Uwe Reinhardt's economic wisdom.

As healthcare continues to change, so will the ways in which administrators manage their operations. Through all of these changes, it is surprising to discover how little attention is paid to honing the financial and economic skills of those responsible for decision making. Most healthcare managers have had little training in finance and rely mainly on their organization's CFO, comptroller or accountant for this information. The problem with this kind of thinking is that data can be interpreted in different ways, and how it is interpreted is often the key determinant of an organization's success or failure.

Recently, I had the good fortune of engaging one of the nation's foremost experts on healthcare financing in a one-on-one interview. Uwe E. Reinhardt, PhD, is the James Madison Professor of Political Economy and Professor of Economics and Public Affairs at Princeton University. A popular speaker on the healthcare convention circuit, he is the recipient of many awards, including honorary degrees from the Medical College of Pennsylvania and from Mt. Sinai Medical College in New York. His advice has helped shape policy on the National Council on Health Care Technology, a special advisory group for the Veterans Administration and the national Physician Payment Review Committee. His doctoral dissertation, entitled Physician Productivity and the Demand for Health Manpower, is considered an important early work regarding the economics of delivering healthcare. He is noted as an outspoken critic of the healthcare financing status quo, but one who couches his observations with humor. Recently, having just received a Healthcare Financial Management Association award, he fielded a few questions from yours truly.

Hyatt: Dr. Reinhardt, I've heard you talk about the 'mysterious force' that can move almost anything, and that CFOs have but clinicians usually lack. Can you share with the readers what you mean by this?

Reinhardt: It is a device I use in my finance course to teach students about the mysteries of corporate finance. I tell them that there are two ways to get the "force." Most of my students grew up watching Star Wars, so I remind them that one way to get the "force" is to go to a jungle - a swampy, stinky jungle - to meet with a creature called Yoda. After you listen to this nitwit for hours, days and even months, you might graduate endowed with the "force." You can use it to move trees and spacecraft and stuff.

But there is another way you can get the "force" and, with it, you can also get things moved. People called CFOs are good at exploiting this second way of getting the "force." Then I pull a $20 bill out of my wallet and show it to my students. I tell them that this, too, is the "force." If you have fistfuls of this stuff and wave it in front of people, they will do darn near anything for you. In Las Vegas they will do anything imaginable for the "force." If you want a hole dug, you wave this and it shall be done. If you want trees moved from your property, wave the force and they shall be moved.

There are two methods of obtaining this particular "force." You can earn it or you can ask others to let you use their force. If you choose the latter, you can rent someone else's "force" for a fixed period and pay a periodic rental called interest. This is often called a bond. Alternatively, you can ask perfect strangers to surrender to you a certain amount of their force based on the promise that you will make them rich in return - either by paying dividends, or by working to increase the value of the ownership certificate you gave them in exchange for their force. A common name for this hope-and-prayer piece of paper is a stock certificate. Remarkably, there are thousands of perfect strangers who will surrender their force to you for this certificate.

Thus, when someone says, "May the force be with you," they really mean, "May Wall Street endow you with enough capital to move whatever and whomever you wish to move, wherever you wish to move them."

In that respect CFOs in healthcare are more powerful than, say, clinicians. CFOs get the force and have a say in how it's used. We call what they do "budgeting the force" or, more familiarly, "capital budgeting."

Hyatt: The employment-based system of healthcare financing is an interesting phenomenon specific to the United States, and it impacts all levels of care. Would you discuss its origin?

Reinhardt: It goes back to the contract that I call the Disneyland Health Insurance Contract. World War II brought about an aberration in this country. There were soldiers fighting in the trenches at fixed wages, but then there were workers at home making the ammunition and charging market rates. The Congress thought that this wasn't right and that the worker should have the same rules; hence, the birth of wage and price control. An employer got around this by offering fringe benefits, a mechanism that was unique to this country - thus, the employment-based health insurance system. The Congress made this more appealing by making this benefit tax-deductible to business and nontaxable to the employee. Therefore, the employee looked to the employer to take the financial risk of illness. The employer didn't mind because the employer knew that the employee was paying for it through lower take-home pay. It wasn't the employer's money, and it wasn't the shareholder's money - it was the employee's own money. The employee got paid in "fringes," not in take-home pay. Every economist will tell you that this is essentially a one-for-one substitution.

At this time the employee benefits manager was born. Employee benefits managers are basically like pickpockets at a garden party who steal money out of your wallet and then turn around and buy you gifts with it. And yet everyone loves them.

In the 1980s, insurance companies raised premiums sometimes as much as 20% per year, but employers didn't mind because employees were paying this bill unknowingly. So, money flowed into this sort of "ignorance is bliss" system. During this same period, the '80s, Medicare and Medicaid paid less than full costs to the providers, both inpatient and outpatient. Private insurance payers were paying about a 30% premium because there wasn't an emphasis on control in their sector, so they basically financed the shortfall that wasn't paid by Medicare and Medicaid. This is what we refer to as "the cost shift."

Hyatt: Now Congress has introduced new regulations that are changing reimbursement and public policy through the Balanced Budget Act of 1997 (BBA). Could you discuss the pressures placed on the healthcare sector, including hospitals, SNFs and home care, because of this act?

Reinhardt: The BBA of 1997 is Congress's attempt to control Medicare spending, a task that had been laid aside during the incessant warfare between the Republicans and the White House since 1994. The BBA hit many areas of healthcare, especially those you mentioned. First it called attention to the inpatient Medicare margins that had been rising throughout the '90s to about 14% in 1997. That really happened because hospitals learned to control their costs better, but also because they had shifted the overhead out of the acute inpatient side into the newly created entities such as SNFs and home care. The hospitals expanded in this direction because Medicare literally reimbursed at cost-plus for SNF care and home care.

The bottom dropped out when the BBA suddenly changed the reimbursement rules for SNFs and home care from retrospective cost reimbursement to prospective payment. It also cut the growth of these items, which had been growing at 20 to 30% a year since 1990. As a result, the SNF and the entire home care industry are being devastated, including the hospital systems that set up these services, because no one had ever learned how to manage these elements within a pre-fixed budget.

Hyatt: What is the future impact of this if it remains as it stands today?

Reinhardt: There was an additional impact brought about by the BBA. Because the inpatient Medicare margin was so high, Congress and the White House jointly also froze the Diagnosis Related Group (DRG) increases for one year, with only limited increases thereafter. The net effect is that the healthcare industry is reeling. Many organizations will face negative total margins by 2002. A recent report by the Lewin organization forecasts that by the year 2002, 70% of these healthcare entities will have negative margins if private and public payers continue as they are currently.

Hyatt: You also speak of Medicaid payments that don't even cover the cost of nursing home care, hospital care or home care - you called it the "ultimate in Medicaid fraud." Could you explain this and how providers are or will be losing their shirts because of the increasing numbers of uninsured persons?

Reinhardt: Over the years as a member of the Physician Payment Review Commission, I was astounded by the low Medicaid fees that states pay relative to Medicare fees or commercial insurance fees. It is a form of fraud. Taxpayers are led to believe that they have taken care of the poor when, in fact, they have not.

Healthcare providers are basically running a "catastrophic insurance policy" for the uninsured. Americans have always relied on their healthcare systems to play a "pin-the-tail-on-the-donkey" game, by which hospitals and doctors were expected to give charity care to low-income uninsured patients and then cover these costs by raising the bill of the insured. In my view this is a dishonest system because, in any other industry, good accounting principles wouldn't permit it. It is fragile, as we shall learn when hospitals hit negative margins en masse.

Hyatt: What are your thoughts about the economic impact of the new information technologies on healthcare?

Reinhardt: The Internet could be a valuable tool that empowers consumers. It will allow for an exchange of important information between professionals and consumers. In the end it might encourage consumers to take the initiative to become better-informed customers with regards to their healthcare.

Hyatt: As one of the foremost authorities on healthcare economic policy, what public policy issues in this area do you believe deserve the most attention?

Reinhardt: I think Congress must address the problem of the increasing numbers of the uninsured. It is simply unreasonable for politicians to expect providers to render care when their profit margins are negative.

Also there needs to be attention paid to the elderly who are on a fixed income and require medications that are not covered or are only partially covered by Medicare. This is a growing issue and one that cannot - and should not - go unattended. It is a form of "moral bankruptcy."

Hyatt: Finally, in looking toward the future, do you believe that we are better off having a healthcare system that is privatized, nonprofit or both, as it is today?

Reinhardt: As it is today nonprofits are, in many ways, for-profits too. I think we will continue to have a mixed system. In the end Americans will probably feel more comfortable with the nonprofit mode for large healthcare systems that give direct patient care. They would, I believe at some point, easily accept for-profit medicine when it is constrained by national or even global standardized medical practices and professional ethics.

I want to thank Dr. Reinhardt for his willingness to share his expertise.

If you have an idea that others in the post-acute field might find useful, please send them to Laura Hyatt, Hyatt Associates, at 2956 Kelton Ave., Los Angeles, CA 90064. Be sure to include your name, organization, address, area code and phone number.

Laura Hyatt is president of Hyatt and Associates, Los Angeles, California.