detailed information on the status of the applications by type of 
application--new facilities or expansions of existing facilities (see 
table 1), hospital specialty (see table 2), and hospital location (see 
table 3).

Table 1: Status of Applications for Specialty Hospital Grandfather 
Determinations, by Type of Application, April 29, 2005:

Application type:  New facility[A];
Application status: Approved: 12;
Application status: Denied: 2;
Application status: Withdrawn: 1;
Application status: Pending: 23;
Application status: Total: 38. 

Application type:  Expansion;
Application status: Approved: 0;
Application status: Denied: 0;
Application status: Withdrawn: 0;
Application status: Pending: 2;
Application status: Total: 2. 

Application type:  Total;
Application status: Approved: 12;
Application status: Denied: 2;
Application status: Withdrawn: 1;
Application status: Pending: 25;
Application status: Total: 40. 

Source: CMS. 

[A] New facilities include ambulatory surgery centers that were being 
converted to specialty hospitals. 

[End of table]

Table 2: Status of Applications for Specialty Hospital Grandfather 
Determinations, by Hospital Specialty, April 29, 2005:

Hospital specialty: Cardiac;
Application status: Approved: 1;
Application status: Denied: 1;
Application status: Withdrawn: 0;
Application status: Pending: 7;
Application status: Total: 9. 

Hospital specialty: Orthopedic;
Application status: Approved: 2;
Application status: Denied: 1;
Application status: Withdrawn: 1;
Application status: Pending: 1;
Application status: Total: 5. 

Hospital specialty: Surgical;
Application status: Approved: 9;
Application status: Denied: 0;
Application status: Withdrawn: 0;
Application status: Pending: 13;
Application status: Total: 22. 

Hospital specialty: Uncertain[A];
Application status: Approved: 0;
Application status: Denied: 0;
Application status: Withdrawn: 0;
Application status: Pending: 4;
Application status: Total: 4. 

Hospital specialty: Total;
Application status: Approved: 12;
Application status: Denied: 2;
Application status: Withdrawn: 1;
Application status: Pending: 25;
Application status: Total: 40. 

Source: CMS. 

[A] Application did not indicate hospital's specialty. 

[End of table]

Table 3: Status of Applications for Specialty Hospital Grandfather 
Determinations, by Hospital Location, April 29, 2005:

Hospital location: Texas;
Application status: Approved: 7;
Application status: Denied: 1;
Application status: Withdrawn: 0;
Application status: Pending: 11;
Application status: Total: 19. 

Hospital location: Louisiana;
Application status: Approved: 3;
Application status: Denied: 0;
Application status: Withdrawn: 0;
Application status: Pending: 3;
Application status: Total: 6. 

Hospital location: California;
Application status: Approved: 1;
Application status: Denied: 0;
Application status: Withdrawn: 0;
Application status: Pending: 2;
Application status: Total: 3. 

Hospital location: Oklahoma;
Application status: Approved: 0;
Application status: Denied: 1;
Application status: Withdrawn: 0;
Application status: Pending: 2;
Application status: Total: 3. 

Hospital location: Other[A];
Application status: Approved: 1;
Application status: Denied: 0;
Application status: Withdrawn: 1;
Application status: Pending: 7;
Application status: Total: 9. 

Hospital location: Total;
Application status: Approved: 12;
Application status: Denied: 2;
Application status: Withdrawn: 1;
Application status: Pending: 25;
Application status: Total: 40. 

Source: CMS. 

[A] Other states include Arizona, Arkansas, Colorado, Indiana, Kansas, 
Nevada, Ohio, and Pennsylvania. 

[End of table]

Limited Verifiable Information Suggests Continued Growth in the Number 
of Specialty Hospitals:

When the Moratorium Expires:

Comprehensive information about specialty hospitals that did not apply 
for a grandfather determination and that may be developed when the 
moratorium expires is not readily available, variable in its quality, 
and often difficult to verify. Although AHA, FAH, and others had 
tentatively identified 52 facilities as potential physician-owned 
specialty hospitals under development, the information available to us 
corroborated this status for only 6 facilities. Available information 
on the remaining facilities was either insufficient for us to determine 
the status and characteristics of the facility or it indicated that the 
facility was not under development or was not a physician-owned 
specialty hospital. Other facilities, in addition to the 52 we 
attempted to confirm, could be under development as specialty 
hospitals. This is particularly true of facilities that are in the 
early planning stages, because those efforts are often not publicized. 
Because of the lack of comprehensive, verifiable information, the 
extent to which the number of specialty hospitals will increase when 
the moratorium expires is uncertain. Representatives of community 
hospitals told us they believe that there will be a rapid expansion in 
the number of new specialty hospitals, while most representatives of 
the specialty hospital industry said they believe that any such growth 
will be both modest and gradual.

Of the 52 facilities tentatively identified as specialty hospitals 
under development, we obtained corroborating information that 6 were 
being planned as physician-owned specialty hospitals. (See table 4.) 
Five of the 6 specialty hospitals were slated to be surgical hospitals 
and 1 was being built as a cardiac hospital. (See table 5.) The 6 
specialty hospitals are located in three states: California (2), South 
Carolina (1), and Texas (3). An additional 4 facilities had opened as 
physician-owned specialty hospitals during the moratorium.[Footnote 10] 
We also identified 4 facilities that had been under development as 
specialty hospitals, but those projects had been terminated.

Table 4: Characteristics of Facilities Identified as Potential 
Specialty Hospitals under Development that Did Not Apply for 
Grandfather Determinations, April 2005:

Physician-owned specialty hospital? Yes; 
Facility characteristics: Under development;
Number of facilities: 6. 

Physician-owned specialty hospital? Yes; 
Facility characteristics: Opened after November 18, 2003;
Number of facilities: 4. 

Physician-owned specialty hospital? Yes; 
Facility characteristics: No longer under development;
Number of facilities: 4. 

Physician-owned specialty hospital? Uncertain;
Facility characteristics: Information insufficient to determine 
characteristics;
Number of facilities: 17. 

Physician-owned specialty hospital? No;
Facility characteristics: Physician-owned general hospital;
Number of facilities: 12. 

Physician-owned specialty hospital? No;
Facility characteristics: Not a hospital or not physician owned [A];
Number of facilities: 9. 

Number of facilities: Total: 52. 

Source: GAO. 

Note: The facilities included in the table had been identified by 
representatives of community hospitals, state hospital associations, 
representatives of specialty hospitals, and GAO as potential specialty 
hospitals under development. We classified each facility based on 
available corroborating information regarding the characteristics of 
that facility. 

[A] Five of the nine facilities are ambulatory surgery centers, two are 
general hospitals that are not physician-owned, one is a physician's 
office, and one is a recovery center. 

[End of table]

Table 5: Location and Type of Specialty Hospitals that Did Not Apply 
for Grandfather Determinations and Were Verified as under Development, 
April 2005:

State: California;
Specialty type: Cardiac: 0;
Specialty type: Surgical: 2;
Total: 2. 

State: South Carolina;
Specialty type: Cardiac: 1;
Specialty type: Surgical: 0;
Total: 1. 

State: Texas;
Specialty type: Cardiac: 0;
Specialty type: Surgical: 3;
Total: 3. 

State: Total;
Specialty type: Cardiac: 1;
Specialty type: Surgical: 5;
Total: 6. 

Source: GAO. 

Note: We did not identify any orthopedic specialty hospitals under 
development. 

[End of table]

The information available on 17 of the 52 facilities was insufficient 
for us to determine whether they were being developed as physician- 
owned specialty hospitals. Consequently, the 52 facilities could 
include from 6 to 23 physician-owned specialty hospitals under 
development. In another 21 of the 52 cases, the available information 
indicated that the facility would not be a physician-owned specialty 
hospital.

Many community hospital representatives that we spoke with said that 
the expiration of the moratorium will lead to a rapid increase in the 
number of specialty hospitals. The representatives stated that such 
development would occur, in part, because physicians view specialty 
hospitals as an attractive financial opportunity. Community hospital 
representatives said that, in some instances, it would be relatively 
easy for physician-owned general hospitals to change their missions and 
begin functioning as specialty hospitals. The representatives also 
raised concerns about some physician-owned hospitals, in existence and 
under development, that classify themselves as general hospitals. The 
representatives said that some of these self-classified general 
hospitals predominately focused, or will focus, on surgical procedures, 
and thus should be considered specialty hospitals by CMS and be subject 
to MMA's moratorium.

Most of the specialty hospital representatives we spoke with expected 
that any growth in the number of specialty hospitals following the 
moratorium's expiration would likely be both modest and gradual. 
Officials representing companies that own specialty hospitals said that 
continued uncertainty regarding future federal restrictions would 
dampen their interest in developing new specialty hospitals and make it 
difficult to obtain the financing necessary for such projects.[Footnote 
11] Some company representatives said that the lack of a clear 
definition of what constitutes a specialty hospital has led their 
companies to avoid investments in certain facilities. The 
representatives said that they were concerned that if Congress extends 
the moratorium, CMS could later classify the facility as a specialty 
hospital, potentially subject to the moratorium or other restrictions. 
Specialty hospital representatives also said that not all physician- 
owned specialty hospitals have been financially successful and that 
some such hospitals have closed and physicians have lost their 
investments. Some representatives added that, although physicians are 
primarily interested in specialty hospitals for nonfinancial reasons, 
the financial risks are now more apparent and may dampen some 
enthusiasm for future development. The representatives said they 
believed that any growth in the number of specialty hospitals will be 
gradual because not all of the specialty hospitals under development 
will open immediately and that it typically takes 2 or more years to 
develop, construct, and open a new facility. Finally, they added that 
it is likely that some of the planned specialty hospitals, especially 
those in the early stages of planning, may never be built or opened.

Concluding Observations:

Whether or not MMA's moratorium is allowed to expire, the number of 
physician-owned specialty hospitals will increase from present levels. 
If the moratorium is extended, at least 12, and perhaps eventually as 
many as 37, new specialty hospitals could be completed and opened 
within a year or two. The exact increase would depend in part on the 
number of applications that CMS approves. If the moratorium is allowed 
to expire, the increase would likely be greater, but how much greater 
is uncertain. Specialty hospitals under development whose applications 
for grandfather status have been denied, and specialty hospitals that 
have not applied, could open.

We identified 6 specialty hospitals under development that had not 
applied. In addition, some or all of the 17 facilities where we had 
insufficient information to classify the facility could also be 
physician-owned specialty hospitals under development. The lack of 
comprehensive, verifiable information makes it difficult to know 
exactly how many hospitals may be under development. Ultimately, the 
extent to which physicians and other investors are attracted to 
specialty hospitals, or are deterred by the uncertainty of future 
federal restrictions or other factors, will decide how quickly the 
industry grows when the moratorium expires.

Agency Comments:

We provided a draft of our report to CMS for review. In written 
comments, CMS acknowledged the usefulness of our report concerning 
physician-owned specialty hospitals under development. CMS provided 
context for the relative potential growth of physician-owned specialty 
hospitals, stating that if the agency were to approve all pending 
applications for grandfather determinations and if all of the 37 
potential specialty hospitals identified by GAO were to open, the 
number of acute care hospitals would increase by just over 1 percent. 
We have reprinted CMS's letter in enclosure II. CMS also provided 
technical comments, which we incorporated where appropriate.

As agreed with your offices, we plan no further distribution of this 
report until 30 days after its date. At that time, we will send copies 
of this report to appropriate congressional committees and other 
interested parties. We will also make copies available to others upon 
request. This report will be available at no charge on GAO's Web site 
at http://www.gao.gov.

If you or your staffs have any questions, please call me on (202) 512- 
7101 or James Cosgrove on (202) 512-7029. Other contributors to this 
report include Zachary Gaumer and Jennifer Podulka.

Signed by: 

A. Bruce Steinwald:

Director, Health Care:

Enclosures:

Scope and Methodology:

This enclosure provides additional details about the scope of our work, 
our methodology, and key limitations. First, it describes the data that 
we obtained from the Centers for Medicare & Medicaid Services (CMS) 
regarding specialty hospitals under development that applied for a 
determination that they were grandfathered under the moratorium. 
Second, it describes the approach we used to identify information about 
other specialty hospitals under development and to verify the accuracy 
of this information.

Information on Specialty Hospitals under Development that Applied for 
Grandfather Determinations:

CMS provided information on the 40 specialty hospitals under 
development that had applied for grandfather determinations as of April 
29, 2005. From CMS, we obtained summary information on each hospital's 
name, state location, and area of specialization; whether the 
application was for a new facility or an expansion of an existing one; 
and the current status of the application: approved, denied, withdrawn, 
or pending.

Information on Other Specialty Hospitals under Development:

To gather information about specialty hospitals potentially under 
development that had not applied for a determination that they were 
grandfathered under the moratorium, we consulted organizations and 
individuals most likely to be aware of such development. Specifically, 
we contacted the two government agencies mandated by the Medicare 
Prescription Drug, Improvement, and Modernization Act of 2003 (MMA) to 
study specialty hospital issues for Congress: CMS and the Medicare 
Payment Advisory Commission. Because hospital officials and hospital 
associations are likely to be aware of developments in their industry, 
we contacted representatives from both community hospitals and 
specialty hospitals. Specifically, the community hospital 
representatives included officials from the American Hospital 
Association, the Federation of American Hospitals, the Coalition of 
Full-Service Community Hospitals, and nine state hospital 
associations.[Footnote 12] We selected the nine state hospital 
associations because our October 2003 report on specialty hospitals 
identified those states as having concentrations of specialty hospitals 
in existence or under development at that time.[Footnote 13] Officials 
of specialty hospitals that we contacted represented the American 
Surgical Hospital Association and five corporations that own specialty 
hospitals: Baylor Health Care System, Hospital Partners of America, 
MedCath Corporation, National Surgical Hospitals, and United Surgical 
Partners International. Many of the organizations and individuals we 
contacted provided us with information on specific facilities that they 
said were likely specialty hospitals under development and offered 
their views on the potential for specialty hospital growth after the 
moratorium expires.

We consolidated the information we obtained from the sources described 
above, along with the information on specialty hospitals under 
development that we had identified for our October 2003 report. After 
excluding those facilities that had submitted applications for 
grandfather determinations to CMS, we were left with a list of 52 
potential new specialty hospitals.

We then sought corroborating information that the 52 facilities in 
question (1) were under development, (2) would specialize in treating 
cardiac or orthopedic patients or in treating patients that need 
surgical procedures, and (3) that these facilities would be owned, at 
least in part, by one or more physicians. If sufficient information was 
available, we attempted to contact a representative of the facility. 
When we were successful in making contact, we used the information we 
obtained to determine the status of the facility. If we could not make 
contact with the facility directly, we turned to a variety of 
independent news sources to obtain information about the facility. 
These sources included local newspapers, local business journals, 
health care industry publications, and company Web sites. Following the 
process outlined above, we determined the status of 35 of the 52 
facilities tentatively identified as specialty hospitals under 
development. In 17 instances, we could not locate sufficient 
information within the time frames allotted for the study to determine 
the status of the facility. Although our findings are based on the best 
information available to us, it is very likely that we do not have a 
complete list of all specialty hospitals under development. Some 
facilities, particularly those in the initial planning stages, may not 
have come to the attention of the individuals and organizations we 
contacted. Our work was performed during April and May 2005 in 
accordance with generally accepted government auditing standards.

[End of section]

Enclosure II: Comments from the Centers for Medicare & Medicaid 
Services:

DEPARTMENT OF HEALTH & HUMAN SERVICES: 
Centers for Medicare & Medicaid Services: 
Administrator: 
Washington, DC 20201:

DATE: MAY 9 2005: 

TO: A. Bruce Steinwald:

Director, Health Care - Economic and Payment Issues:

FROM: Mark B. McClellan, M.D., Ph. D., Administrator:

Signed by: Mark B. McClellan:

SUBJECT: Government Accountability Office's (GAO) Draft Report: 
Specialty Hospitals: Information on Potential New Facilities (GAO-05-
647R):

The Centers for Medicare & Medicaid Services (CMS) appreciates the 
opportunity to review and comment on this report. The growth of 
physician-owned specialty hospitals in the last ten years has been the 
subject of much debate. Much of the concern has focused upon the impact 
of these new specialty hospitals upon community hospitals, the type of 
care rendered by these facilities, the types of patients treated at 
these facilities, and particularly financial incentives for physician 
owners to refer patients to facilities in which the physicians have an 
ownership or investment interest. This report is particularly timely in 
light of the Medicare Payment Advisory Commission's recently released 
study and our soon to be released study and recommendations concerning 
this issue.

As of May 3, 2005, there are approximately 5,000 acute care hospitals 
currently participating in the Medicare program. There are 25 "under 
development" advisory opinion requests pending a determination from 
CMS. In addition, the GAO report projects that between l 1 and 37 
additional specialty hospitals may open within a year or two. To 
provide some context, if CMS were to approve all pending advisory 
opinion requests, and i f all those specialty hospitals plus the 
projected 11 to 37 additional specialty hospitals actually opened, this 
would represent only a 1.24 percent increase in the current number of 
acute care hospitals.

Thank you for your efforts to study this matter. The report will assist 
us in formulating recommendations to the Congress concerning the impact 
of specialty hospitals. Attached are our technical comments on the 
report. 

[End of section]

(290453):

FOOTNOTES

[1] Specialty Hospitals: Geographic Location, Services Provided, and 
Financial Performance, GAO-04-167 (Washington, D.C.: Oct. 22, 2003) and 
Specialty Hospitals: Information on National Market Share, Physician 
Ownership, and Patients Served, GAO-03-683R (Washington, D.C.: Apr. 18, 
2003).

[2] We considered a hospital to be a specialty hospital if the 
diagnosis-related group (DRG) classification for at least two-thirds of 
its Medicare patients (or two-thirds of all of its patients where such 
data were available) fell into no more than two major diagnosis 
categories, such as diseases of the circulatory system, or if at least 
two-thirds of its patients were classified in surgical DRGs. We 
excluded hospitals that were government owned or that specialized in 
providing long-term care or otherwise had missions largely distinct 
from the missions of short-term, acute care hospitals. Our analysis 
included specialty hospitals that were owned, in whole or in part, by 
physicians and those that had no physician owners.

[3] In its 2005 report to Congress, the Medicare Payment Advisory 
Commission (MedPAC) stated that there were 48 physician-owned cardiac, 
orthopedic, or surgical specialty hospitals in 2002. MedPAC identified 
fewer specialty hospitals than we did in our previous reports primarily 
because MedPAC excluded from its count women's specialty hospitals and 
specialty hospitals that had no physician owners. See Medicare Payment 
Advisory Commission, Report to the Congress: Physician-Owned Specialty 
Hospitals (Washington, D.C.: March 2005).

[4] MMA imposed an 18-month moratorium during which a physician who has 
an ownership or investment interest in a new specialty hospital (or has 
immediate family members who do) may not refer Medicare patients to 
that hospital for designated health services. Thus, in effect, the 
moratorium halted further development of physician-owned specialty 
hospitals. Pub. L. No. 108-173, 507, 117 Stat. 2066, 2295-97. 

[5] Certain aspects of the physician self-referral prohibition have 
been made applicable to the Medicaid program, 42 U.S.C. 1396b(s)(2000).

[6] CMS has not issued guidance to define the phrase "primarily or 
exclusively engaged." For example, CMS has not stated whether the 
definition of "primarily" is based on the number of patients, percent 
of revenues, or other factors.

[7] Certain types of hospitals, for example, psychiatric hospitals and 
children's hospitals, cannot be designated specialty hospitals for the 
purposes of the moratorium. CMS has not designated other types of 
specialty hospitals in addition to the ones (cardiac, orthopedic, and 
surgical) specifically mentioned in MMA.

[8] An increase in the number of beds is allowed only on the main 
campus of the hospital.

[9] CMS indicated that 3 of the 40 applicants also requested 
determinations that the hospital in question was not a specialty 
hospital. In addition to the 40 applications, CMS received 8 
applications from physician-owned specialty hospitals seeking advisory 
opinions on issues other than whether or not the hospital was under 
development as of November 18, 2003. 

[10] None of the four specialty hospitals (one cardiac, one orthopedic, 
and two surgical) had applied to CMS for a determination of their 
development status under the moratorium. CMS stated that the agency 
strongly recommends, but does not require, entities to seek a favorable 
grandfather determination before opening as a specialty hospital. 

[11] Some specialty hospital representatives stated that uncertainly 
also exists with regard to potential state legislative efforts. Several 
states are considering legislation that would prohibit or discourage 
future specialty hospital growth.

[12] The nine states were Arizona, California, Idaho, Kansas, 
Louisiana, Oklahoma, South Dakota, Texas, and Wisconsin.

[13] GAO-04-167.