FTC Staff Comment Before the Health Systems Agency of New York Concerning its Draft Medical Facilities Plan

\J U 	.......
UNITED ST Ans OF AMERICA
FEDERAL TRADE COMMISSION
WASHINGTON. D.C. 2O~SO
Health 	Systems 	Agency 	of 	New 	York 	City
275 	Seventh 	Avenue
New 	York, 	New 	York 	10001
COMM'SSIO~
APPROVED
February 	9. 	1987 	(Jf
~7
~SS
Attention: 	Mr. 	Giri 	Vuppala
Assistant 	Director, 	Planning 	and 	Implementation
Dear 	Mr. 	Vuppala:
The 	Federal 	~rade Commission's Bureaus 	of 	Competition,
Consumer 	Protection, 	and 	Economics 	are 	pleasen 	to 	submit 	this
response 	to 	the 	request 	of 	the 	Health 	Systems 	Agency 	of 	New 	York
City 	(nHSA") 	for 	pUblic 	comment 	on 	its 	draft 	Medical 	Facilities
Plan 	("Draft 	MFP"). 	1/ 	Our 	comments 	address 	recommendations 	in
the 	Draft 	MFP 	that 	some 	acute 	care 	hospitals 	in New 	York 	City 	be
closed.or 	converted 	to 	non-acute 	care 	uses, 	and 	that 	some 	acute
care 	beds 	at 	many 	other 	hospitals 	in New 	York 	City 	be 	delicensed,
in 	order 	to 	eliminate 	substantial -amounts 	of 	bed 	capacity 	not
"needed" 	under 	health 	planning 	standards. 	Those 	recommendations,
if 	adopted, 	would 	be 	implemented 	by 	1990 	through 	the 	state
certificate 	of 	need 	("CON") 	regulatory 	process. 	In 	our 	view,
their 	implementation 	would 	be 	contrary 	to 	the 	interests 	of 	health
care 	consumers 	in 	New 	York 	City.
Our 	response 	is 	divided 	into 	two 	principal 	parts. 	First, 	we
express 	concern 	about 	the 	competitive 	implications 	of 	regulatory
reductions 	of 	medical/surgical 	hospital 	bed 	capacity 	of 	the
magnitude 	proposed 	in 	the 	Draft 	MFP. 	Such 	reductions 	would
substantially 	reduce 	the 	incentives 	for 	hospitals 	in 	New York
City 	to 	improve 	the 	price 	and 	quality 	of 	their 	services. 1/
Second, 	we 	urge 	the 	HSA 	to 	recognize 	that 	recent 	changes 	in 	the
health 	care 	financing 	system 	have 	reduced 	incentives 	for
hOSpitals 	to 	maintain 	excessive 	bed 	capacity. 	Careful
consideration 	should 	therefore 	be 	given 	to 	relying 	on 	the
1/
1/
These 	comments 	represent 	the 	views 	of 	the 	Bureaus 	of
Competition, 	Consumer 	Protection, 	and 	Economics 	of 	the 	Federal
Trade 	Commission, 	and 	do 	not 	necessarily 	represent 	the 	views
of 	the 	Commission 	or 	of 	any 	individual 	Commissioner. 	However,
the 	Commission 	has 	authorized 	their 	submission.
,
While 	our 	comments 	focus 	on 	recommendations 	relati~g to
medical/surgical 	beds 	(the 	licensure 	classification 	of 	most
acute 	care 	hospital 	beds 	in 	New 	York 	City, 	and 	of 	most 	of 	the
beds 	the 	Draft 	MFP 	recommends 	be 	eliminated), 	some 	points 	we
raise 	may 	also 	apply 	to 	recommendations 	in 	the 	Draft 	MFP 	for
reductions 	in 	maternity 	and 	pediatric 	bed 	capacity.

Mr. 	Giri 	Vuppala 	Page 	2
hospitals 	themselves, 	rather 	than 	government 	res~lation, 	to
determine 	appropriate 	capacity 	levels. 	2/
Interest 	and 	Experience 	of 	the 	Federal 	Tra:e 	Commission
For 	more 	than 	a 	decade, 	the 	Federal 	Trade 	Commission 	has
engaged 	in 	extensive 	efforts 	to 	preserve 	and 	prccote 	competition
in 	health 	care 	markets. 	We 	have 	been 	active 	bot~ in 	antitrust
law 	enforcement 	and 	in 	advocacy 	of 	regulatory 	reforms, 	in 	the
belief 	that 	competition 	in 	health 	care 	service 	~arkets, 	like
other 	markets, 	will 	benefit 	consumers 	by 	strengthening 	incentives
for 	providers 	to 	meet 	consumer 	needs. 	The 	Co~ission's efforts
in 	the 	health 	care 	field 	have 	placed 	particular 	emphasis 	on 	the
hospital 	industry. 	As 	a 	result 	of 	Commission 	a~titrust enforce-
ment 	efforts 	in 	that 	industry 	(including 	litigated 	cases 	and 	non-
pUblic 	investigations 	involving 	hospital 	markets 	in 	many
different 	areas 	of 	the 	United 	States), 	as 	well 	as 	economic
analyses 	of 	CON 	regulation ii, 	the.Commission's 	staff 	has 	gained
considerable 	experience 	with 	the 	economics 	of 	hos~ital
competition, 	and 	with 	how 	health 	planning 	regulatlon 	affects 	such
competition. 	We 	believe 	we 	can 	offer 	a 	valuable 	perspective 	on
the 	proposals 	before 	the 	HSA 	by 	drawing 	upon 	that 	experience.
'The 	Desirability 	of 	Retaining 	Some 	"Unneeded"
Medical/Surgical 	Bed 	Capacity
Implementation 	of 	the 	Draft MFP's 	hospital 	~d 	reduction
recommendations, 	which 	are 	based 	on 	a 	target 	occupancy 	rate 	of
90%, 	would 	eliminate 	so many medical/surgical 	hospital 	beds 	in
New 	York 	City 	that 	the 	remaining 	beds 	would 	be 	operating, 	for 	all
practical 	purposes, 	at 	or 	near 	capacity. 	As 	a 	:esult, 	we 	believe
local 	hospitals 	will 	have 	substantially diministed 	incentives 	to
atiract 	additional 	patients 	by 	improving 	the 	price 	and 	quality 	of
their 	services. 	These 	considerations 	counsel 	against 	forcing
1/ 	Because 	the 	points 	we 	raise 	apply 	generally 	to 	New 	York 	state
poli~y regarding 	reductions 	of 	hospital 	bed 	capacity, 	we 	are
sendlng 	a 	copy 	of 	these 	comments 	to 	Brian 	H~idricks, Office
of 	Health 	Systems 	Management, 	New 	York 	State Department 	of
Health, 	for 	consideration 	respectihg 	state-level 	policy.
See, ~, 	Hospital 	Corp. 	of America, 	106 	F.'!'.C. 	361 	(1985),
arI'd; 	1986-2 	Trade 	Cas. 	(CCH) 	, 	67,377 	(7tt 	Cir. 	1986);
American 	Medical 	Int'l, 	Inc., 	104 	F.T.C. 	1 	( 984); 	K.
Anderson 	& D. 	Kass,Certificate 	of 	Need 	Regu 	ation 	of 	Entry
Into 	Home 	Health 	Care 	(Jan. 	1986) 	(FTC 	staff 	report).

Mr. 	Giri 	Vuppala 	Page 	3
hospitals 	in 	New York 	City 	to 	eliminate 	medical/surgical 	bed
capacity 	deemed 	"unneeded" 	by 	the 	HSA 	that 	the 	market 	would
otherwise 	support.
The 	vigor 	of 	hospitals' 	efforts 	to 	lower 	the 	price, 	and
improve 	the 	quality, 	of 	inpatient 	care 	depends 	heavily 	on 	the
motivation 	and 	ability 	of 	hospitals 	to 	increase 	their 	market
shares 	at 	the 	expense 	of 	other 	hospitals 	by 	offering 	attractive
combinations 	of 	price 	2/ 	and 	quality. 	Hospitals 	that 	perform
well 	will 	be 	rewarded 	by 	increased 	inpatient 	business, 	and
hospitals 	that 	fall 	short 	of 	the 	norm 	will 	anticipate 	that 	other
hospitals 	will 	compete 	away 	many 	of 	their 	patients.
The 	Draft 	MFP 	recommends 	a 	reduction 	by 	1990 	of 	more 	than
16% 	in 	the 	supply 	of 	medical/surgical 	beds 	in 	New York 	City
hospitpls. 	The 	amount 	of 	medical/surgical 	bed 	capacity 	that
would 	remain 	after 	those 	reductions 	would 	be 	that 	which 	the 	HSA
estimates 	to 	be 	"needed" 	to 	accommodate 	the 	demand 	for 	inpatient
care 	it 	projects 	for 	1990 	-- 	a 	level 	of 	demand 	which 	the 	HSA
expects 	to 	be 	sUbstantially 	less 	than 	existing 	levels 	of
inpatient 	hospital 	utilization 	-- 	at 	an 	average 	occupancy 	rate 	of
90%. 	~/
, It 	is 	likely 	that, 	for 	all 	practical 	purposes, 	hospital
medical/surgical 	facilities 	operating 	at 	such 	high 	occupancy
rates 	would 	be 	full, 	or 	close 	to 	full, 	and 	not 	especially 	eager
to 	seek 	additional 	patients. 	For 	a 	variety 	of 	reasons 	(including,
21 t 	While 	state 	hospital 	rate 	regulation 	places 	upper 	limits 	on
what 	hospitals 	can 	charge, 	hospitals 	remain 	free 	to 	compete
against 	others 	by 	setting 	rates 	below 	what 	the 	state 	would
allow, 	and 	by 	reducing 	charges 	to 	the 	third 	party 	payors
entitled 	under 	rate 	regulation 	to 	negotiate 	discounts 	from
standard 	charges.
~/ 	See 	Draft 	MFP 	at 	A52-A53; 	Health 	Systems 	Agency 	of 	New 	York
City, 	Acute 	Care 	Bed 	Needs Methodology 	(709.2) 	Update 	(March
19, 	1986) 	at 	1-17 	("Bed 	Needs 	Methodology 	Update") 	(earlier
estimate 	of 	beds 	"needed" 	to 	meet ,1990 	demand, 	with 	dis-
cussion 	of 	various 	factors 	HSA 	expects 	to 	reduce 	demand 	from
present 	levels).
We 	note 	that 	capacity deemed 	"unneeded" 	by 	health 	planning
standards 	is 	not 	necessarily 	"excess 	capacity· 	in 	the
economic 	sense. 	As 	we 	discuss 	below, 	"unneeded" 	capacity 	may
sometimes 	serve 	an 	economically 	useful 	purpose. 	.

Mr. 	Giri Vuppala 	Page 	4
among 	others, 	the 	need 	to 	hold 	capacity 	in 	reserve 	to 	accommodate
fluctuations 	in 	demand 	for 	inpatient 	care), 	acut~ care 	hospitals
cannot 	comfortably 	operate 	at 	average 	occupancy 	rates 	of 	100%. 	7/
Well 	before 	a 	hospital's 	average 	occupancy 	rate 	reaches 	that 	-
level, 	its 	efforts 	to 	compete 	aggressively 	for 	new 	patients 	to
fill 	empty 	beds 	will 	yield 	less 	and 	less 	net 	income. 	The
hospital 	will 	more 	frequently 	have 	to 	turn 	away 	patients ~/,
making 	the 	hospital's 	efforts 	to 	attract 	patients 	fruitless, 	and
inconveniencing 	the 	patients' 	physicians 	by 	forcing 	them 	to 	use
other 	hospitals. 	~/ 	Information 	we 	have 	received 	in 	connection
with 	our 	cases 	and 	non-public 	investigations 	in 	the 	hospital
industry 	(including 	interviews 	with 	hospital 	officials 	and
hospital 	planning 	documents) 	suggests 	that 	hospitals 	in 	New 	York
City 	generally 	would 	become 	markedly 	less 	aggressive 	in 	their
efforts 	to 	attract 	new 	patients 	by 	lowering 	price 	and 	improving
quality, once 	their 	average 	occupancy 	rates 	climb 	to 	around 	90%,
the 	HSA's 	target 	occupancy 	rate 	for 	medical/surgical 	beds.
The 	competitive 	efforts 	of 	hospitals 	in 	New 	York 	City, 	such
as 	intensified 	marketing 	campaigns 	and 	efforts 	to 	negotiate
1/ 	See 	Joskow, 	The 	Effects 	of 	Competition 	and 	Regulation 	on
HOSoital 	Bed SupplY 	and 	the 	Reservation 	Quality 	of 	the
Hospital, 	11 Bell 	J. 	Econ. 	421 	(1980); 	P. 	Joskow, 	Controlling
Hospital 	Costs 	49-55 	(1981).
~/. 	In 	other 	industries, 	the 	absence 	of 	unused 	capacity 	does 	not
necessarily 	diminish 	competitive 	incentives, 	because 	capacity
can 	be 	expanded 	to 	meet 	demand. 	CON 	regulation 	in 	New 	York,
'however, 	appears 	to 	preclude 	that 	option 	here. 	Also, 	capacity
tconservation 	techniques 	such 	as 	reducing 	usage 	of 	inpatient
treatment 	in 	favor 	of 	outpatient 	care, 	and 	reducing 	average
lengths 	of 	stay, 	have 	already 	been 	incorporated 	into 	the 	HSA's
1990 	bed 	need 	estimates 	and 	thus 	are 	not 	available 	to 	further
reduce 	utilization 	to 	solve 	the 	capacity 	constraints 	on
increased 	patient 	loads.
1/ 	A hospital 	that 	must 	frequently 	turn 	away 	patients 	may 	have
difficulty 	attracting 	physicians 	who 	would 	like 	to 	concen-
trate 	their 	admissions 	at 	one 	hospital.
We 	understand 	there 	may 	be 	other 	problems 	with 	operating 	at
high 	occupancy 	rates 	t~at also 	make 	it 	unattractive 	to
operate 	near 	100% 	occupancY,on 	a 	regular 	basis. 	For 	exampl~,
placing 	male 	and 	female 	patlents, 	and 	smokers 	and 	non-
smokers, 	in 	different 	semi-private 	rooms 	may 	sometim~s 	be
difficult 	when 	few 	rooms 	have 	unused 	beds 	and 	the 	male/female
or 	smoker/non-smoker 	ratio 	differs 	from 	the 	norm.

Mr. 	Giri 	Vuppala 	Page 	5
affiliations 	with 	health 	maintenance 	organizatio~s (RHMOs·),
started 	becoming 	more 	and 	more 	conspicuous 	as 	av~:age hospital
occupancy 	rates 	fell 	from 	their 	historical 	levels 	of 	around 	90\
to 	their 	present 	levels 	of 	about 	82%. 	10/ 	With 	~any hospitals'
medical/surgical 	beds. now 	running 	at 	below 	90% 	oc~upancy, 	and
some 	running 	at 	much 	lower 	occupancy 	rates, 	a 	hos?ital 	whose
performance 	falls 	behind 	its 	peers 	runs 	the 	substantial 	risk 	of
losing 	patients. 	In 	other 	hospital 	markets 	(incl~ding some 	that
were 	the 	subjects 	of 	our 	investigations), 	these 	incentives 	appear
to 	have 	had 	a 	significantly 	positive 	effect 	on 	t~e 	responsiveness
of 	hosoitals 	to 	consumer 	needs. 	11/ 	It 	is 	unfortJnate 	that 	just 	as
lively-competition 	seems 	to 	be 	eStablishing 	a 	foc:~old 	in 	the 	New
York 	City 	hospital 	market, 	the 	HSA's 	staff 	is 	re~~mmending
elimination 	of 	the 	unused 	hospital 	bed 	capacity 	t~at 	appears 	to
be 	an 	important 	contributing 	factor.
We 	are 	particularly 	troubled 	that 	the 	Draft MFP's 	hosoital
bed 	reduction 	proposals 	could 	hamper 	the 	growth 	of 	HMOs. 	The
rate 	of 	development 	and 	growth 	of 	HMOs 	is 	likely 	:0 	be 	aff~cted
by 	how 	well 	HMOs 	can 	exploit 	competition 	in 	hospi:al 	markets 	to
reduce 	their 	costs 	relative 	to 	the 	costs 	incurrec 	~v other 	third
party 	payors. 	For 	example, 	HMOs 	can 	use 	their 	p~rchasing power
and 	their 	ability 	to 	channel 	patients 	to 	the 	~ost cost-effective
providers 	to 	economize 	on 	hospital 	costs 	by, 	among 	other 	means,
seeking 	discounts 	and 	other 	preferential 	terms 	from 	hospitals 	(such
as 	hospital 	assistance 	to HMO 	utilization 	review 	?rograms). 	12/
10/ See 	New 	York 	Times, 	Oct. 	6, 	1986, 	at 	04: 	Draft MFP 	at 	A13.
"Notably, 	New 	York 	City's 	average 	hospital 	occJpancy 	rate
!rernains 	substantially 	higher 	than 	the 	national 	average. 	See
American 	Hospital 	Ass'n, 	Hospital 	Statistics 	(1986 	ed.) 	at:Vii.
11/ For 	example, 	in 	some 	metropolitan 	hospital 	markets 	with 	which
we 	are 	familiar, 	levels 	of 	unused 	hospit~l ca?acity 	somewhat
higher 	than 	those 	prevailing 	in 	New 	York 	City 	have 	helped
some 	third-party 	payors 	negotiate 	preferential 	reim~ursement
arrangements 	yielding 	the 	equivalent 	of 	discounts 	from
standard 	charges 	in 	exceS5 	of 	40%.
12/ See, 	e.s., 	P. 	Fox, 	Lewin 	& Associates, 	Private 	Health 	Care
-- 	Initiatlves: 	A Case 	Study 	of 	the 	Denver 	Area 	(June 	1983) •
Notably, 	HMOs 	(unlike 	other 	pri?ate 	third-party 	payors,
except 	for 	Blue 	Cross) 	are 	permltted 	under 	New 	York's
hospital 	rate 	regulation 	system 	to 	negotiate 	preferential
reimbursement 	rates .for 	hospital 	services 	provided 	to 	their
subscribers. 	See 	N.Y. 	Pub. 	Health 	Law 	~ 	2807-a(3) 	(McKinney
Supp. 	1986).

Mr. 	Giri Vuppala 	Page 	6
Such 	economies 	can, 	in 	turn, 	help 	HMOs 	expand 	the:: 	memberships
by 	enabling 	them 	to 	reduce 	subscri~er premiums. 	13/
We 	believe 	the 	impact 	of 	the 	proposed 	bed 	re~uctions on 	HMOs
merits 	special 	concern, 	because 	HMOs 	often 	playa 	significant
role 	in 	promoting 	well-functioning 	health 	care 	ma:<ets, 	in
addition 	to 	b~nefitting their 	subscribers 	throuc~ more 	economical
use 	of 	health 	resources. 	14/ 	Moreover, 	the 	HSA·i:self 	is 	relying
on 	the 	prospect 	of 	substantial 	increases 	in 	H~O ~embership in 	the
non-Medicare 	popufation 	during 	the 	next 	few 	years 	to 	reduce 	hos-
pital 	utilization, 	and 	thus 	the 	"need" 	for 	hospi::il 	be~s. 	15/ 	To
the 	extent 	that 	imolementation 	of 	the 	Draft 	MFP's 	bed 	reduction
proposals 	would 	diminish 	t~e 	economies 	HMOs 	C3n 	3chieve 	by 	taki~g
advantage 	of 	hospital 	comp~tition, HMO membershi? 	may 	not 	grow 	--
and 	hospital 	utilization 	may 	not 	decline 	-- 	as 	q~ickly as 	the
HSA's 	staff 	expects. 	Paradoxically, 	then, 	efforts 	to 	reduce 	the
number 	of 	empty, 	"unneeded" 	hospital 	beds 	may 	inc=eas~ 	the 	number
of 	utilized, 	"n~eded" beds.
All 	of 	these 	reasons 	c~unsel against 	mandat~:y bed 	capacity
reductions 	to 	meet,a 	90% 	occupancy 	target. 	Such 	regulatory
reductions 	would 	remove 	desirable 	incentives 	tha: 	encourage
hospitals 	to 	serve 	consumers 	better.
The 	Diminishing 	Justification 	for 	Regulatory 	Reductions
of 	"Unneeded" 	Hospital 	Bed 	Capacity
, 	The 	extent 	to 	which 	there 	are 	offsetting 	pu~lic benefits
from 	reducing 	the 	amount 	of 	unused 	bed 	capacity 	i~ 	the 	New 	York
City 	hospital 	market 	has 	been 	the 	subject 	of 	vigo:ous 	debate.
For 	example, 	the 	HSA's 	staff 	has 	estimated 	capital 	cost 	savings
of 	about 	$ 	500,000 	per 	·unneeded" 	bed 	that 	does 	not 	have 	to 	be
replaced, 	and 	operating 	cost 	savings 	of 	up 	to 	$ 	150,000 	per 	year
per 	·unneeded" 	bed 	taken 	out 	of 	operation. 	Hospital 	industry
13/ Cf. 	American 	Medical 	Int'l, 	Inc., 	104 	P.T.C. 	at 	45-46, 	49
- 	(1984) 	(initial 	decision) 	(in 	California 	duri~g ~arly 1980s,
HMOs 	and 	self-insured 	health 	benefit 	plans 	that 	were 	able 	to
negotiate 	preferential 	hospital 	rates 	on 	competitive 	basis
grew 	rapidly 	enough, 	at 	the 	expense. of 	other 	third-party
payors, 	to 	prompt 	the 	other 	payors 	to 	support 	legislation
enabling 	them 	to 	also 	negotiate 	hospital 	discounts).
14/ See 	Hospital 	Corp. 	of 	America, 	106 	F.T.C. 	at 	480.
15/ Bed 	Needs 	Methodology 	Update 	at 	11, 	15 	(proje=ting 	increase 	in
HMO 	membership 	to 	30% 	of 	adult 	non-Medicare 	population 	by 	1990) .

Mr. 	Giri 	Vuppala 	Page 	7
participants 	have 	disputed 	these 	claimed 	cost 	savings, 	parti-
cularly 	respecting 	operating 	costs. 	16/
We 	are 	nQt 	in 	a 	position 	to 	contribute 	~ubsta~tially to
resolving 	disputes 	of 	this 	tyoe. 	However, 	we 	ques:ion 	whet~er 	it
is 	wort~w~ile for 	the 	HSA 	to 	second-guess 	hospitals' 	deter-
mina:ions 	as 	to 	the 	costs 	and 	~enefits of 	maintai~ing hospital
bed 	capacity. 	Market 	forces 	are 	generally 	far 	superior 	to 	the
decisior.s 	of 	government 	planners 	for 	allocating 	~o~iety's
resourc~s, and 	should 	be 	allowed 	to 	operate 	absent 	demonstrable
market 	failures 	that 	prevent 	competitive 	forces 	from 	operating
well. 	Thus, 	the 	HSA 	should 	consider 	the 	effects 	of 	ongoing
i~provements in 	the 	health 	care 	financing 	system, 	including
prospective 	payment 	mechanisms 	and 	prospects 	for 	greater 	price
competition. 	These 	improvements 	are 	eliminating 	t~e 	feature5 	of
the 	ho~pital market 	(e.g., 	reimbursement 	system 	incentives 	for
hospitals 	to 	maintain 	more 	bed 	capacity 	than 	econo~ically
justified) 	that 	may 	have 	indicated-a 	need 	for 	CON 	regulation 	of
hospital 	bed 	supply 	in 	the 	past. 	To 	toe 	extent 	t~ese 	features
have 	been 	eliminated, 	maintaining 	whatever 	"unneeded" 	bed
capacity 	the 	market 	would 	support 	may 	be 	presumed 	to 	create 	more
benefits 	(including 	those 	outlined 	above) 	than 	costs. 	We 	believe
that 	the 	HSA 	and 	state 	health 	planners 	should 	accord 	more
deference 	than 	they 	have 	in 	the 	past 	to 	hospitals' 	determinations
as 	to 	the 	"public 	need" 	for 	whatever 	unused 	capaci:y 	they 	may
choose 	to 	maintain.
At 	one 	time 	it 	was 	generally 	believed 	that 	t~e 	prevailing
me~hods of 	reimbursement 	for 	hospital 	care 	(under 	which 	the
revenues 	a 	hospital 	received 	for 	treating 	patients 	were 	hased 	on
costs 	incurred 	by 	the 	hospital) 	resulted 	in 	incentives 	favoring
(or- at 	least 	in 	a 	lack 	of 	incentives 	o~posing) overinvestment 	in
capital 	assets 	at 	the 	expense 	of 	third 	party 	payors. 	Under 	those
circumstances, 	CON 	regulation 	of 	bed 	capacity 	was 	~onsidered
necessary 	to 	counter 	hospitals' 	tendency 	to 	build 	and 	maintain
more 	capacity 	than 	was 	necessary 	to 	serve 	their 	patients.
The 	Draft 	MFP 	summarizes 	the 	trend 	toward 	reforms 	in 	health
care 	reimbursement 	that 	are 	eliminating 	those 	incentives 	for
inefficient 	health 	resources 	usage. 	17/ 	Most 	prominent 	of 	the
new 	reimbursement 	systems 	aimed 	at 	elLlminating 	incentives 	to
waste 	is 	the 	Medicare 	DRG 	(diagnosis 	related 	group) 	prospective
reimbursement 	system, 	which 	pays 	oper~ting expenses 	for 	hospital
16/ See 	"14% 	cut 	in 	~.Y. 	hospital 	beds 	urged,· 	Modern 	Healthcare,
- 	Jan. 	2, 	1987, 	at 	11.
17/ Draft 	MFP 	at 	A7-A9.

Mr. 	Giri 	Vuppala 	Page 	8
care 	of 	Medicare 	patients 	18/ 	at 	predetermined 	flat 	rates 	not
linked 	to 	the 	specific 	costs 	a 	particular 	hospital 	incurs.
Hospital 	capital 	expenditures 	will 	likely 	be 	reimb~rsed on 	a
similar 	basis 	in 	the 	near 	future. 	19/ 	The 	Draft 	MFP 	suggests
that 	New 	York's 	prospective 	reimbursement 	hospital 	rate
regulation 	system, 	which 	governs 	charges 	for 	all 	other 	payors
except 	HMOs, 	is 	also 	evolving 	in 	the 	same 	direction. 	20/ 	The
salient 	characteristic 	of 	these 	reimbursement 	syste~s-rs that
they 	reduce 	or 	elLminate 	incentives 	to 	maintain 	inefficiently
high 	levels 	of 	unused 	bed 	capacity 	by 	reducing 	or 	~liminating
providers' 	ability 	to 	shift 	elsewhere 	the 	costs 	of 	inefficiencies.
This 	effect 	may 	well 	be 	reinforced 	by 	increased 	price
competition 	among 	hospitals 	in 	New 	York 	City. 	Suc~ price
competition 	may 	be 	stimulated 	by 	HMOs 	(which, 	as 	discussed
earlier, 'are 	expected 	by 	the 	HSA 	to 	cover 	an 	increasingly 	large
percentage 	of 	the 	local 	population, 	and 	which 	are 	well-positioned
to 	channel 	subscribers 	to 	hospitals 'offering 	lower 	rates),
preferred 	provider 	organizations 	(~hich are 	similarly 	able 	to
direct 	patients 	toward 	cost-effective 	hospitals), 	and 	improve-
ments 	in 	conventional 	health 	benefit 	plans 	to 	provide 	subscribers
financial 	incentives 	(such 	as 	copayments) 	to 	channel 	themselves
toward 	economical, 	and 	away 	from 	profligate, 	providers. 	21/
It 	should 	be 	emphasized 	that 	prospective 	reforms 	(e.g.,
elimination 	of 	cost-based 	reimbursement 	of 	capital 	costs 	under
state 	hospital 	rate 	regulation) 	reinforce 	the 	improved 	incentives
arising 	from 	reforms 	that 	have 	been 	or 	are 	being 	implemented.
The 	strong 	likelihood 	that 	any 	incentives 	toward 	inefficiency
that 	now 	remain 	will 	be 	eliminated 	should 	deter 	providers 	from
maki~g long-lived 	capital 	investments 	whos~ financial 	feasibility
181 Medicare 	patients 	account 	for 	about 	half 	the 	medicall
surgical 	patient 	days 	in 	New 	York 	City 	hospitals. 	See 	Bed
Need 	Methodology 	Update 	at 	6.
191 Draft 	!{FP 	at 	A6, 	A8: 	see 	also, 	e.q., 	"Lawmakers 	mull 	capital
payment 	plans," 	Modern 	Healthcare, 	August 	1, 	1986, 	at 	20:
·HHS' 	capital 	plan 	arouses 	provider 	anxieties,· 	Hospitals,
June 	20, 	1986, 	at 	24 	(legislative 	debate 	on 	Medicare 	pro-
spective 	reimbursement 	of 	hospital tosts 	focusing 	on 	how, 	not
whether, 	that 	should 	be 	implemented).
20/ 	Draft 	MFP 	at 	A6-A8.
211 Suora 	p. 	5: 	Draft 	MFP 	at 	A8-A9, 	A14, 	AI?: 	see 	also, 	e.g.,
"Hospital 	industry 	price 	wars 	heat 	up," 	Hosoitals, 	Oct. 	1,
1985, 	at 	59: 	Hospital 	Corp. 	of 	America, 	l06~F.1.C. at 	480-82.

Mr. 	Giri 	Vuppala 	Page 	9
depenjs 	on 	shifting 	costs 	to 	third 	party 	payors. 	22/ 	And 	it
seems 	unlikely 	that 	providers 	still 	harboring 	s~~~illusions will
find 	support 	in 	the 	bond 	market 	for 	implementatiQn 	of 	their
plans. 	23/
If 	the 	"market 	failure" 	underlying 	the 	need 	for 	CON
regulation 	of 	hospital 	bed 	capacity 	has 	been 	or 	is 	being
remedied, 	there 	is 	less 	reason 	to 	presu~e that 	h~spitals'
decisions 	respecting 	unused 	capacity 	will 	be 	economically 	in-
correct. 	A hospital 	unable 	to 	shift 	capital 	or 	Qperating 	cost
inefficiencies 	onto 	third 	parties 	will 	presumably 	not 	maintain
unused, 	or 	rarely-used, 	bed 	capacity 	unless 	it 	-~ll ena~le 	the
hospital 	to 	earn 	future 	patient 	revenues 	sufficient 	to 	cover 	the
costs 	of 	maintaining 	the 	capacity. 	And 	if 	the 	hospital's 	judg-
ment 	proves 	to 	be 	faulty, 	the 	hospital 	-- 	not 	t~e government, 	and
not 	third 	party 	payors 	-- 	will 	bear 	the 	burden 	c: 	its 	error. 	24/
Indeed; 	the 	Draft 	MFP 	indicates 	that 	some 	of 	the 	·unneeded" 	bed
capacity 	it 	has 	targeted 	for 	elimination 	is 	unli~ely to 	survive
in 	the 	present 	reimbursement 	environment, 	with 	or 	without
regulatory 	action, 	for 	these 	reasons.
While 	we 	believe 	the 	maintenance 	of 	at 	le3st 	som~
"unneeded" 	bed 	cap3citv 	that 	the 	market 	would 	SU?Dort 	would
serve' consumer 	interests, 	we 	do 	not 	sugqest 	conserving 	"unneeded"
hospital 	facilities 	that 	would 	require 	public 	s~~sidies to
survive, 	or 	that 	the 	hospitals 	believe 	would 	be 	more 	profitably
used 	for 	purposes 	other 	than 	providing 	acute 	care 	hospit3liza-
tion. 	It 	seems 	entirely 	appropriate 	for 	the 	HSA 	to 	facilitate
th~ 	voluntary 	exit 	of 	hospitals 	and 	hospit3l 	beds 	from 	the
acute 	care 	sector 	of 	the 	health 	care 	industry 	(s~ch as 	by
advising 	hospitals 	on 	possible 	alternative 	uses 	for 	their
I
22/ 	Cf. 	Raske, 	"Assn. 	seeks 	sound 	capital 	pay 	p~licy," Modern
Healthcare, 	Nov. 	7, 	1986 	at 	120 	(uncertainty 	about 	future 	of
reimbursement 	for 	capital 	expenses 	encouragi~g hospitals 	to
make 	more 	conservative 	capital 	investment 	decisions 	for
inpatient 	services).
23/ See 	Draft 	MFP 	at 	A6 	(prediction 	that 	mortgage 	financing 	will
-- 	be 	difficult 	or 	impossible 	to 	obtain 	for 	many 	hospital
modernization 	projects 	as 	result 	of 	prospect 	of 	severe 	li~its
on 	future 	reimbursement 	of 	hospital 	capital 	costs) •
24/ This 	may 	not 	be 	true, 	however, 	if 	the 	hospit3l 	is 	depending
on 	subsidies 	from 	outside 	the 	reimbursement 	system 	(such 	as
lo~n quarantees 	or 	operating 	subsidies 	from 	the 	state 	fund
for 	financially-distresse~ facilities) 	to 	maintain 	arguably
"unneeo~d" capacity 	the 	market 	would 	not 	otherwise 	support.

Mr. 	Giri 	Vuppala 	Page 	10
facilities, 	and 	facilitating 	state 	ap~roval of 	such 	alternative
uses) •
In 	summary, 	the 	HSA 	and 	state 	health 	planne~s should
consider 	whether, 	in 	view 	of 	recent 	changes 	in 	the 	reimbursement
environment, 	hospitals 	still 	have 	substantial 	incentives 	to 	make
economically 	incorrect 	decisions 	to 	maintain 	unused 	bed 	capacity,
and 	whether 	such 	decisions 	made 	by 	hospitals 	are 	a~y 	less 	likely
to 	be 	correct 	than 	the 	inevitably 	imperfect 	decisions 	made 	by
government 	regula~ors. 	To 	the 	extent 	that 	such 	incentives 	are 	no
longer 	substantial, 	the 	pUblic 	interest 	would 	best 	be 	served 	by
exercising 	the 	discretion 	available 	under 	New 	Yor~ 	health
planning 	statutes 	and 	regulations 	to 	find 	"public 	need" 	for
whatever 	level 	of 	bed 	capacity 	hospit3ls 	choose 	t~ maintain.
Conclusion
For 	th~ 	foregoing 	reasons, 	we 	urge 	that 	1) 	t1e 	HSA's
recomm~ndations to 	the 	Department 	of 	Health 	regarding 	hospital
closures 	and 	bed 	r~ductions take 	into 	account 	the 	ootential 	bene-
ficial 	effects 	of 	unused 	medical/surgical 	bed 	capacity; 	and 	2)
the 	HSA 	consider 	whether, 	in 	light 	of 	the 	tre~d toward 	elimi-
nation 	of 	reimbursement 	system 	incentives 	to 	main:ain 	economi-
cally 	unjustified 	hospital 	bed 	capacity, 	hospitals 	themselv~s can
be 	relied 	upon 	to 	determine 	approp~iate capacity 	levels.
We 	appreciate 	this 	opportunity 	to 	comment 	on 	the 	HSA's
proposals. 	We 	would 	be 	happy 	to 	answer 	any 	questions 	you 	may
have 	regarding 	these 	comments, 	or 	provide 	any 	other 	assistance
you .may 	need.
I Sincerely,
c;r/~~~~I.'
~{~~~. zucllrman
Bureau 	of 	Competition
• C :-.,