Death cycle

In 2004, the region’s two largest hospital systems sought to redraw the map of Pennsylvania. Although their hospitals, clinics and headquarters all sit in and around Allegheny County, the University of Pittsburgh Medical Center and West Penn Allegheny Health System asked Medicare, the federal health insurance program for the elderly, to identify them as a part of greater Philadelphia.

Medicare said no to both systems’ requests, but not for the reasons you might expect.

In West Penn Allegheny’s case, Medicare felt they had chosen the wrong location — somewhere closer to the center of the state might have been more appropriate. In UPMC’s case, it was a matter of money. Medicare, which had $900 million and not a penny more to pay for such reclassifications nationwide, spent it all before UPMC’s could be accommodated.

No one questioned the sanity of UPMC’s and West Penn Allegheny’s requests to be part of a geographic region hundreds of miles from where their hospitals are located. More than 540 U.S. hospitals asked for the same thing in 2004, and Medicare said yes to 121 of them. And before Pittsburghers get prickly about it, know that what UPMC and West Penn Allegheny sought doesn’t reflect how they feel about the rivers and valleys of western Pennsylvania or the people who live here. It was business, not personal.

A hospital in western Pennsylvania sits on the short end of a wage-adjusted Medicare payment index that shrinks year after year, despite the fact that hourly wages climb steadily higher. In other words, Medicare payments to hospitals fail to accurately reflect actual labor costs and haven’t for some time.

UPMC and West Penn Allegheny asked to be reclassified as part of the greater Philadelphia area, because payments to similar hospitals are based on a Medicare Area Wage Index that is nearly 25 percent higher. And the fact that UPMC and West Penn Allegheny remain stuck in this Medicare Twilight Zone is why officials of these competing health systems find themselves at the same table, putting their heads together to find a solution.

“It’s a big issue for all of us,” says Edward Karlovich, UPMC’s chief financial officer. “It’s essentially moving money that would otherwise have been available for investment in western Pennsylvania out of the region. That’s the nuts and bolts of it.”

The way Medicare pays hospitals for treating elderly patients is remarkably complex. Since 1983, it has set the prices it will pay for treating specific health problems, breaking them into 511 categories, or diagnosis-related groups, such as heart failure, pneumonia or replacing a hip or a knee. Because the cost of this care varies across geographic areas, Medicare adjusts payments for local market conditions. In these adjustments, the single most important factor is the wage index, which determines approximately 71 percent of the total payment amount.

Medicare’s wage index compares the average hourly wage for hospital workers in each metropolitan or rural area against the national average. Western Pennsylvania’s index value of .8568 for fiscal 2007 means the average hourly hospital wages paid by hospitals in the region are about 15 percent less than the national average for all hospitals receiving Medicare payments. Hospitals are sensitive to this index for good reason — if it slips even slightly, the index can have a significant impact on a hospital’s Medicare reimbursements. A 5 percent change in the wage index, for example, can result in a payment change of about $200 per Medicare discharge for the typical hospital.

In western Pennsylvania, the wage index has fallen 12 percent from fiscal 2001, when it stood at .9741. UPMC officials say the decline in the wage index translates into more than $137 million in lost revenue. For West Penn Allegheny, the seven-year drop in the region’s wage index has meant $81.6 million in lost revenue.

Meanwhile, hospital wages in the region have risen 20 percent — from an average hourly wage of $21.21 in fiscal 2001 to $25.41 in fiscal 2007.

This paradox occurs because Medicare operates under a budget-neutral payment system, in which a fixed sum is set aside — about $112.7 billion in fiscal 2007 — to pay for all Medicare-eligible hospital inpatient services. In this zero-sum game, the winners are almost always the regions reporting the highest wage growth. When Medicare hikes one region’s wage index, it must find the money to pay for it by lowering the wage index somewhere else. So, despite the fact western Pennsylvania’s average hourly wage has risen like clockwork for seven years, “it’s not increasing enough compared to the national average, which results in a lower wage index,” says Ellen Griffith, spokesperson for the Centers for Medicare and Medicaid Services, the federal agency that administers the Medicare program.

Hospital insiders refer to this as a “death cycle” and it’s something the region’s hospitals say they must escape if they hope to remain financially healthy in the coming years. Today, the two largest health systems are operating in the black: UPMC reported an 8.7 percent profit margin in fiscal 2006 and West Penn Allegheny posted a 2.75 percent margin in fiscal 2005. “But,” says UPMC’s Karlovich, “it becomes more and more of a struggle when Medicare doesn’t recognize the increased cost of salaries and wages in our region.”

Western Pennsylvania hospitals, in particular, treat a high proportion of Medicare patients. For example, Medicare accounts for at least half of the net patient revenue at UPMC’s St. Margaret, South Side, Braddock, Passavant and McKeesport hospitals, and West Penn Allegheny’s Forbes Regional Hospital, Canonsburg General Hospital and Alle-Kiski Medical Center, according to a 2005 Pennsylvania Health Care Cost Containment Council statewide financial analysis.

In fact, nearly 18 percent of Allegheny County’s citizens are over the age of 65 — the 13th largest senior population among 3,141 U.S. counties. Of greater concern to the region’s hospitals: Seniors will account for 22 percent of the population in Allegheny, Armstrong, Beaver, Butler, Washington and Westmoreland counties by 2020 and trigger a 27 percent increase in Medicare hospital discharges, according to the Cost Containment Council’s projections. “We’ve been cost conscious, cost effective, generated new sources of revenue and improved the bottom line — all while absorbing this rather material reduction (in Medicare payment rates),” says Denis Lukes, vice president of patient financial services at West Penn Allegheny. “But, when you look at it over the long haul, how many more places can you find to go to and make up those dollars?”

The region’s hospitals point out such things when pleading their case before Medicare policymakers. “We’ve argued that because of our large concentration of Medicare-eligible population we are particularly disadvantaged. We tell people that, in many cases the region’s largest employers are in health care. But, aside from our (Congressional) delegation, those arguments seem lost on Washington,” says Margaret McCormick-Barron, West Penn Allegheny’s vice president of legislative affairs.

More than a year ago, UPMC, West Penn Allegheny and Mercy Hospital began a joint effort to define the impact that falling wage index values are having on the region’s hospitals and craft a strategy to address it with the help of a team of consultants that includes the professional services firm, Ernst and Young, and Ian Rawson, retired president of the Hospital Council of Western Pennsylvania. Their short-term goal is to press for an immediate wage index adjustment. For a longer term solution, they advocate a Medicare payment system that would eliminate the inequities in the wage index.

Their efforts and those of the Hospital and Healthsystems Association of Pennsylvania (HAP) helped rally Pennsylvania’s U.S. senators, Rick Santorum and Arlen Specter, to the cause. They co-sponsored a bill that would make it easier for hospitals to be reclassified into a more favorable wage index area.

For some, it could provide a temporary fix, much like the 2004 one-time reclassification opportunity that allowed fewer than 25 percent of the hospitals who argued hardship to improve their wage index for three years only. But the Santorum-Specter bill was introduced in September, too

late for debate and a vote before recess. With the congressional session set to expire at the end of the year — and with it any bill not voted into law — its fate is uncertain.

The good news for hospitals is that the groundswell of discontent has been channeled into efforts by healthcare associations and others across the country to change the Medicare payment system to more accurately reflect trends in hospital labor costs.

The not-so-good news is that satisfying all aggrieved hospitals using the money at hand may well be a problem without a solution. “The big, looming question is how do you do this without new money,” says Michael Strazzella, HAP’s vice president of federal relations. “If we had the answer, you probably would have already seen a legislative fix in the works.”