Editor’s Note: This is the second in a series of posts in response to Jon Gabel’s article “Where Do I Send Thee? Does Physician-Ownership Affect Referral Patterns To Ambulatory Surgical Centers?,” published March 18 on the Health Affairs Web site. Rep. Michael Burgess (R-TX) began the series, which will also feature Chris Cassel.

Policymakers are increasingly concerned over incentives facing physicians to refer more lucrative, well-insured patients to facilities in which they have a proprietary interest. Acute general hospitals complain that they bear the burden of the “unraveling” of their industry into alternative sites of care by providing free care to a growing number of uninsured people. Biased referral incentives certainly exist, but many suggested solutions could make things worse, not better. Preferred solutions require a clear understanding of how the system has evolved over the past twenty years since Medicare implemented its per case inpatient payment system.

Prior to 1984, surgery was performed almost exclusively in acute hospitals — almost always with an inpatient stay. The industry was stratified into primary, secondary, and tertiary facilities performing increasingly complex surgery. Hospitals enjoyed government and Blue Cross cost-based reimbursement that protected them against low volumes by spreading their own facility costs across all patients. City and county hospitals were subsidized to care for the uninsured.

The arrival of bundled payment. Stability reigned until Medicare’s per case bundled payment arrived, reinforced by aggressive government denials of inpatient coverage for simpler procedures (e.g., laser eye surgery). Stays became shorter, and less complex surgery migrated to ambulatory settings, including hospital outpatient departments (OPDs) and ambulatory surgery centers (ASCs). Stark laws prohibiting referral “kickbacks” and gain sharing of profits in acute hospitals encouraged surgeons to set up their own ASCs. New technologies such as endoscopes and smaller diagnostic machines, developed by a rejuvenated device industry, responded eagerly to the burgeoning demand for ambulatory surgery. Private, for-profit ASCs, many with physician-ownership, flourished under a lower cost structure and easier patient access. Nonprofit hospitals, seeking to retain lost surgical revenue, began expanding their own day-surgery capabilities.

Reengineering surgery by site of care produced a natural market segmentation of care by patients’ (a) ability to pay (insurance segmentation) and (b) surgical risk (severity segmentation). Acute inpatient surgery became far more complex and much more costly, on average. It also involved a higher proportion of uninsured patients as ASCs siphoned off better-paying patients. Private insurers’ fixed per diems and per case payments began to restrict hospitals’ ability to cross-subsidize the uninsured. At the same time, the industry was hemorrhaging inpatient cases that left many fixed costs of operating a full service facility uncovered. Federal legislation (the Emergency Medical Treatment and Active Labor Act, or EMTALA) requiring hospitals to treat all patients on an emergency basis provided the legal mandate for “backup” support of ASCs that lacked emergency rooms and complementary medical services.

The arrival of specialty hospitals. Beginning in the mid-1990s, the acute hospital industry underwent yet another fracturing with the advent of heart, orthopedic, and other surgical specialty hospitals — nearly all with some physician-ownership. The Stark laws had provided acute hospitals with a safe harbor for referrals by physician-owners because it was assumed that any one physician would contribute trivially to overall hospital profits. Single-line-of-business specialty hospitals contradicted this logic by concentrating on a narrow set of lucrative procedures in just one or two specialties. Some ASCs even converted to specialty hospital status so that physician-owners could “double dip” by operating on more complex, higher-paying patients and share in profits from facility nursing care and diagnostic services. (Healy, Cromwell, and Thomas, 2008; HCA/FAH, 2004)

Defenders of acute general hospitals have asserted that specialty hospitals, and ASCs by extension, enjoy an unfair competitive advantage in three ways. (Veitz, 2005; HCA/FAH, 2004) First, it is true that ASC and specialty hospital physician-owners refer uninsured and Medicaid patients to acute hospitals more often. However, many of these nonprofit institutions receive Medicare and Medicaid disproportionate-share hospital (DSH) funds based on their uninsured patient counts, and many are also subsidized as city and county hospitals with a mission to treat the uninsured. Also, nonprofit facilities pay no income taxes. ASCs and specialty hospitals (as well as for-profit acute general hospitals) pay income taxes in lieu of treating more Medicaid and uninsured patients. Greenwald et al. found that community benefits, including taxes, provided by specialty hospitals actually exceeded benefits from charity care and other sources provided by local nonprofit acute general hospitals per dollar of revenue (see also Kane and Wubbenhorst, on the low levels of community benefits in many hospitals).

Second, it is true that ASCs and specialty hospitals reap the benefits of physicians referring more complex, costly patients to acute general hospitals while focusing on less complex, more profitable patients. (Cromwell et al. 2005; Greenwald et al. 2006) But it makes little sense to require these facilities to become “full service” providers or to open large emergency rooms.

Third, it is true that acute general hospitals serve as “backup” for difficult patients referred immediately or transferred by ASCs and specialty hospitals after complications arise. But triaging patients by surgical risk has always been the case in an industry with rural and urban hospitals having differing capabilities.

At bottom, the real question for policymakers is: Who will be responsible for allocating the infra-marginal profits enjoyed by providers from biases in the public and private payment systems? Managers of acute hospitals long for the old days when they cross-subsidized care as they saw fit on a voluntary, nontransparent, basis: a “don’t ask, don’t tell” policy also favored by many politicians. ASC and specialty hospital physician-owners like the new world that allows them to pick and choose among patients based on ability to pay. It seems too late to prohibit ASCs and specialty hospitals altogether — especially when many are jointly owned by physicians and local hospitals. Prohibiting physician ownership of ASCs or specialty hospitals would treat the symptom, not the cause, of “insurance segmentation.”

A far more efficient and equitable solution would be universal health insurance coverage for Americans, thereby minimizing any financial bias in physician referral incentives. Even with universal coverage, public and private insurers would still have to develop payment systems that better discriminate among patients by medical and surgical complexity. Medicare, in particular, should rebase its inpatient payments based on the true costs of operating a full-service tertiary inpatient hospital, to cover the backup costs incurred by acute general hospitals from ASC and specialty hospital referrals.


Hospital Corporation of America, Federation of American Hospitals, “Physician-Owned Limited Service Hospitals,” CMS briefing, September 29, 2004.

Veitz, L. “Testimony before the U.S. Senate Committee on Finance by CEO of Lookout Memorial Hospital,” March 8, 2005.

Greenwald, L., J Cromwell, W Adamache, E Drozd, S Bernard, E Root, K Devers. “Specialty versus Community Hospitals: Referrals, Quality, and Community Benefits,” Health Affairs 25(1): 106-118.

Healy, D, J Cromwell, F Thomas, “Repricing Specialty Hospital Outpatient Services using Ambulatory Surgery Center Prices,” Health Care Financing Review, Winter, 2007-08

Cromwell, J, E Drozd, S Bernard, W Adamache, E Root, L Greenwald, “Physician Referral Patterns to Specialty Hospitals: An Evaluation,” CMS Contract No. 500-00-0024, TO # 12, September, 2005

Kane, N, X Wubbenhorst, 2000. “Alternative Funding Policies for the Uninsured: Exploring the Value of Hospital Tax Exemptions.” Milbank Quarterly 78(2): 185-212.