DAVID S. ABERNETHY
        Deputy Commissioner for Program and Policy Development and Evaluation
                       State of New York Department of Health
                  Governor Nelson A. Rockefeller Empire State Plaza
                                  Albany, New York

T HE New York State prospective hospital reimbursement methodology
     for bureaucrats is called NYPHRM. It is not, in fact, a new approach
to hospital reimbursement, but at least I would like to think of it as the ul-
timate expression of a philosophy about reimbursement and about regulat-
ing hospital reimbursement that has been present in the State of New York
for many years and, of course, has not been present in very many other
   New York started very early with prospective hospital reimbursement.
Work on the system in place today began in the 1960s and has been
expanded over time. Three general principles have guided its development
over those years. First, cost containment measures should not adversely
affect actual patient care. Second, payment should be based only on care
that is efficiently provided. And last, unnecessary services must be elimi-
nated or, at the very least, sharply reduced. The system based on these
principles in New York State works. There is no question about it. In the
latter part of the 1970s the rate of increase in hospital costs nationally was
twice the rate of increase in the State of New York, and New York, being
as populous as it is, retards the national rate of increase. In fact, many be-
lieve that the hospital voluntary effort of the late 1970s was made
successful by the drag created by New York on national rates of increase
in hospital costs. I am sure to get some argument about that, but there is
evidence to support this view.
   The New York system is a very technical and esoteric subject, but a
very interesting one. Jeffrey Merrill is going to talk about diagnosis

  *Presented in a panel, The Response of the States and Communities: Experiments in Funding
Health Care, as part of the 1983 Annual Health Conference, Restructuring the Financing of Health
Care in the Eighties, held by the Committee on Medicine in Society of the New York Academy of
Medicine April 28 and 29, 1983.

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related groups, or DRGs, so I will not discuss that except to talk a little
about case mix and how a hospital reimbursement system tries to insure
that when it imposes controls it measures comparable things. It is very
difficult to set an equitable and adequate rate of payment without a way to
insure that the product being priced is the same product across a wide
range of hospitals.
   So how do we do that? First, the units of cost most frequently selected
for cost comparison are patient days or admissions. The problem is that
obviously neither of these units offer uniform measurements. Differences
in the care delivered and the severity of patient illnesses admitted may
have important consequences for patient care and of course, subsequently,
for costs. In New York we started in 1978 with a federally-funded study
of case mix that was one of the first large scale demonstration projects to
examine case mix. That led, in our own system, to a case mix adjustment
factor, called "service intensity weights," being directly incorporated into
hospital rates.
   New York reimburses on the basis of an all inclusive per diem rate. We
use a formula-based methodology built upon adjusted historical expendi-
ture levels. We go to a base year, currently 1981, and trend forward using
an inflation factor which we call the "trend factor" to get to the rate year.
We do not actually review budgets, to ask if this particular expenditure is
reasonable or not reasonable?
   However, the base is subject to adjustments. We do not simply accept
historical expenditure patterns because those levels do not, of course,
necessarily represent efficient hospital services. To insure that we only
reimburse for the efficient production of health care services, we compare
hospitals to their peers. New York developed a grouping methodology that
uses a variety of factors, including the case mix adjustments I noted, to in-
sure that only similar hospitals end up in the same group. I must admit
that some people have accused us of developing a methodology that no
one else could understand so that only we would know how the rates were
established, but in fact the system is based on a very sophisticated
algorithm called seed clustering. The basic idea, without going into all the
details, is to insure that hospitals are grouped with similar hospitals. We
then impose a standard or ceiling based on the average cost of the group.
Any institutions whose base cost is above that ceiling is assumed to have
costs equal to that ceiling. In other words, they are brought down to the
ceiling or penalized for their costs over the ceiling. In effect, this
establishes average cost as our basic standard for the efficient production
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  30                          D. S. ABERNETHY

of services. We do, however, allow appeals to those standards.
   Length of stay and volume are a major concern of any reimbursement
system. New York's does two things in this regard. First, it imposes an
occupancy standard on those institutions in which occupancy is below an
optimum level for efficient production of services. Richard Merrit's com-
ments about California reminded me that California has an average occu-
pancy rate of about 55% in their hospitals, a lot of excess capacity, for
which everyone in California is paying. In New York the average occu-
pancy rate is above 90% for virtually the entire state. There is not a great
deal of excess hospital capacity in the state of New York.
   Clearly, the basic question of volume is more critical to total costs than
occupancy rates. We often focus on rates and examine the rate per day or
the rate per diagnosis related group. In the long run, rates are not the most
important factor in determining hospital costs. More important is the
number of days or the number of admissions or the total amount of health
care provided. In an effort to provide an incentive to reduce volume and a
disincentive to increase volume, New York's system, in essence, imposes
a total revenue cap on an institution. Revenue stays roughly the same as
volume increases or decreases.
   If the volume goes up, the cost or rate per day should go down and,
conversely, if the volume goes down, the cost or rate per day should go
up. This is precisely what New York State does. In contrast, the new
Medicare system does not do this. As the volume goes up, the rate stays
the same per day or per admission and, therefore, an institution can collect
more revenue by increasing its volume. Conversely, as volume goes
down, revenue, under most systems, shrinks. Under the New York State
system, within certain narrow limits, that does not occur. As volume goes
up, reimbursement per day goes down, overall revenue stays reasonably
even. As volume goes down, revenue stays the same, the cost per day
goes up. In my view, creating an incentive to reduce volume is one of the
most critical factors included in New York's reimbursement system.
However, New York has taken several other steps equally important in
insuring that the reimbursement system is equitable and fair to both
providers and consumers. In addition, as is the case with the volume
adjustment, the system is very different from the system proposed and
adopted by the federal government.
   First and foremost, New York State's system is an all payer system. It
covers Medicare, Medicaid, Blue Cross, private insurance, worker's com-
pensation, and self payers across the board. That means that, opposed to
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the federal system, where only Medicare will be controlled, there is no
opportunity under the system to shift costs to other payers.
   We have all seen the advertisements in the national press, paid for by
the private health insurance companies, arguing against single payer cost
containment systems because of their concern that, in fact, their compan-
ies will foot the bill for that shifting of cost. That is not an idle concern on
their part. It happened in New York, and has happened in every other
state of the union. The private health insurance industry does end up
picking up the tab when the public payers particularly, or Blue Cross, for
that matter, reduce their reimbursement. For this reason an all payer
system is clearly critical to assure equity.
   Second, the New York State system pays an allowance for bad debt and
charity care. Hospitals for years and years have complained that Medicare
and Medicaid did not reimburse them for their bad debts or for the costs of
charity care. In any other business, bad debt, at least, is a legitimate cost
of doing business. In the hospital industry these costs are not reimbursed
and an all payer cost containment system precludes cost-shifting to cover
these costs. The New York system responds to this problem through the
creation of regional bad debt and charity care pools. The dollars in those
pools are limited by a fixed add-on to the reimbursement that all hospitals
receive. These funds are paid out based upon the ratio of total bad debt
and charity care cost incurred in the region to the amount available in the
pool. We estimate that, by the end of the third year, each hospital will re-
ceive about 60 to 70 cents for each dollar of bad debt and charity care cost
incurred by that hospital.
   In a state like New York, with substantial numbers of individuals who
cannot afford to pay for their medical care and were not covered by third
party programs, this issue was critical in building the political and
community consensus needed to create this system. It was absolutely
imperative that New York find a way to reduce the burden of bad debt and
charity care that had let to severe financial distress for many institutions.
Several hospitals in New York City have flirted with bankruptcy, and bad
debt and charity care, more than any other issues, have contributed to
their financial difficulty.
   Stabilization of the system promoted by the bad debt and charity care
allowance is therefore one of the most critical and most important aspects
of the system. Moreover, the system also includes an additional, but
smaller, percentage add-on to reimbursement for a special financially
distressed hospital pool. There are hospitals whose problems are so great
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  32                           D. S. ABERNETHY
                               D. S. ABERNETHY

that the bad debt and charity care allowance will not provide sufficient
stability. Under the New York system, these institutions will be eligible
for funds from the financially distressed pool. It is not a large pool in
terms of the system; for example, the financially distressed pool for the
New York City region will equal about $12 million this year. Neverthe-
less, since these funds will go to those hospitals on the critical list, we be-
lieve that the financially distressed pool will make a dramatic contribution
to stabilizing the system.
   The last critical component of the New York system is the discretionary
allowance. This allowance responds to one of the drawbacks of a reim-
bursement system that is almost totally cost-based. Under such systems
hospitals are paid their costs and nothing more. Institutions have no way
to build up equity, and in essence have no way to put money aside for
capital expenditures other than through depreciation. This means that
hospitals' ability to undertake discretionary projects is limited. Moreover,
hospitals have difficulty in handling cash flow problems through other
than short-term loans because they generally are short of working capital.
In New York we concluded that this was not an appropriate way to
reimburse hospitals, and that it was appropriate to insure that discretionary
funds were available for projects of importance to the institutions and for
working capital. Therefore, the system includes a 1% discretionary
allowance to provide needed flexibility to hospital management.
   That is the basic structure of the New York Prospective Hospital
Reimbursement System. But I think it is very important to point out that
the question of hospital reimbursement is only one of the many health
policy issues before us. New York has focused on this issue and has been
extremely successful. However, other measures must be undertaken if we
are finally to honor the goal of quality health care at reasonable cost. A
second, and perhaps in the long run more important, issue is our approach
to health planning and the certificate of need process. We in New York
have embarked upon a new process to impose reasonable limits of
affordability on capital expenditure decisions made in the health care
industry each year. That is to say that we believe very stongly that it is
critical to assess what the system can afford in advance, to set that limit in
advance, and to make decisions about capital investment in light of that
limit or that test of affordability based upon the relative priorities that each
project has in relationship to all others. At the present time, each project is
considered alone. It is considered on three absolute criteria: need, finan-
cial feasibility, and character and competence of the operator. No longer,
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we believe, can we continue to make these decisions based on absolute
need because we simply cannot afford every needed project each year in
the State of New York. We now have before us some five billion dollars
in proposed capital expenditures pending before the state. We have three
projects pending in northern Manhattan, of which the total capital expen-
diture proposed is some 1.3 billion dollars for those three projects alone.
Do not, however, get hung up on the dollar amounts, because the dollar
amounts in and of themselves are not the issue. The issue is what can the
system afford each year in operating costs? That is what we are examining
and that is how we are trying to redevelop, modernize if you will, the
health planning system to take into account explicitly, each year, prospec-
tively what the limits of affordability are, and then to make capital
expenditure decisions in light of those limits.
   As is clear, one basic tenet underlies New York's strategy. We believe
that government has the responsibility to assure that health care is accessi-
ble and affordable. New York regulates the health care industry, and does
so firmly, because of a commitment to the idea that access to health care
at a reasonable cost is a matter of basic social equity. We have been
accused of over-regulating, a critique which we perhaps deserve. Never-
theless, until a proven alternative to public regulation is developed, we
shall continue to pursue vigorously the strategies which have saved New
Yorkers billions of dollars over the last two decades.

Vol. 60, No. 1, January-February 1984

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