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Full text of "Indiana Law Review"

IKOIAWA UNIVtRSlTY 

MAY 2 21987 

SCHQOl CF lAW-taOPlS. 







law 
Review 




Volume 19 No. 4 1986 



SYMPOSIUM ON FINANCING AND REGULATING 

HEALTH CARE SERVICES: HARD CHOICES AND 

ETHICAL DILEMMAS 

Coverage and Care for the Medically Indigent: Public and Private Options 

Randall R. Bovbjerg & William G. Kopit 

State Hospital Cost Containment: An Analysis of Legislative Initiatives 

Carl J. Schramm 

Liver Transplantation in Massachusetts: Public Policymaking as Morality 
Play 

Clark C. Havig hurst & Nancy M. P. King 

The Lithotripsy Game in North Carolina: A New Technology Under 
Regulation and Deregulation 

Clark C. Havighurst & Robert S. McDonough 

Full Circle: The Return of Certificate of Need Regulation of Health Facilities 
to State Control 

James B. Simpson 

Reform Revisited: A Review of the Indiana Medical Malpractice Act Ten 
Years Later 

James D. Kemper & Myra C. Selby & Bonnie K. Simmons 

Making Hard Choices Under the Medicare Prospective Payment System: One 
Administrative Model for Allocating Medical Resources Under a 
Government Health Insurance Program 

Eleanor D. Kinney 

Bowen v. American Hospital Association: Federal Regulation Is Powerless 
to Save Baby Doe 

Dennis F. Cantrell 

NOTE 

Denying Hospital Privileges to Non-Physicians: Does Quality of Care Justify 
a Potential Restraint of Trade? 




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INDIANA LAW REVIEW 

INDIANA UNIVERSITY 

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Price $10.00 

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Indiana Law Review 

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Indiana luai^ Revieiv 

Volume 19 1986 Number 4 

Copyright C^J 1986 by the Trustees of Indiana University 



TABLE OF CONTENTS 

SYMPOSIUM ON FINANCING AND REGULATING 
HEALTH CARE SERVICES 

Foreword Eleanor D. Kinney 

Barbara McCarthy Green 853 

ARTICLES 

Coverage and Care for the Medically Indigent: 

Public and Private Options Randall R. Bovbjerg 

William G. Kopit 857 

State Hospital Cost Containment: An Analysis of 
Legislative Initiatives Carl J. Schramm 919 

Liver Transplantation in Massachusetts: Public Policymaking 

as Morality Play Clark C. Havighurst 

Nancy M. P. King 955 

The Lithrotripsy Game in North Carolina: A New Technology 

Under Regulation and Deregulation Clark C. Havighurst 

Robert S. McDonough 989 

Full Circle: The Return of Certificate of Need Regulation 
of Health Facilities to State Control James B. Simpson 1025 

Reform Revisited: A Review of the Indiana Medical 

Malpractice Act Ten Years Later James D. Kemper 

Myra C. Selby 
Bonnie K. Simmons 1129 



Volume 19 Fall 1986 Number 4 

The INDIANA LAW REVIEW (ISSN 0090-4198) is the property of Indiana University and is published quarterly by 
the Indiana University School of Law— Indianapolis, which assumes complete editorial responsibility thereof. Subscription 
rates: one year $18.00; foreign $21.50. Please notify us one month in advance of any change in address and include 
both old and new addresses with zip codes to ensure delivery of all issues. Send all correspondence to Editorial Assistant, 
Indiana Law Review, Indiana University School of Law— Indianapolis, 735 West New York Street, Indianapolis, Indiana 
46202. Publication office: 735 West New York Street, Indianapolis, Indiana 46202. Second class postage paid at Indianapolis, 
Indiana 46201. 

POSTMASTER: Send address changes to INDIANA LAW REVIEW, 735 West New York Street, Indianapolis, 
Indiana 46202. 



Making Hard Choices Under the Medicare Prospective Payment 
System: One Administrative Model for Allocating Medical 
Resources Under a Government Health Insurance Program 
Eleanor D. Kinney 1151 

Bowen v. American Hospital Association: Federal Regulation Is 

Powerless to Save Baby Doe Dennis F. Cantrell 1199 

NOTE 

Denying Hospital Privileges to Non-Physicians: Does 
Quality of Care Justify a Potential Restraint of Trade? 1219 



Indiana 


La^iv R 


eviep 


Volume 19 




1986 




Editor-in-Chief 




I 


Debra D. McVicker 






Executive Editors 




Articles and Production Notes and Topics 


Mary Arlien Findling 


Dennis F. Cantrell 




Articles Editors 




Jerry A. Garau 


Cathleen Johnson Perry 


Douglas Westfall Holly Michael B. Watkins 


Brian L. Woodward 






Business Editor 






John Gardner 




Note and Development Editof 


•s 


David C. Bransdorfer 


Michael 


Patrick Maxwell 


Mary Beth Claus 


Ellen C. 


Siakotos 


Herbert O. Hintze, Jr 


Andrew 


P. Wirick 




Associate Editors 




Vivian K. Aichele 


Elizabeth R. Gingerich 


Mark A. Bailey 


Douglas E. Greer 


Curtis Alan Baldwin 


Brian K 


Hugen 


Arthur R. Baxter 


Larry R 


. Jackson 


Jan Barteau Berg 


Todd J. 


Kaiser 


Philip A. Book 


Mark A 


. Kapouraios 


Hilary A. Bowe 


Sally A. 


Kendall 


Laura L. Bowker 


Andrew 


A. Kleiman 


Susan D. Burke 


Gary W 


. Larson 


Gregory M. Cole 


Susan D 


. Rafferty 


Kathryn J. Cook 


Jeffrey A. Riggs 


Robert T. Drew 


Patricia L. Sosbe 


Lucy A. Emison 


Lori A. 


Torres 


Michael J. Gabovitch 


Judy L. 
Peter C. Wright 


Woods 




Editorial Assistant 





Mary J. Deschler 

Faculty Advisor 
Paul J. Galanti 



Indiana University School of Law — Indianapolis 
1985-86 ADMINISTRATIVE OFFICERS AND FACULTY 

Administrative Officers 

John W. Ryan, Ph.D., President of the University 

Glenn W. Irwin, Jr., M.D., Vice-President 

Gerald L. Bepko, LL.M., Dean 

James F. Bindley, J.D., Assistant Dean for Administration 

G. Kent Frandsen, J.D., Associate Dean for Student Affairs 

Jeffrey W. Grove, J.D., Associate Dean for Academic Affairs 

Faculty 

Thomas B. Allington, Professor. B.S., University of Nebraska, 1964; J.D., 1966; LL.M., 
New York University, 197 L 

Edward P. Archer, Professor. B.M.E., Rensselaer Polytechnic Institute, 1958; J.D., George- 
town University, 1962; LL.M., 1964. 

James F. Bailey, III., Associate Professor and Director of Law Library. A.B., University of 
Michigan, 1961; J.D., 1964; M.A.L.S., 1970. 

Gerald L. Bepko, Dean and Professor. B.S., Northern Illinois University, 1962; J.D., 
IIT/Chicago-Kent College of Law, 1965; LL.M., Yale University 1972. 

James F. Bindley, Assistant Dean for Administration and Lecturer in Law. B.A., Loyola 
University, 1969; J.D., University of Kentucky, 1972. 

Paul N. Cox, Visiting Professor. B.S., Utah State University, 1971; J.D., University of 
Utah, 1974; LL.M., University of Virginia, 1980. 

Clyde Harrison Crockett, Professor. A.B., University of Texas, 1962; J.D., 1965; LL.M., 
University of London (The London School of Economics and Political Science), 1972. 

Debra a. Falender, Professor. A.B., Mount Holyoke College, 1970; J.D., Indiana Univer- 
sity, 1975. 

G. Kent Frandsen, Associate Dean for Student Affairs and Associate Professor. B.S., Bradley 
University, 1950; J.D., Indiana University, 1965. 

David A. Funk, Professor. A.B., College of Wooster, 1949; J.D., Case Western Reserve Univer- 
sity, 1951; M.A., The Ohio State University 1968; LL.M., Case Western Reserve Univer- 
sity, 1972; LL.M., Columbia University, 1973. 

Paul J. Galanti, Professor. A.B., Bowdoin College, 1960; J.D., University of Chicago, 1963. 

Helen P. Garfield, Professor. B.S.J. , Northwestern University, 1945; J. D., University of Col- 
orado, 1967. 

Harold Greenberg, Associate Professor. A.B., Temple University, 1959; J.D., University of 
Pennsylvania, 1962. 

Jeffrey W. Grove, Associate Dean for Academic Affairs and Professor. A.B., Juniata 
College, 1965; J.D., George Washington University, 1969. 

William F. Harvey, CarlM. Gray Professor of Law. A.B., University of Missouri, 1954; J. D., 
Georgetown University, 1959; LL.M., 1961. 

W. William Hodes, Professor. A.B., Harvard College 1966; J.D., Rutgers Newark, 1969. 

Lawrence A. Jegen, III., Thomas F. Sheehan Professor of Tax Law and Policy , 1982. A.B., 
Beloit College, 1956; J.D., The University of Michigan 1959; M.B.A., 1960, LL.M., 
New York University, 1963. 

Henry C. Karlson, Professor. A.B., University of Illinois, 1965; J.D., 1968; LL.M., 1977. 

William Andrew Kerr, Professor. A.B., West Virginia University, 1955. J.D., 1957, LL.M., 
Harvard University, 1958; B.D., Duke University, 1968. 

Eleanor D. Kinney, Assistant Professor. A.B., Duke University, 1969; M.A., University 
of Chicago, 1970; J.D., Duke University, 1973. 

Walter W. Krieger, Associate Professor. A.B., Bellarmine College, 1959; J.D., University 
of Louisville, 1962; LL.M., George Washington University, 1969. 

David P. Leonard, Associate Professor. B.A., University of California at San Diego, 1974; 
J.D., UCLA School of Law, 1977. 

Robin Paul Malloy, Assistant Professor. B.S., Purdue University, 1971; J.D., University 
of Florida, 1980; LL.M., University of Illinois, 1983. 

William E. Marsh, Professor. B.S., University of Nebraska, 1965; J.D., 1958. 



SusANAH M. Mead, Associate Professor. B.A., Smith College, 1969; J.D., Indiana University, 

1976. 

Mary H. Mitchell, Associate Professor. A.B., Butler University, 1975; J.D., Cornell Law 
School, 1978. 

David R. Papke, Associate Professor. A.B., Harvard College, 1969; J.D., Yale Law School, 
1973; M.A. in American Studies, Yale University, 1973; M. Phil., in American Studies, 
The University of Michigan, 1980; Ph.D., 1983. 

David E. Pierce, Assistant Professor of Law. B.A., Pittsburgh State University, 1974; J.D., 
Washburn University, 1977; LL.M., University of Utah, 1982. 

Ronald W, Polston, Professor. B.S., Eastern Illinois University, 1953; LL.B., University of 
Illinois, 1958. 

Kenneth M. Stroud, Professor. A.B., Indiana University, 1958; J.D., 1961. 

James W. Torke, Professor. B.S., University of Wisconsin, 1963; J.D., 1968. 

James Patrick White, Professor (on special assignment). A.B., University of Iowa, 1953; J.D., 
1956; LL.M., George Washington University, 1959. 

Law^rence p. Wilkins, Professor. B.A., The Ohio State University, 1968; J.D., Capital Univer- 
sity Law School, 1973; LL.M., University of Texas School of Law, 1974. 

Mary Wolf, Visiting Assistant Professor of Law, B.A., Saint Xavier College, 1969; J. D., Univer- 
sity of Iowa College of Law, 1974. 

Harold R. Woodard, Professorial Lecturer. B.S., Harvard University, 1933; J.D., 1936. 



Emeriti 

Agnes P. Barrett, Associate Professor Emeritus. B.S., Indiana University, 1942; J.D., 1964. 
Cleon H. Foust, Professor Emeritus. A.B., Wabash College, 1928; J. D., University of Arizona, 

1933. 
John S. Grimes, Professor Jurisprudence Emeritus. A.B., Indiana University. 1929; J. D., 1931. 
Melvin C. Poland, Cleon H. Foust Professor of Law Emeritus, B.S. Kansas State University, 

1940; LL.B., Washburn University, 1949; LL.M., The University of Michigan, 1950. 
R. Bruce Townsend, Cleon H. Foust Professor of Law Emeritus, A.B., Coe College, 1938; 

J.D., University of Iowa, 1940. 

Legal Writing Instructors 

Jeffrey Been, A.B., Wabash College, 1981; J.D., Indiana University, 1984. 

Michael Mullett, Lecturer. B.A., University of Michigan, 1966; M.A., 1973; J.D., Indiana 

University, 1982. 
Vickie Renfrov^, Lecturer. B.A., University of Northern Iowa, 1970; M.A., 1971; Ph.D., 

Indiana University, Bloomington, 1976; J.D., Indiana University, Bloomington, 1981. 
Joan Ruhtenberg, Lecturer. B.A., Mississippi University for Women, 1959; J.D., Indiana 

University, 1980. 

Law Library Staff 

Terri Lea Hardin, Affiliate Librarian, B.A., Indiana University, 1982; M.L.S., 1983. 
Mary P. Hudson, Assistant Librarian, B.A., Ball State, 1969; M.L.S., Indiana Universtiy, 1973. 
Wendell E. Johnting, Technical Services Librarian. A.B., Taylor University, 1974; M.L.S., 

Indiana University, 1975. 
Constance Matts, Associate Librarian. B.A., 1973, Case Western Reserve University; 

M.S.L.S., 1974, Case Western Reserve University; M.A.I.R., 1976, Creighton 

University. 
KiyoskiOtsv, Assistant Librarian, Parkland College, A. A., 1976; A. B., University of Illinois, 

1980; M.S., 1982; C.A.S., 1983. 



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I 



Indiana Laiv Revieiiv 



Volume 19 1986 Number 4 



Foreword 

This Symposium marks the inauguration of the Program for Law, 
Medicine and the Health Care Industry at the Indiana University School 
of Law — Indianapolis. The primary mission of the program is to con- 
duct scholarly research on health law issues of concern to the state of 
Indiana and to the nation. The Program has undertaken research on a 
variety of legal issues affecting the health care industry ranging from 
reform of the administrative appeals procedures for the Medicare pro- 
gram and medical malpractice to the thorny bioethical issues emerging 
in the treatment of individuals with AIDS. The program is also dedicated 
to improving teaching and enhancing the law school curriculum in the 
field of health law. Finally, the program is committed to serving as an 
information and educational resource for the health care community. 

In this Symposium, entitled Financing and Regulating Health Care 
Services: Hard Choices and Ethical Dilemmas, the Program joins the 
Indiana Law Review in drawing together several disparate voices in a 
discussion of the implications of adjusting the financing and regulation 
of health care services to accommodate diminishing resources for and in- 
creasing constraints on the health care system. The Symposium opens with 
an article by Randall R. Bovbjerg of The Urban Institute and William 
G. Kopit of Epstein Becker Borsody & Green, Washington, D.C. entitled 
Coverage and Care for the Medically Indigent: Public and Private Op- 
tions. In this comprehensive examination of the problem of "uncompen- 
sated care," the authors evaluate alternative ways of organizing and 
financing coverage or care for the medically indigent. The authors bring 
to this topic significant expertise in health policy. Mr. Bovbjerg has con- 
ducted extensive research on insurance and health policy issues and served 
as a practicing insurance regulator and health specialist at the 
Massachusetts Insurance Department. In addition to representing a number 
of hospitals and hospital associations, Mr. Kopit served on the Task Force 
on Indigent Care of the District of Columbia Hospital Association and 
chaired its subcommittee on financing indigent care. 

In the second article, Carl T. Schramm, former chairman of the 
Maryland Health Care Cost Review Authority and a leading scholar of 
hospital rate-setting issues for the last decade, examines the political pro- 
cess underlying state efforts to reform hospital financing mechanisms. In 



853 



854 INDIANA LA W REVIEW [Vol. 19:853 

State Hospital Cost Containment: An Analysis of Legislative Initiatives, 
Professor Schramm identifies the interested parties and describes the posi- 
tion each party is Ukely to take, the dynamics of various legislative tac- 
tics, and the Hkely outcomes of state rate-setting initiatives. 

Two articles by Clark C. Havighurst of the Duke University School 
of Law follow. In the first, Liver Transplantation in Massachusetts: Public 
Policymaking as Morality Play, Professor Havighurst and Nancy M.P. 
King present the story of Jamie Fiske as a case study of how a centrally- 
controlled health care system faces difficult choices concerning health care 
and health care technology. In the second, The Lithotripsy Game in North 
Carolina: A New Technology Under Regulation and Deregulation, Pro- 
fessor Havighurst and Robert S. McDonough examine how one state 
handled the distribution of a costly and highly sophisticated new technology 
in two contrary contexts — regulation and deregulation. 

Even though the federal government no longer mandates health plan- 
ning and certificate of need, many states have retained these strategies 
to control distribution of health care facilities and services. In Full Cir- 
cle: The Return of Certificate of Need Regulation of Health Facilities 
to State Control, James B. Simpson, the Director of the Legal Resources 
Program at the Western Center for Health Planning, recounts the changes 
that have evolved in the scope of coverage of state certificate of need 
programs from their origins to the present. 

In Reform Revisited: A Review of the Indiana Medical Malpractice 
Act Ten Years Later, James D. Kemper, Myra C. Selby, and Bonnie K. 
Simmons of Ice Miller Donadio and Ryan, Indianapohs, describe one 
state's attempt to address the medical malpractice "crisis" of the 1970's. 
These authors, leading health law practitioners in the state of Indiana, 
consider in turn the original purpose of the Indiana Act, the impact of 
recent amendments, the functioning of the medical review panel, constitu- 
tional challenges to the Act and the impact of federal cost containment 
measures on state malpractice law. 

These articles, with their focus on state law issues, emphasize the 
critical development of health policy in the 1980's: the flow of financial 
and programmatic responsibility for government health programs to the 
states. This development has resulted in increased state interest in address- 
ing the pressing health pohcy issues of today, i.e., paying for care for 
the medically indigent, controlUng hospital costs, mitigating the threat of 
medical malpractice to access to and cost of medical care, and the ever 
present pressure to impose rationality on the distribution of health care 
resources through planning and regulation. 

The final three articles address health policy issues arising at the federal 
level. Throughout the 1980's, the federal government has retained the 
dominant role in the public financing of health care services through the 
Medicare and Medicaid programs and, since 1980, has adopted a radically 
different system for paying for hospital services under the Medicare pro- 



1986] FOREWORD 855 

gram — the prospective payment system with prices based on patient 
diagnosis. In Making Hard Choices Under the Medicare Prospective Pay- 
ment System: One Administrative Model for Allocating Medical Resources 
Under a Government Health Insurance Program, Eleanor D. Kinney, 
Director of the Program for Law, Medicine and the Health Care Industry, 
analyzes the administrative model by which the federal government and 
also hospitals and physicians make decisions about the allocation of 
hospital services to Medicare beneficiaries under the Medicare prospective 
payment system. In Bowen v. American Hospital Association: Federal 
Regulation Is Powerless to Save Baby Doe, Dennis Cantrell of Bingham 
Summers Welsh & Spilman, Indianapolis, explores the Reagan Administra- 
tion's effort, born of a profound commitment to the preservation of fetal 
hfe, to regulate treatment of severely handicapped newborns through 
federal civil rights laws, and the Supreme Court's response. The Sym- 
posium closes with a student note on how the predominant federal 
economic policy of promoting competition in the marketplace through 
the antitrust laws plays out with respect to one aspect of the health care 
system. In Denying Hospital Privileges to Non-Physicians: Does Quality 
of Care Justify a Potential Restraint of Trade?, the author proposes 
heightened judicial scrutiny of a hospital's claim that quality of care con- 
cerns justify its denial of staff privileges to a group of competitors. 

Our foreword to this Symposium would be incomplete without 
acknowledging the numerous people who assisted in this endeavor. 
Specifically, we would like to thank the editorial board and staff of the 
Indiana Law Review, particularly Gayle Reindl and Debra McVicker. We 
would also hke to recognize the support and encouragement of Gerald 
L. Bepko, former Dean of the law school and now Vice President of 
Indiana University-Purdue University at Indianapolis. Finally, we would 
like to thank Mabel K. Hart of the Program staff and law students 
KimberHe L. Forgey, Barbara A. Knotts, Marilyn Wilder, and Michael 
D. Wright for their invaluable assistance in the production of this 
Symposium. 

Eleanor D. Kinney 
Barbara McCarthy Green 



Coverage and Care for the Medically Indigent: 
Public and Private Options 



Randall R. Bovbjerg* 
William G. Kopit** 



I. Introduction 



As of March 1984, about 35 million people had no health insurance 
coverage, public or private, although some of them were only temporarily 
uncovered. Up to 40-odd miUion more, often called the "underinsured," 
had incomplete coverage.^ These people, with little or no insurance, need 
periodic medical attention as much as or more than the well insured, 
but face far more trouble getting it.^ Often, they have been forced to 
rely on the charity of providers, particularly hospitals. 

From a hospital's viewpoint, the issue is how much "uncompensated 
care" to give. As every newspaper reader or "Sixty Minutes" viewer 
knows, hospitals in today's more competitive environment have more 
limited ability to care for the needy with public funds or from margins 
earned caring for the better-off.^ From the patient's perspective, the 
problem is access to care. One hears of patients being shuttled from 
hospital to hospital in search of care, even when the need seems urgent,"^ 

♦Senior Research Associate, Health Pohcy Center, The Urban Institute, Washington, 
D.C.; Research Fellow (off -site). Program for Law, Medicine, and the Health Care Industry, 
Indiana University School of Law— Indianapolis. A.B., University of Chicago, 1968; J.D., 
Harvard Law School, 1971. 

♦♦Partner, Epstein Becker Borsody & Green, P.C. A.B., Bucknell University, 1961; 
J.D., Columbia University, 1964. 



The authors gratefully acknowledge the assistance of Joyce Cowan, Associate with 
the firm of Epstein Becker Borsody & Green, P.C, in preparing this Article. 



'On the numbers of uninsured and underinsured, see infra text accompanying notes 
11-29. 

^See infra text accompanying notes 27-29. 

^According to data from the American Hospital Association, for the year ending June 
1986, hospitals' net patient margin was only 0.8%; total net margin (including non-patient 
revenues) was 5.4%, down from 2.0% and 6.3% the previous year. Hosp. Research & Educ. 
Trust, Selected Hospital Performance Indicators: June 1985 & 1986, Econ. Trends, Fall 
1986, at 5. 

*See, e.g., Cahan & Pave, When the Patient Can't Pay the Medical Bill, Bus. Wk., 
Feb. 18, 1985, at 59; Taylor, Ailing, Uninsured and Turned Away, Washington Post, 
June 30, 1985, at Al, col. 3. 

857 



858 INDIANA LA W REVIEW [Vol. 19:857 

and of hospitals * 'dumping" impecunious patients on the nearest public 
hospital legally obligated to take them.^ The problems that poor patients 
have in receiving more routine care from physicians, hospital outpatient 
departments, or other providers are far less dramatic or well documented. 

The intertwined problems of the uninsured population and of un- 
compensated care have grown rapidly in the recent past and are likely 
to continue to grow in the near future. Private insurance, public pro- 
grams, and hospital margins are all in a "cutback*' era, and unfortu- 
nately, the uninsured are on the cutting edge.^ 

Under our legal system, states and localities bear the ultimate re- 
sponsibility for fashioning whatever responses are made. Indeed, the 
uninsured/uncompensated care problem was high on the agenda of most 
state legislatures during the 1986 sessions and will probably remain so 
for 1987.^ BilHons of dollars in new assistance seem needed. The current 
federal administration is unlikely to offer new assistance for these efforts.^ 
Thus, it seems Hkely that the usual American genius for weaving together 
various strands of partial solutions through varied mechanisms will have 
to come into play. This Article suggests what such mechanisms may be. 

II. The Nature and Extent of Problems 

A. The Medically Indigent and the Uninsured 

The problem of providing health care for those who cannot or do 
not provide for themselves can be seen from a number of perspectives. 
In fact, there is no consensus on what "the" problem is. Localities 
around the country differ tremendously in their populations' medical 
needs and in their patterns of medical financing and delivery, and there 
is probably even more diversity in practical and philosophical approaches 
to proposed solutions in each area. Some people are concerned only 
about providing emergency care for the very poor and uninsured; others 
worry that even many insured people are not well covered and hence 
cannot pay, in full, providers who treat them. 

Nevertheless, it seems clear that insufficient financing adversely af- 
fects access to care and, thus, the health of the medically indigent. By 



^See, e.g., Schiff, Ansell, Schlosser, Idris, Morrison & Whitman, Transfers to a 
Public Hospital, 314 New Eng. J. Med. 552 (1986); Wrenn, No Insurance, No Admission, 
312 New Eng. J. Med. 373 (1985); The 'Dumping' Problem: No Insurance, No Admission 
(letters) 312 New Eng. J. Med. 1522 (1985); Knox, Some Local Hospitals 'Dump' The 
Uninsured, Boston Globe, Feb. 6, 1984, at 31, col. 2. 

^See infra text accompanying notes 46-64. 

''See, e.g.. Intergovernmental Health Policy Project, George Washington 
Univ., Major Changes in State Medicaid and Indigent Care Programs (July 1986). 

^See infra note 63. 



1 



1986] CARE FOR MEDICALLY INDIGENT 859 

''medically indigent," this Article means the class of people who cannot 
afford necessary medical care from their own resources or from health 
insurance coverage, if any.^ It should be noted that the Article follows 
general usage by recognizing that even middle class people can become 
"medically" indigent when their net medical bills, after insurance, are 
very high relative to their income and assets. Of course, the likelihood 
of medical indigency is far less for such people than it is for those who 
begin with low incomes and little or no insurance coverage. 

B. The Uninsured: Number and Characteristics 

People without public or private health insurance are the core of 
the medical indigency problem.'^ People who have coverage, but coverage 
that does not fully protect against catastrophic losses — and hence against 
medical indigency — are a lesser problem.^' 

How many people are uninsured and face problems of medical access? 
Who are they and why do they lack resources? How much care do they 
get now? What is the extent of the financial shortfall? All of these 
pertinent questions can be answered only imperfectly from available 
evidence. 

To understand who lacks coverage, one must appreciate how most 



'None of the three elements — necessary care, poverty, and lack of (adequate) in- 
surance — readily allows of a clear-cut, operational definition. Opinions vary greatly on 
how much medical care is truly needed, on how poor one must be to be truly needy, 
and on what constitutes inadequacy in insurance. Moreover, deciding on medical indigency 
in advance of a known level of medical need (or spending) is even more difficult. 

'""Insurance" as used here means any financing method available to a patient other 
than out-of-pocket payment or charity. Public coverage includes Medicare, Medicaid, and 
other medical assistance plans. Private coverage need not be "insurance" under the state 
insurance code. It may be conventional coverage from a commercial life and health 
insurance company, such as Prudential, or from a not-for-profit Blue Cross/Blue Shield 
plan; or it may be one of many alternative styles of coverage from a health maintenance 
organization (HMO), a preferred provider organization (PPO), or some other financing 
and delivery entity. Finally, it may resemble any of the above but be managed on a self- 
insured basis by an employment group that "insures" its own risk rather than placing it 
with a separate insurer. 

"Such people generally have coverage for routine hospital stays and some physician 
and other services as well, but not for very large medical expenses. At some point, their 
uncovered bills become sizable compared with their income (especially if they cannot work), 
and they become medically indigent. The best estimate of the extent of such problems 
comes from 1977 national survey data indicating that 13% of the population under 65 
was uninsured. Depending on the definitions applied, an additional 10 to 24% of the 
under-65 population is w/zotennsured. The smaller figure consists of those who have at 
least a 5% expectation of out-of-pocket expenses exceeding 10% of annual family income; 
the larger figure includes all those whose insurance does not limit out-of-pocket hospital 
expenses. Farley, Who Are the Underinsured? , 63 Milbank Mem. Fund Q. 476 (1985); 
see also M. Sulvetta & K. Swartz, The Uninsured and Uncompensated Care 3, 19 
(1986) (Tables 1 and 4). 



860 INDIANA LAW REVIEW [Vol. 19:857 

Americans are covered. After World War II, private health insurance 
grew by leaps and bounds. Provided largely as a fringe benefit of 
employment, private coverage was greatly encouraged by its exclusion 
from income taxation and its inclusion as a subject of collective bar- 
gaining.^^ In 1965, pubUc coverage took a quantum leap with the congres- 
sional enactment of Medicare, largely for the aged, and Medicaid, for 
the "deserving" poor, as defined by participating states. ^^ Coverage 
continued to expand through the 1970*s, not only in terms of the number 
of peojple covered but also in the breadth and depth of the benefits 
provided; ^^ as a result, the number of uninsured people decHned.^^ 

In contrast, the early 1980's saw a rise in the number of people 
without coverage,*^ for reasons considered below. As of early 1984, about 
35 million people under age sixty-five, or about seventeen percent of 
them, reported that they lacked health coverage at the time surveyed. 
Most of them were probably uninsured for the full year, some for only 
part of the year.*^ 

Table 1 shows the growth in the uninsured population between 1977 
and 1984. 



'^In 1945, only 32 million people were privately covered for hospital inpatient care; 
by 1965, 139 million were. Health Ins. Ass'n. of America, Source Book of Health 
Ins. Data, 1986 Update, Table 1.1, at 3. The average marginal "tax subsidy" for U.S. 
workers has been estimated to exceed 3597o of premiums, C. Phelps, Taxing Health 
Insurance: How Much Is Enough? (The Rand Corporation, Report P-6915, 1983), or 
about 10*^0 of total private health insurance spending, Congressional Budget Office, 
Containing Medical Care Costs Through Market Forces (May 1982). See generally 
Pauly, Taxation, Health Insurance and Market Failure, 24 J. Econ. Lit. 629 (1986). 

'^Social Security Act, tit. XVIII & XIX, 42 U.S.C §§ 1395, 1396 et. seq. (1982 & 
Supp. 1985). 

'"See Health Ins. Ass'n of America, supra note 12. 

'^K. SwARTZ, Who Has Been Without Health Insurance? Changes Betw^een 
1963 AND 1979 (Urban Institute, 1984). 

'*M. SuLVETTA & K. SwARTZ, supra note 11, at 1, 3; see also Health Ins. Ass'n. 
OF America, supra note 12. 

'■'M. SuLVETTA & K. SwARTZ, supra note 11, at 3; see also K. Swartz, Interpreting 
THE Estimates from Four National Surveys of the Number of People Without Health 
Insurance: A Project Summary Report (Urban Institute, 1985). Surveys done in 1977 
and 1980 compared those without coverage for the full year with those uncovered only 
part of the year. About three-quarters of those uninsured at a single point in time were 
uninsured all year; about 9% of 13%, for the 1977 survey. An additional 4% were 
uninsured part of the year. See M. Sulvetta & K. Sw^artz, supra note 11, at 3; Friedman, 
Health Insurance and Cross-Subsidization, Hospitals, Oct. 16, 1985, at 126. (interview 
with Jack Hadley and Katherine Swartz). Most estimates of the uninsured exclude people 
aged 65 and older because virtually all of them are now covered by Medicare, after the 
expansions of recent years to include federal workers and others. 



Millions 


of 


Percentage of 


Uninsured 


Population 


26.2 




13.8<^o 


26.0 




13.7 


28.6 




14.6 


30.7 




15.2 


32.7 




16.1 


35.1 




17.1 



1986] CARE FOR MEDICALLY INDIGENT 861 

Table 1 

Increases in the Uninsured over Time 

(selected survey estimates, under age 65) 



Year 

1977 

1978 

1980 

1982 

1983 

1984 

(adapted from M. Sulvetta & K. Swartz, supra note 11, Table 1). 



Why have the numbers of uninsured people climbed? One reason 
is Medicaid cutbacks in eligibility, encouraged by recession-induced short- 
falls in expected state revenues and required or encouraged by federal 
welfare and Medicaid changes in 1981.'^ Medicaid now covers only about 
forty percent of people below the poverty line.'^ 

The recession of the early 1980's also put many people at least 
temporarily out of work and hence out of private health coverage as 
well. 2^ Unemployment was especially high in heavy industry, hit by both 
recession and intensifying foreign competition. Jobs lost in this sector, 
traditionally the best insured area of the economy, often were not 
regained, and replacement jobs in service and other industries were far 
less likely to offer employer-paid health insurance.^' 



'*See generally R. Bovbjerg & J. Holahan, Medicaid in the Reagan Era: Federal 
Policy and State Choices (1982); J. Holahan & J. Cohen, Medicaid: The Trade-off 
Between Cost Containment and Access to Care (1986). Medicare eligibility cutbacks, 
in contrast, have been minimal, largely achieved through administrative revisions in disabiUty 
standards. 

"J, Holahan & J. Cohen, supra note 18. Medicaid covers about one-third of poor 
adults, one-half of poor children. Id. at 47. However, for various reasons, about one- 
third of Medicaid recipients have incomes above poverty levels. Conversely, the main 
reason so many poor people are not covered under Medicaid is the program's categorical 
nature; only certain categories of poor people can qualify. Notably, childless people and 
intact families are generally ineligible. But see infra notes 237, 239. Cutbacks among even 
eligible groups are also responsible. See J. Holahan & J. Cohen, supra note 18. 

^^See, e.g.. Health Insurance for the Unemployed: Hearing Before the Subcomm. 
on Health of the Senate Comm. on Finance, 98th Cong., 1st Sess. (1983); Staff of 
Subcomm. on Health and the Environment of the House Comm, on Energy and 
Commerce, 98th Cong., 1st Sess., Report on Health Benefits: Loss Due to Unem- 
ployment (Comm. Print 1983). 

^^See, e.g., K. Sw^artz, The Changing Face of the Uninsured (Urban Institute, 
May 1984); Friedman, The Right Issue at the Wrong Time, CHA Insight, June 9, 1986, 
at 1; Friedman, supra note 17, at 126-27; see also infra note 45. 



862 INDIANA LAW REVIEW [Vol. 19:857 

Moreover, even those who retained coverage at work in the 1980's 
often have found their coverage cut back. Cutbacks have taken the form 
of increased requirements for patient cost sharing, utiUzation review, 
and the Hke,^^ as well as decreased employer payment of insurance 
premiums, especially for dependents. ^^ 

What explains the lack of insurance among non-poor working adults? 
Obviously, their employers have not bought them insurance. Type of 
employment also matters, especially size of employment group, because 
insurance is much cheaper for large groups than for small ones or for 
individuals.^"* Beyond workplace characteristics comes individual willing- 
ness to pay for coverage; presumably nonbuyers either cannot afford 
coverage that is attractive to them or they do not appreciate its value. 

One of the most discouraging findings of recent surveys is that 
households that contain at least one insured adult also contain many 
uninsured dependents. In fact, one third of all uncovered children — over 
3 million children — came from such households. ^^ Although direct caus- 
ation is not established, presumably this lack of coverage reflects the 
worker's choice not to pay the additional amount necessary to obtain 
family cover age. ^^ 



^^See, e.g., J. Calif ano, America's Health Care Revolution: Who Lives? Who 
Dies? Who Pays? (1986); P. Fox, W. Goldbeck & J. Spies, Health Care Cost Man- 
agement: Private Sector Initiatives (1984). 

"5ee, e.g.. Bureau of Labor Statistics, U.S. Dep't of Labor, Employee Benefits 
in Medium and Large Firms, 1985 (1986). Having to pay for dependents out of pocket, 
with after-tax dollars, is a major disincentive to buying coverage, especially when that 
coverage features increasingly higher deductibles and coinsurance. 

^On economies of larger-scale insurance, see, e.g., Bovbjerg, Insuring the Uninsured 
Through Private Action: Ideas and Initiatives, 23 Inquiry 403 (1986). On large versus 
small employers, see, e.g., Moyer & Cahill, HHS Survey Illustrates Difference in Large, 
Small Employers' Health Plans, Bus. & Health, Nov. 1984, at 50. Unfortunately for 
insurance coverage, some two-thirds of new jobs are created in small firms, mainly in 
the service industry. See, e.g.. In Praise of Pizza Parlours, The Economist, May 17, 
1986, at 75. See generally Monheit, Hagen, Berk & Farley, The Employed Uninsured and 
the Role of Public Policy, 22 Inquiry 348 (1985) (characteristics of employment that 
affect coverage). 

"Friedman, supra note 17, at 128. 

2^Two other possible reasons for a decline in insurance coverage deserve brief mention. 
For various reasons, the proportion of households headed by women has risen, and these 
households are less likely than male-headed ones to have coverage, especially given Medicaid 
acts. See id. at 128. Moreover, to an unknown extent, more individuals have probably 
become "uninsurable" in the private market, especially outside of large employment group 
plans. Such people include those with chronic conditions needing care or adverse medical 
histories that put them at high risk of significant expense; they cannot get ordinary coverage 
without major exclusions. See, e.g., Gottschalk, People with Chronic Diseases Often Find 
Insurance Is Unaffordable—or Unavailable, Wall St. J., Aug. 12, 1986, at 29, col. 3. 
This phenomenon is an unfortunate side effect of progress; medical treatment now saves 
many who formerly would have died (e.g., through better emergency care or cardiac 
resuscitation) but who now survive with an adverse health history. Additionally, medical 



1986] 



CARE FOR MEDICALLY INDIGENT 



863 



Who are the uninsured? They fit no simple stereotype. Common 
expectations are that the uninsured are exclusively poor, unemployed, 
young, and nonwhite. Persons with any of those characteristics are indeed 
at higher risk of being uninsured, as Table 2 shows. 



Table 2 

Some Characteristics That Put People at High Risk 

OF Being Uninsured (1984) 



Group 


Percentage Not Insured 


Relative Risk 


Entire under-65 






Population 


15.2<yo 


1.00 


Unemployed Adults 


33.6<7o 


2.21 


Income Below Poverty 






Line 


33.8% 


2.22 


Age 18-24 


29.0<^o 


1.91 


Children Age 0-18 






Below Poverty Line 


34.1% 


2.24 


Blacks Age 18-64 


25.0% 


1.64 


Never Married Males 


30.6% 


2.01 


Married Female, 






Spouse Absent 


36.0% 


2.37 


Children in Single-Parent 






Household 


34.2% 


2.25 


Adults with No High 






School Diploma 


25.5% 


1.68 



(computed from M. Sulvetta & K. Swartz, supra note 11, passim). 



But, in fact, most of the uninsured have family incomes at least somewhat 
above the poverty line, are employed, are adults, and are white, as Table 
3 shows. These people may thus seem less appeahng for consideration 
as medical indigents; still, medical bills of a substantial size would clearly 
throw most of these people into the medically indigent category. 



diagnosis has improved physicians' ability to predict future problems and hence insurance 
expenses; the most glaring example is screening for antibodies to the acquired immune 
deficiency syndrome (AIDS) virus. 



864 



INDIANA LA W REVIEW 



[Vol. 19:857 



Table 3 

The Share of the Uninsured Contributed by Groups 

WITH Certain Characteristics (1984) 



Characteristic 



Percentages* of Under-65 Uninsured Who Are 



Family Income 


Below Poverty 


35.6% 


(All Ages) 


1 to 2x Poverty - 


29.3% 




2 to 3x Poverty - 


15.4% 




Over 3x Poverty - 


19.7% 


Employment Status 


Employed 


- 56.5% 


(Adults, 18-64) 


Housekeeping 


- 15.2% 




School 


- 7.2% 




Unemployed 


- 12.1% 




Unable to work, 






early retirement 


- 8.9% 


Age 


0-17 - 33.0% 






18-24 - 23.6% 






25-44 - 27.4% 






45-64 - 16.0% 




Race (Adults) 


White - 79.3% 
Black - 17.3% 
Other - 3.5% 





♦Percentages in each group may not add to 100.0% because of rounding, 
(adapted from M. Sulvetta & K. Swartz, supra note 11, passim). 



C. Problems Posed by Lack of Coverage 

1. Poor Access to Care and Poor Health for the Uninsured. — 
Uninsured people get less medical care, for a combination of reasons: 
they seek less care on their own, they are referred less often for specialized 
care or hospitalization, or they are turned away or otherwise discouraged 
by some providers.^'' The uninsured are far more likely not to have a 
regular source of care and much less likely to use medical services than 
are the insured, as Table 4 indicates. 



^^See Aday & Andersen, The National Profile of Access to Medical Care: Where 
Do We Stand?, 74 Am. J. Pub. Health 1331 (1984); see also Davis & Rowland, Uninsured 
and Underserved: Inequities in Health Care in the United States, 61 Milbank Mem. Fund 
Q. 149 (1983); Robert Wood Johnson Foundation, Updated Report on Access to 
Health Care for the American People (Special report no. 1, 1983). For a more rousing 
portrait of the uninsureds' problems, see Dallek, Six Myths of American Medical Care: 
What the Poor Really Get, Health/PAC Bull., May-June 1985, at 9. 



90.0 


47.0 


4.8% 


15.0% 


17.1% 


32.9% 


9.7% 


23.1% 



1986] CARE FOR MEDICALLY INDIGENT 865 

Table 4 
How Insurance Status Affects Medical Care 

Indicator of Medical Use Insured Uninsured 

Physician visits per person under age 65 in 1977 3.7 2.4 

Hospital patient days per 100 persons under age 65 in 

1977 

Families who needed care but did not receive it in 1982 
Families who did not see a physician in 1982 
People with no regular source of health care in 1982 

(adapted from M. Sulvetta & K. Swartz, supra note 11, at 4 (citing Davis & 
Rowland, supra note 27; Robert Wood Johnson Foundation, supra note 27)). 

It is undocumented to what extent reduced access to care hurts the 
health of the uninsured, but it is reasonable to assume that their health 
does suffer. ^^ Thus, the uninsured are generally thought to be sicker 
than the insured, a difference probably reflecting not only reduced medical 
attention as such but also low income, inability to work, depression 
from unemployment, and possibly other factors as well.^^ 

2. Uncompensated Care for Providers. — Much of the recent concern 
over lack of health coverage derives from hospitals' fears of **uncom- 
pensated care," which is a frequent result of treating uninsured persons. ^° 
Uncompensated care consists of both charity care (provided to the 
indigent with no expectation of payment) and "bad debts" (unpaid bills 
of those expected to pay).^' In 1982, about five or six percent of total 
hospital charges went uncompensated.^^ Because aggregate hospital charges 



^See generally Mundinger, Health Service Funding Cuts and the Declining Health 
of the Poor, 313 New Eng. J. Med. 44 (1985). 

^'Empirical evidence on this point is weak. Cf. id. (loss of access to medical care 
hurts health); Davis & Rowland, supra note 27, at 165-66 (15% of uninsured rate health 
as fair or poor, vs. 11% of insured; sick uninsured have 4.1 physician visits annually, 
vs. 6.9 for sick insured). 

^°See generally Uncompensated Hospital Care: Rights and Responsibilities (F. 
Sloan, J. Blumstein & J. Perrin eds. 1986) [hereinafter Uncompensated Hospital Care]. 

^'It does not include "contractual allowances" or "discounts" below charges or costs 
that some hospitals give to some insurers' patients by virtue of participation agreements 
(as for Blue Cross/Blue Shield plans in many areas) or special negotiations (as for "preferred 
provider" arrangements under which hospitals trade a discount for more insured patients). 
Sloan, Valvona & Mullner, Identifying the Issues: A Statistical Profile, in Uncompensated 
Hospital Care, supra note 30, at 16. 

"M. Sulvetta & K. Swartz, supra note 11 at 25; Sloan, Valvona & Mullner, supra 
note 31, at 16, 19. The latter put 1982 uncompensated hospital care at $6.2 billion, or 
5 percent of charges, and 6 percent of total receipts; using different survey data, the 
former put the 1982 level at $7.5 billion. 



866 INDIANA LAW RE VIEW [Vol. 19:857 

exceed costs or revenues, the percentage of uncompensated care is about 
a percentage point lower when expressed as a fraction of hospital budgets. ^^ 

The burden of uncompensated care is not spread evenly across 
providers. PubHc hospitals provide a vastly disproportionate amount of 
uncompensated care (40.1^o of uncompensated charges, double their 
19.0<^o share of total charges), as do major teaching hospitals (35.8% 
of uncompensated charges vs. 24.09/o of total charges), and large city 
hospitals generally (49.1% of uncompensated charges vs. 39.1% of all 
charges). ^"^ Whether for-profit hospitals contribute their "fair share" 
relative to similar not-for-profit community hospitals is hotly debated. ^^ 

It is not reliably known what share of uncompensated hospital care 
goes to indigents. Charity is said to constitute about one third of 
uncompensated care,^^ but there is no single accepted operational def- 
inition of "charity care." Existing accounting practices allow hospitals 
discretion in applying classification standards for charity care, and re- 
ported charity varies by hospital. ^^ Thus, there is no guarantee that 
reported hospital "charity" accords with social expectations or public 
desires with regard to the medically indigent. ^^ 

How is "uncompensated care" financed? After all, institutions like 
hospitals cannot give charity without themselves incurring costs. Indi- 
vidual professionals can donate "free" personal attention, time, and 
skill beyond normal working hours. But hospital care involves ancillary 
services, supplies, or multiple personnel which must be paid for with 
revenue from some source. 

The conventional wisdom is that hospitals cross-subsidize nonpaying 



"See supra note 32. According to data collected by the American Hospital Associa- 
tion, this amount increases to 5.6% by 1984. See infra note 61. 

^''M. SuLVETTA & K. SwARTZ, supro tiott 11, at 28, 31, 30. 

''See generally For-Profit Enterprise in Health Care 97-126, 209-23, 225-32 (B. 
Gray ed. 1986) [hereinafter For-Profit-Enterprise] (asserts that for-profit hospitals do 
not contribute enough). But see Sloan & Becker, For-Profits v. Non-Profits: A Phantom 
Issue, Tech. Rev., April 1984, at 11. 

'^See, e.g., Cohodes, America: The Home of the Free, the Land of the Uninsured, 
23 Inquiry 227, 228 (1986) (charity care comprises one-third of uncompensated care); see 
also Sloan, Valvona & MuUner, supra note 31, at 19 (of 1982's $6.2 biUion in uncompensated 
charges, hospitals designated $1.7 billion as charity, $4.5 bilHon as bad debt). 

"For-Profit Enterprise, supra note 35, at 102; Sloan, Valvona & Mullner, supra 
note 31, at 19. More defined descriptions do exist for Hill-Burton purposes. See infra 
notes 121-31. 

^*In fairness to hospitals, it must be noted that there is little consistency in public 
programs' definition of indigency for purposes of eligibility determinations. One of few 
existing uniform standards is that established by the federal Department of Health and 
Human Services — belatedly, under pressure of repeated litigation — to measure hospitals' 
adherence to Hill-Burton requirements to deliver "free" care to indigents. See For-Profit 
Enterprise, supra note 35, at 102. See also infra notes 121-28 and accompanying text. 



1986] CARE FOR MEDICALLY INDIGENT 867 

patients largely with revenues earned from paying patients, especially 
those who pay hospital charges (or whose insurers do), since charges 
are higher than costs. ^^ Lesser sources of revenue include philanthropic 
contributions, nonpatient revenues — both relatively minor for most hos- 
pitals — and, mainly for public institutions, direct public subsidies from 
tax funds/*^ 

Alternatively, a hospital can subsidize uncompensated care from its 
own capital, incurring a deficit met largely by not funding depreciation. 
This last option obviously hurts the long-run viabihty of an institution 
and may impair its ability to raise operating capital as well. In 1980, 
fully one-third of the hospitals that provided a high volume of care to 
poor people were fiscally "stressed" in that they had deficits in operating 
and total accounts. "^^ 

Little is known about what care the uninsured indigent receive outside 
of hospitals, although it seems likely that non-hospital providers render 
relatively less uncompensated care than do hospitals. ^^ For society at 
large, hospital service comprises some forty-six percent of personal health 
care spending (exclusive of public health activities, medical research, and 
construction); the balance goes to physicians, other professionals, drugs, 
nursing homes, and so on."^^ Hospitals, especially pubhc ones, are the 
traditional "providers of last resort," and their legal obligations to 
provide care are greater than those of other providers.'^'* Moreover, 
hospital care is the most heavily insured, which traditionally has given 
hospitals more "third-party" revenues from which to cross-subsidize 
charity care. 



^^5ee, e.g., For-Profit Enterprise, supra note 35, at 106-07; Phelps, Cross-Subsidies 
and Charge Shifting in American Hospitals, in Uncompensated Hospital Care, supra 
note 30, at 108. It is often argued that cost-paying "insurers," especially Medicare and 
Medicaid, do not contribute to this shift. See, e.g., J. Meyer, Passing the Health Care 
Buck: Who Pays the Hidden Cost? (1983). 

'^"For-Profit Enterprise, supra note 35, at 100, Table 5.2, & 106 (public subsidy 
of $1.9 billion in 1984). 

"'Hadley, Mullner & Feder, The Financially Distressed Hospital, 307 New Eng. J. 
Med. 1283 (1982). This study focused on hospitals for which uncompensated care plus 
Medicaid constituted 24% or more of charges. 

'*^The only estimates of non-hospital charity with which the authors are familiar 
confirm this expectation. One estimate holds that physicians provided some $2.9 billion 
of free care in 1982. See G. Bazzoli, Health Care for the Indigent: Literature 
Review and Research Agenda for the Future (1985). But see F. Sloan, J. Valvona 
& G. HicKSON, Analysis of Health Care Options in Tennessee: Uncompensated Care 
(Vanderbilt Univ. 1985) (Tennessee doctors provided only one-seventh the amount of 
uncompensated care as Tennessee hospitals). 

''^Levit, Lazenby, Waldo & Davidoff, National Health Expenditures, 1984, Health 
Care Financing Rev., Fall 1985, at 1, 9 [hereinafter National Health Expenditures] (in 
1984, hospital care claimed $157.9 billion out of $341.8 of personal health care). 

^See infra text accompanying notes 101-31. 



868 INDIANA LAW REVIEW [Vol. 19:857 

Uncompensated care is clearly a multibillion dollar problem for 
hospitals, presumably a smaller one for other providers. It is likely to 
have totalled about $10 bilUon in 1982 (assuming that two-thirds or 
three-quarters of it occurred in hospitals). The volume of uncompensated 
care has probably grown since then, as the next subsection discusses; 
certainly, the pressures on hospitals have increased. "^^ 

D. Growing Problems 

Recent developments have made access to insurance and care more 
difficult for the medically indigent. Not only has the number of uninsured 
grown through 1984 (Table 1), but it is likely to continue to rise in the 
long run, despite a generally improved economy. A number of portents 
point in this direction. First, the normal, "structural" level of unem- 
ployment, below which the percentage of people looking for work is 
not apt to fall, even in good times, seems to have risen above the 
expected 3-4% of the 1970's to perhaps 5-6^^0 or more. Few of the 
unemployed have employer-paid health coverage. "^^ Second, employment 
patterns also seem to be undergoing a structural shift. To oversimpHfy, 
the United States is moving from manufacturing to service jobs, from 
unionized to nonunionized work forces, from mainly full-time to in- 
creasingly part-time workers, and from large employers to smaller ones — 
all moves from well-insured types of employment to less well-covered 
ones."^"^ 

Finally, the recent federal tax reform bilP reduces the incentives 
for companies and workers alike to shelter income in tax-free benefits 
like health insurance. Business in the aggregate will be paying considerably 
more federal income tax (although at a lower official marginal rate), 
which should make companies even more zealous about cutting corporate 



"^Large as $10 billion may seem, it is not large in relation to some 31 million 
uninsured people in 1982 {see supra Table 1). Per capita, that amounts to little more 
than $300 for the year, far less than 1982's $1,184 per capita spending for the general 
population. National Health Expenditures, supra note 43, at 16. It may be safely assumed 
that this amount of charity care did not meet all the medical needs of the medically 
indigent, given the extent to which the uninsured receive less care (see supra Table 4). 
Meeting those needs on a prepayment basis would be substantially more costly. See infra 
notes 257-58. 

*^See supra note 20. 

^'Black, Comment on "The Employed Uninsured and the Role of Public Policy," 
23 Inquiry 209 (1986); Monheit, supra note 24. Black's and Monheit's observations rest 
mainly on 1977 data about employment and insurance coverage. Unpublished research on 
changes in insurance status during 1980-86 by Stephen M. Long and Jack Rodgers of the 
Congressional Budget Office disputes some of the details of these findings, arguing that 
long-term structural changes do not explain the rapid rise in the number of uninsured in 
the early 1980's. 

^«Tax Reform Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085; Summary of Con- 
ference Agreement on H.R. 3838, Tax Notes, Sept. 8, 1986, at 985. 



1986] CARE FOR MEDICALLY INDIGENT 869 

health benefits than they have already been/^ Individuals will pay less 
federal tax overall, and at lower marginal rates, especially at the high 
and low ends of the scale. High-income and low-income taxpayers alike 
will thus find tax-free health benefits considerably less attractive than 
before, compared with the alternative of higher cash income. 

At the same time, the cost of offering workplace health benefits 
has been raised by numerous government requirements in the form of 
'^mandated benefits," thus making insurance benefit packages richer for 
some^^ and more available to others, including the recently unemployed 
and divorced dependents.^' These developments are helpful in some regard 
to those already in well-insured positions but, again, do not ease the 
difficulties of the marginal company and its workers in attempting to 
get affordable health coverage. All of these trends seem to indicate that 
the future will see more people without health coverage, not fewer. 

Meanwhile, uncovered people also seem to face even greater problems 
in obtaining care — especially if they cannot prepay in cash, at least in 
part. The main reason is that the ability of hospitals to cross-subsidize 
care to the indigent seems to be declining. All providers, including 
hospitals, face increased price competition from their competitors as well 
as greater price resistance from their customers. Both developments have 
adverse implications for the uninsured, at least in the short run." 

Hospitals generally seem to manage the extent to which they provide 
uncompensated care in order to match their fiscal capacity. ^^ It is safe 
to assume that they will cut back if increased price competition threatens 
their earnings or their ability to attract paying patients. Cutback strategies 
will include choosing locations and services attractive to insured rather 
than uninsured populations, avoiding services like obstetrics and emer- 
gency treatment of trauma that often go uncompensated, and screening 
out or transferring indigents or requiring deposits from them, at least 
for non-emergency care.^"* 

Although almost all hospitals provide some level of charity care, in 
most locations the institutional provider of last resort, if one exists, is 
the pubUc hospital. Anecdotal evidence indicates that the demand for 



'^^See supra notes 22 & 23. 

5°State laws regulating insurance have for a decade or more been altered to require 
insurance plans to include mental health benefits, among others. One estimate is that 
nearly 600 such statutes exist. Demkovich, Covering Options Through Mandated Benefits, 
Bus. & Health, Jan. /Feb. 1986, at 27 (more than 580 laws at the end of 1984, requiring 
coverage of everything from alcoholism services, in 38 states, to hospices, in 5 states, 
with an almost equal number of new bills pending). 

^^See infra note 207 on the federal "COBRA" entitlements allowing continuance as 
a group member even after layoff, divorce, or other separation from the group. 

"See, e.g., Kinzer, Care of the Poor Revisited, 21 Inquiry 5 (1984). 

"Hadley, Mullner & Feder, supra note 41, 

^■♦For-profit Enterprise, supra note 35, at 104-05. 



870 INDIANA LAW REVIEW [Vol. 19:857 

public hospital care has risen, in part as a result of transfers from other 
hospitals. ^^ At the same time, state and local governments that tradi- 
tionally have funded public hospitals' net deficits (after collections from 
Medicaid and other third-party payers) often have found themselves 
under considerable fiscal pressure, in the aftermath of recession and the 
"taxpayers' revolt. "^^ Indeed, a number of public hospitals have closed 
since the late 1970's, perhaps most notably Philadelphia's," and there 
is some movement toward "privatizing" others. ^^ 

For the future generally, some observers predict closures of as many 
as one thousand of today's six thousand short-term general hospitals, 
both public and private. ^^ The remaining hospitals will have to be more 
concerned with competition for paying patients and less concerned about 
indigent care (which raises prices). Thus, in the 1990's, it is quite possible 
that the medically indigent will have less access to care than they do 
now, unless there are changes in public policy. 

As a political matter, it seems undeniable that hospitals — not the 
indigent themselves — will continue to be largely responsible for making 
"uncompensated care/indigent care" a legislative issue. ^^ The American 
Hospital Association has recently completed a report on indigent care, 
and almost every state has commissioned a task force on the topic. ^^ 
In this way, hospitals can provide an effective political voice for their 
largely disenfranchised poor patients. ^^ 

For the moment, neither the administration nor the Congress seems 
inclined to assist in finding solutions, certainly not solutions that require 



^^See, e.g., Schiff, supra note 5. 

'^See, e.g.. There's Life Yet in Tax Revolt, The Economist, Aug. 30, 1986, at 18. 

"Reportedly, 111 nonfederal, short-term general hospitals, 19 of which were state 
or local institutions, closed between 1980 and 1982. Sloan, Valvona & Mullner, supra 
note 31, at 26. 

^^Bovbjerg, Held & Pauly, Privatization and Bidding in the Health Care Sector, 6 J. 
Pol'y Analysis & Mgmt. (1987) (forthcoming). 

'^See, e.g., Mullner & McNeil, Rural and Urban Hospital Closures: A Comparison, 
Health Aff., Fall 1986, at 131. 

^See, e.g., Richards, Special Interests Push Indigent Care Solutions, Hospitals, Oct. 
16, 1984, at 106. 

^'American Hospital Ass'n, Cost and Compassion: Recommendations for Avoiding 
A Crisis in Care for the Medically Indigent, Report of the Speclax Committee on 
Care for the Indigent (1986). Most of the state studies consider their topic as much 
"uncompensated care" as "indigent care." For a summary of state studies during 1982- 
84, see J. Luehrs & R. Desonla, A Review of State Task Force and Speclu, Study 
Recommendations to Address Health Care for the Indigent (1984) (responses of 21 
states to survey); see also Nat'l Conf. of State Legislatures, 12 Questions: What 
Legislators Need to Know About Uncompensated Hospital Care (undated, issued 
1985). 

"See, e.g.. Law, A Consumer Perspective on Medical Malpractice, 49 Law & 
Contemp. Probs. 305, 307 (1986). 



1986] CARE FOR MEDICALLY INDIGENT 871 

new federal funding. ^^ As a result, states and localities are scrambling 
to find new ways to bear the burden of financing care for the medically 
indigent. ^"^ This Article next considers the legal obligations for providing 
or financing care and concludes with an examination of state policy 
options for aiding the medically indigent. 

III. Legal Rights to Health Care or Coverage 



A. Rights and Responsibilities 

The supply of medical care for the medically indigent may be 
diminishing, but there is no shortage of statements that medical care is 
a basic human * 'right." Religious leaders, moral philosophers, politicians, 
and even some judges have been heard from on this score. ^^ Existing 
commentary on the subject is voluminous^^ and will not be reviewed 
here. Many arguments about rights occur on an abstract, philosophical 
plane. One underlying ethical-legal issue is whether society or medical 



"In post-Gramm-Rudmann Washington, concern over reducing the massive federal 
deficit seems to preclude new funding initiatives. The administration has repeatedly at- 
tempted to cut existing indigent health programs like Medicaid, see R. Bovbjerg & J. 
HoLAHAN, supra note 18, and community health centers, see G. Peterson, R. Bovbjerg, 
B. Davis, W. Davis, E. Durman & T. Gullo, The Reagan Block Grants: What Have 
We Learned (1986) [hereinafter G. Peterson]. Congress has protected the basic scope 
of Medicaid and some other existing programs, but seems unwilling to fund new ones. 
It will consider mandates for employer or state contributions, but not new federal taxes. 
Thus, COBRA requires employers to offer group insurance continuation benefits. See 
infra note 207. "Risk pool" legislation seriously considered but not passed would have 
required states to help pay for "insurance of last resort" for the otherwise uninsured. 
Access to Health Care Bill, S. 2402, 99th Cong., 2d Sess., 132 Cong. Rec. S5218 (1986) 
discussed infra at note 290. 

^See supra notes 7 & 61; infra note 136. 

^^See, e.g.. The Labor Day Statement of Cardinal John J. O'Connor on "The Right 
to Health Care" ("Every person has a basic right to health care which flows from the 
sanctity of life and the dignity of human persons" (citing 1981 Pastoral Letter on Health 
Care from American Catholic Bishops)), excerpted in Health/PAC. Bull., July /Aug. 
1985, at 6-7; WiUiams, The Idea of Equality, in Philosophy, Politics, and Society 121- 
22 (P. Laslett & W. Ronciman eds. 1962) (It is a "necessary truth" that "the proper 
ground of [medical] treatment is need"); E. Kennedy, In Critical Condition (1972) 
(especially Chapter 10, Good Health Care: A Right for All Americans); Memorial Hosp. 
V. Maricopa County, 415 U.S. 250, 259 (1974) (dictum) ("[M]edical care is as much 'a 
basic necessity of life' to an indigent as welfare assistance. And ... of greater constitutional 
significance. . . ."). 

^See, e.g.. President's Commission for the Study of Ethical Problems in Medicine 
and Biomedical and Behavioral Research, Securing Access to Health Care, Volume 
Two: Appendices, Socioculture and Philosophical Studies (1983) (twelve articles on 
access and right to it, each referencing various literatures); Fried, Equality and Rights 
in Medical Care, in Implications of Guaranteeing Medical Care 3 (J. Perpich ed. 
1975). 



872 INDIANA LAW REVIEW [Vol. 19:857 

providers owe the same care to all or whether charitable obligations are 
limited to some "decent minimum" of care.^^ Legal and policy analysis 
must consider how any such rights are determined and what, if any, 
corresponding responsibility attaches. 

The most fundamental right to health care would be one derived 
from federal constitutional provisions. The constitutional authority of 
the federal government to fund health care for the medically indigent 
is indisputable,^^ and the federal-state Medicaid program is tangible 
evidence of that authority. ^^ The government may assume by statute an 
obligation to fund medical care, but it has no general constitutional 
duty to do so. For example, the government may cut back previously 
offered Medicaid benefits^° and may refuse to fund certain care, even 
care considered by some to be medically necessary. 

The abortion cases well illustrate the distinction between a patient's 
right to receive care and a public obligation to pay for it. A patient's 
right to receive an abortion cannot be unduly restricted by government, 
but this limited right carries no corresponding funding obligations.^' 
Government may even deny funds for abortions while paying for similar 
treatments under Medicaid or other programs. "^^ 

Two limited exceptions prove this rule. First, people involuntarily 
confined to mental institutions may have a "right to treatment" grounded 
in substantive due process or even in the eighth amendment's prohibition 
of cruel and unusual punishment. A number of lower federal courts 
have so held in cases of involuntary civil commitment. ^^ The remedy 
for institutionalization without adequate treatment is not easily framed. 



^^Compare, e.g.. President's Commission for the Study of Ethical Problems in 
Medicine and Biomedical Research, Summing up: Final Report on Studies of the 
Ethical and Legal Problems in Medicine and Biomedical and Behavior Research 
29-30 (1983) ("The Commission proposes a standard of 'an adequate level of care' for 
all, not 'a right to health care' that offers patients access to all beneficial care, to all 
care that others are receiving, or to all that they need — or want.") and Fried, supra note 
66 ("decent standard of care for all") with, e.g., E. Kennedy, supra note 65 (especially 
chapter 10, Basic Right of Access for All to Quality Care). 

*^U.S. Const. Preamble ("promote the general welfare . . ."). 

^'Social Security Act, tit. XIX, 42 U.S.C. §§ 1396 et seq. (1982 & Supp. 1985). 

^"Generally, states, rather than the federal government, are sued for implementing 
cutbacks, because most cutbacks have historically been undertaken at state discretion rather 
than by federal mandate. See. e.g., Alexander v. Choate, 469 U.S. 287 (1985) (Tennessee 
cut of hospital coverage to 14 inpatient days held valid). In contrast, federal eligibility 
cutbacks in 1981 received no judicial challenge. 

^'Beal V. Doe, 432 U.S. 438 (1977); Roe v. Wade, 410 U.S. 113 (1973). 

"Harris v. McRae, 448 U.S. 297 (1980). 

''See, e.g., Wyatt v. Aderholt, 503 F.2d 1305 (5th Cir. 1974); Rouse v. Cameron, 
373 F.2d 451 (D.C. Cir. 1966), appeal after remand, 387 F.2d 241 (D.C. Cir. 1967); 
Wyatt V. Stickney: Retrospect and Prospect (L. Jones & R. Parlour eds. 1981). See 
generally D. Wexler, Mental Health Law: Major Issues (1981). 



1986] CARE FOR MEDICALLY INDIGENT 873 

but courts generally require either deinstitutionalization, sometimes also 
with treatment, "^"^ or improved institutional care, going beyond the merely 
custodial. ^^ Determining precisely what care is required and at what cost 
proves rather difficult in practice.^^ The Supreme Court has given only 
limited support to even this narrow concept of a right to mental health 
treatment,^^ and the recent trend seems to disfavor such litigation. ^^ 

The second exception entitles incarcerated prisoners to adequate 
health care. Traditionally, what little health care was available in jails 
and prisons was very poor.^^ A series of lawsuits has established that 
prison inmates must be given at least that level of care that prevents 
their medical situation from being cruel and unusual punishment. ^° Again, 
precisely what level of care meets the constitutional minimum is not 
clear, nor is the extent to which a prisoner must contribute toward his 
own care.^^ 

These two exceptions are readily understood. Both institutionalized 
mental patients and prisoners are individually made wards of the state. 
It is an easy step to hold that the act of taking away their liberty (and 
with it their capacity to help themselves or to seek private charity) 
requires the government to give them in return a reasonable level of 
medical care, along with humane treatment in other regards. ^^ These 



^^Callahan v. Carey, N.Y.LJ., Dec. 11, 1979, at 10, col. 5 (N.Y. Sup. Ct. Dec. 
10, 1979). 

^^See, e.g., Wyatt v. Stickney: Retrospect and Prospect, supra note 73. 

^^See id.; see also Miller, The "Right to Treatment": Can The Courts Rehabilitate 
and Cure?, 46 The Public Interest 96 (1977). 

''See, e.g., McNeil v. Director, Patuxent Inst., 407 U.S. 245 (1972) (holding that 
the state of Maryland could not confine appellant indefinitely on basis of administrative 
referral for observation under "defective delinquent" law; dictum noted remarkable rarity 
of litigation to set "substantive constitutional limitations on this [civil commitment] power"). 

'^See, e.g., Jones v. United States, 463 U.S. 354 (1983) (civil commitment of convicted 
criminal upheld despite not meeting standards for independent civil commitment); Young- 
berg V. Romeo, 457 U.S. 307 (1983) (constitutional "right to habilitation" grounded on 
deprivation of personal freedom and safety, not on extent of available medical treatment); 
Pennhurst State School v. Halderman, 451 U.S. 1, 18 (1982) (poorly treated mentally 
retarded patients not entitled to redress against the state under federal handicapped statute; 
Congress did not intend to require states "to assume the high cost of providing 'appropriate 
treatment' " in exchange for federal funds). 

'^See, e.g., S. Goldsmith, Prison Health: Travesty of Justice (1975). 

^^See generally Neisser, Inmate Welfare Funds: Reassessing Prisoner Assessments, 
in Prisoners and the Law 16-1, 16-18 through 16-20 (I. Robbins ed. 1985); Neisser, Is 
there a Doctor in the Joint? The Search for Constitutional Standards for Prison Health 
Care, 63 Va. L. Rev. 921 (1977). 

«'In City of Revere v. Massachusetts General Hospital, 463 U.S. 239 (1983), the 
Supreme Court carefully refrained from deciding to what extent the hospital could collect 
from the patient, who was granted bail while hospitalized with wounds received during 
arrest, stating that this was a matter of state law. Id. at 245-46, 

«2C/. Wyatt V. Aderholt, 503 F.2d 1305, 1312 (5th Cir. 1974) (treatment is "the 
quid pro quo society [has] to pay as the price of . . . denial of individuals' liberty"). 



874 INDIANA LAW REVIEW [Vol. 19:857 

exceptional cases do not support a fundamental positive "right to health 
care," but there may be a fundamental negative right allowing a sort 
of "free exercise." Thus, whereas certain aspects of medical practice 
are subject to restrictions under licensure or economic regulation, ^^ courts 
have recognized the importance of professional freedom^ and patients' 
free choice,^^ even the choice not to receive care of any sort.^^ 

However, for the most part, the medically indigent have only those 
entitlements that have been voluntarily enacted, in whole or in part, to 
help them.^'^ Each statute — Medicare, veterans' coverage, maternal and 
child health, and so on — carries with it greater or lesser entitlements to 
a more or less defined population. The negative imphcation of each 
program of special assistance is that no general federal obligation exists. 

Beyond basic federal law, there are three other possible sources of 
indigent rights. These are the duties of providers, of states and localities, 
and of health insurers. 

B. Obligations of Health Care Providers 

1. Physicians, a. Duty to treat. — Although physicians may vol- 
untarily provide charity care to the indigent, they have no affirmative 
legal duty to do so. Like anyone else, physicians are free not to render 
aid even in an emergency.^* Any assistance that a physician may gra- 
tuitously render is considered the act of a "good Samaritan. "^^ This 
same view has been echoed by numerous courts across the nation, and 
stands unchanged by statute. ^'^ 

Most legal doctrine on the subject arises from malpractice law, 
enforced through tort suits for damages. Doctors are remarkably free 
of legal duty to treat anyone, paying customers and the impecunious 
alike. The classic statement of this non-duty comes from Hurley v. 



''See, e.g. Ind. Code §§ 25-22.5-1-1 et seq. (1982). 

«^C/. Roe V. Wade, 410 U.S. 113, 163 (1973) (importance of noninterference with 
doctors' judgment). 

«^The malpractice rule that patients must give "informed consent" is based on the 
importance of personal sovereignty. See generally J. Katz, The Silent World of Doctor 
AND Patient (1984). 

'"•In re Quinlan, 70 N.J. 10, 355 A. 2d 647 (1976), is the seminal case. For a full 
discussion, see President's Commission for the Study of Ethical Problems in Medicine 
and Biomedical and Behavioral Research, Deciding to Forgo Life-Sustaining Treat- 
ment: Ethical, Medical, and Legal Issues in Treatment Decisions (1983). 

«^On federal medical programs, see generally F. Wilson & D. Neuhauser, Health 
Services in the United States 137-228 (2d ed. 1982). 

'^See Restatement (Second) of Torts § 314 comment c (1965). 

'^State law typically protects such medical Samaritans from ordinary negligence actions. 
See, e.g., Ind. Code §§ 34-4-12-1 to -2 (1982). 

^See e.g.. Harper v. Baptist Medical Center-Princeton, 341 So. 2d 133 (Ala. 1976); 
Childers v. Frye, 201 N.C. 42, 158 S.E. 744 (1931); Lyons v. Grether, 218 Va. 630, 239 
S.E.2d 103 (1977). 



1986] CARE FOR MEDICALLY INDIGENT 875 

Eddingfield,^^ a turn-of-the-century case in which the Indiana Supreme 
Court ruled that a physician had no duty to treat anyone. The court 
saw no common law duty, even though the doctor was not otherwise 
occupied, the would-be patient was very sick (he later died), was a 
former patient of the refusing physician, and tendered payment in advance. 
The court rejected any medical analogy with the common law duty of 
innkeepers to serve all comers as well as the argument that the then recently 
enacted state regulatory scheme of physician licensure had created such 
a duty. This minimalist legal view of physicians' obligations to would-be 
patients has long been an accepted tenet of organized medicine as well 
as of the law.'^ The traditional rule that physicians are free to reject anyone 
as a patient may have been tempered somewhat by civil rights legisla- 
tion," but medical indigency is not a protected civil rights category. 

A physician's legal duty to treat a patient arises only from mutual 
consent — by express contract or by one implied by the parties' behavior. 
Whether this contractual physician-patient relationship exists is a factual 
question that turns upon whether the physician accepted the case and 
whether the patient accepted the physician's professional services. ^"^ Under 
certain circumstances, some courts have inferred a duty to treat even 
absent specific consent. For example, an Arizona court ruled that a 
physician on the staff of a hospital who agreed to be an "on-call" 
emergency room doctor could no longer refuse treatment to an individual 
seeking emergency care.^^ A New York court found a physician-patient 
relationship based solely on a telephone conversation between a hospital 
physician and an emergency room visitor, even though the physician 
was said mainly to have directed the patient to see his own doctor. ^^ 
For the most part, however, mutual consent remains a requirement. 



"156 Ind. 416, 59 N.E. 1058 (1901). 

^^Am. Med. Ass'n, Principles of Medical Exmcs § 6 (1985); cf. Relman & Reinhardt, 
An Exchange on For-Profit Health Care, in For-Profit Enterprise, supra note 35, at 
209 (lack of duty to serve shows profit orientation of physicians). 

"^^See generally Nat'l Health Law Program, Manual on State and Local Gov- 
ernment Responsibilities to Provide Medical Care for Indigents 163-71 (M. Dowell 
ed. 1985) [hereinafter State and Local Government Responsibilities] (Chapter IV, 
"Access to Health Care and Civil Rights Legislation"). 

^"Lyons, 218 Va. 630, 239 S.E.2d 103; see also 61 Am. Jur. 2d Physicians, Surgeons, 
and Other Healers § 96 (1972). 

^'Hiser v. Randolph, 126 Ariz. 608, 617 P.2d 774 (Ariz. Ct. App. 1980), overruled 
on other grounds, Thompson v. Sun City Community Hosp., Inc. 141 Ariz. 597, 688 
P. 2d 605 (Ariz. 1984) (The court in Thompson also distinguished Hiser on the issue of 
the physicians' duty to treat in emergency situations). But see, e.g., Wilmington Gen. 
Hosp. V. Manlove, 54 Del. 15, 174 A.2d 135 (1961); Richard v. Adair Hosp. Found. 
Corp., 566 S.W.2d 791 (Ky. Ct. App. 1978). See infra discussion at notes 112-20 on 
emergency care and duty to serve. 

^O'Neill V. Montefiore Hosp., 11 A.D.2d 132, 202 N.Y.S.2d 436 (1960). 



876 INDIANA LAW REVIEW [Vol. 19:857 

b. Standard of care and extent of treatment. — Once a patient-phy- 
sician relationship has been estabHshed, the physician must exercise the 
same standard of care — customary skill and diligence^^ — regardless of 
whether the patient is an indigent or a paying customer. Even when 
physicians render their services gratuitously, their potential liability for 
negligence or malpractice remains the same as in treating any other 
patient. ^^ 

Having once begun treatment, a physician must continue treatment 
as long as medical care is necessary or face a possible malpractice action 
for abandonment if actionable damage occurs. ^^ Physicians may safely 
withdraw from a case only when services are no longer needed, when 
the patient voluntarily terminates the relationship, when referral is made 
to an equally qualified practitioner, or when the patient has a reasonable 
opportunity to see another physician. '°° 

2. Hospitals, a. Duty to treat. — As a general matter, private hospitals, 
like physicians, have no legal duty to accept all potential patients seeking 
care, except perhaps in emergency situations. ^°' Public hospitals, by 
statute, by charter, or by tradition, generally are obligated to accept all 
patients, at least in emergencies, '°^ but the ''right" of admission to public 
hospitals for non-emergency cases is not absolute. ^°^ 

Even more than that of physicians, hospitals' discretion to refuse 
patients is limited by civil rights provisions, '^'^ but in general, ability to 
pay can be considered in deciding whether to treat. Indeed, absent an 
emergency, a hospital may require a cash deposit as a condition of 
admission. ^°^ Significantly, in only about half of the states are hospitals 



'The classic article is McCoid, The Care Required of Medical Practitioners, 12 
Vand. L. Rev. 549 (1959); see also A. Holder, Medical Malpractice Law 40-43, 53- 
55 (1975). 

"'See, e.g.. Rule v. Cheeseman, 181 Kan. 957, 317 P.2d 472, 477 (1957) (the fact 
that the patient was a charity patient was immaterial in determining the surgeon's neg- 
ligence); see also 70 C.J.S. Physicians and Surgeons § 52 (1951). 

"""See, e.g., A. Holder, supra note 97, at 374-402. 

'""Lyons v. Grether, 218 Va. 630, 239 S.E.2d 103 (1977); see also Annotation, Liability 
of Physician Who Abandons Case, 57 A.L.R.2d 432, 439 § 3 (1958). 

'°'See, e.g., Birmingham Baptist Hosp. v. Crews, 229 Ala. 398, 157 So. 224 (1934) 
(physician in emergency room diagnosed child's advanced diphtheria and began treatment 
but hospital denied admission because the disease was contagious; held no liability for 
later death); Hill v. Ohio County, 468 S.W.2d 306 (Ky. 1971), cert, denied, 404 U.S. 
1041 (1972) (pregnant woman had no right to hospital admission, absent emergency); see 
also A. SouTHWiCK, The Law of Hospital and Health Care Administration 161-62 
(1978). 

'"^See Wilmington Gen. Hosp. v. Manlove, 54 Del. 15, 174 A.2d 135 (1961) (dictum 
on public hospital duty); A. Southwick, supra note 101, at 162-64. 

"^^See A. Southwick, supra note 101, at 163. 

^'^See State and Local Government Responsibilities, supra note 93, at 163-71. 

'°^Joyner v. Alton Ochsner Medical Found., 230 So. 2d 913 (La. App. 1970) (auto 
accident victim given emergency treatment but refused admission). 



1986] CARE FOR MEDICALLY INDIGENT Sll 

legally required to have emergency rooms. ^^^ 

As with physicians, once a hospital begins to provide diagnosis and 
treatment for an indigent patient, it is held to the same standard of 
care as for any other patient. ^^^ Particularly when financial considerations 
prompt an early discharge of a patient, the hospital may be found liable 
for damages in a tort suit for abandonment. ^^^ 

However, tort actions constitute an abysmal enforcement tool for 
achieving access to care. Only those emergency refusals that result in 
compensable damages are normally actionable, and severe damage is 
usually needed to justify the expense of a suit. Indigents are also 
disadvantaged because their economic damages are likely to be low and 
they may have poor access to legal assistance. ^°^ Moreover, if indigents 
are receiving public assistance, they may not be allowed to keep much 
of any recovery. 

Malpractice doctrine is, therefore, of little help to indigents seeking 
care."^ Indeed, if anything, malpractice law may actually hurt indigents' 
access to private care, because offering any care may make a provider, 
especially a hospital, liable to provide all needed care, perhaps entirely 
without recompense. It is precisely this concern that presumably prompts 
'* dumping." 

One way to reduce the malpractice incentive to dump patients would 
be to grant immunity from tort actions to providers that conform to 
the coverage and utilization requirements of any applicable indigent care 
program. The existing federal Professional Review Organization (PRO) 
legislation provides such immunity with regard to the appropriateness 



'°*About half of states directly or indirectly require certain categories of hospitals to 
have emergency facilities. A. Southwick, supra note 101, at 183-84. See, e.g.. III. Ann. 
Stat. ch. Ill 1/2, para. 86, 87 (Smith-Hurd 1977 & Supp. 1986) (private and public 
hospitals providing general medical or surgical services); Pa, Stat. Ann. tit. 62, § 443.3 
(Purdon 1986) (all hospitals receiving payments from Department of Public Welfare). 
State and Local Government Responsibilities, supra note 93, provides a table of 
emergency care laws; on tax rules, see id. at 489-90. 

'"^Hospital Law Manual 1 1-3 (1981). 

'°«See e.g., Meiselman v. Crown Heights Hosp., 285 N.Y. 389, 34 N.E.2d 367 (1941) 
(hospital discharged patient when open wounds were still draining); Jones v. City of New 
York, Hosp. for Joint Diseases, 134 N.Y.S.2d 779 (N.Y. Sup. Ct. 1954), rev'd on other 
grounds, 286 A.D. 825, 143 N.Y.S.2d 628 (1955) (transfer of a stabbing victim who later 
died was for hospital convenience rather than necessity and thus actionable). 

•°^he last point is not self-evident, given free legal assistance as a free point of 
entry and the wide availability of the private, contingent-fee personal injury bar. No direct 
evidence on this point seems to exist. The only major empirical analysis of medical 
malpractice, however, provides indirect evidence, that the incidence of claims does not 
vary by differences in per capita income or in the proportion of people on welfare among 
states. P. Danzon, Medical Malpractice: Theory, Evidence, and Public Policy 75 
(1985). 

"°See Law, supra note 62, at 306-15; Rosenblatt, Rationing "Normal" Health Care: 
The Hidden Legal Issues, 59 Texas L. Rev. 1401, 1410-15 (1981). 



878 INDIANA LAW REVIEW [Vol. 19:857 

of treatment when Medicare has denied payment. ^^^ However, a broader 
immunity provision could apply equally to coverage issues as well as to 
issues of appropriateness. Under such a provision, a hospital would be 
immune from suit if it failed to provide uncompensated care beyond 
that covered under the indigency care program. 

Of course, there are other ways to discourage providers from trans- 
ferring patients, at least emergency patients, inappropriately. New federal 
legislation specifically addresses inappropriate transfers. 

b. Emergency room as a source of duty to treat. — Under 1986 
federal legislation, hospitals that operate emergency rooms and that 
participate in the Medicare or Medicaid programs must follow certain 
protocols in assessment, treatment, and transfer of emergency patients 
(including patients arriving in active labor). ^^^ The duty appHes to all 
patients, not merely to public program beneficiaries. ^'^ 

This legislation was passed in response to growing concern over 
refusals of care and "dumping" of patients on public facilities. ^'"^ Bas- 
ically, affected hospitals must examine all patients and then either accept 
them for full treatment or at least sta^bilize their condition so that they 
can be safely transferred. UnstabiHzed patients may be transferred only 
with their express consent or when the transfer is certified to be in their 
own interest. ^'^ The federal act specifically states that it does not preempt 
state rules except when they are plainly inconsistent with federal re- 
quirements.'^^ Clearly the state remains free to enforce more stringent 
standards. 

The federal act was in many ways modeled upon landmark Texas 
legislation that took effect the week before the federal action. ''"^ Under 
the Texas law, a physician must examine all emergency patients within 

'"42 U.S.C. § 1320c-6(c) (1982). This little known and little used provision was also 
included in the predecessor PSRO legislation. It applies to Medicare, and to Medicaid as 
well where the state elects to use the PRO to perform Medicaid review. 

•'^Consolidated Omnibus Budget Reconciliation Act of 1985, Pub. L. No. 99-272, 
§ 9121, 100 Stat. 82, 164 et. seq. (COBRA, approved Apr. 7, 1986). Almost all hospitals 
participate in one or both of these programs, and many have emergency rooms. See supra 
note 106. 

"The legislation's constitutionality might be challenged on the ground that no le- 
gitimate purpose is served by requirements for non-Medicare persons as well as for Medicare 
beneficiaries. In defense, one could argue that it is unwise, in emergency circumstances, 
to make distinctions among various patients according to their insurance status. 

'"•See supra notes 4 & 5. 

"^Specifically, transfers before stabilization or during active labor may occur only at 
the request of the patient or upon certification of the physician that the medical benefits 
expected from transferring outweigh the risks of effecting the transfer. In addition, transfers 
may be made only to facilities with available space and qualified personnel who have 
agreed to accept the transfer and to provide appropriate medical treatment. 

"^Consolidated Omnibus Budget Reconcilation Act of 1985, Pub. L. No. 99-272, 
§ 9121, 100 Stat. 82. 

"Texas Indigent Health Care and Treatment Act, Tex. Rev. Stat. Ann. art. 4438f 
(Vernon Supp. 1986). See Chershov, Texas Transfer Law Still Spurs Controversy, Hospitals, 
May 5, 1986, at 160. 



1986] CARE FOR MEDICALLY INDIGENT 879 

twenty minutes of their arrival. Patients are to be stabilized before any 
transfer, and the receiving hospitals and physicians must agree to the 
transfer. 

In the absence of applicable statutory enactments, emergency treat- 
ment and transfer is governed mainly by malpractice law. In this con- 
nection, many state courts have held that operating an emergency room 
creates a duty to treat emergency cases regardless of payment. *^^ However, 
not all courts have accepted the emergency room exception to the general 
no-duty rule,'^^ and some have rejected it.^^^ 

c. The Hill-Burton Act as a source of duty to treat. — In the past, 
many hospitals have accepted federal capital grants or loans under the 
Hill-Burton program. ^^^ The terms of these grants obligate hospitals to 
provide a "reasonable volume" of free or below-cost services to persons 
unable to pay for hospital care. Until the 1970's, it was unclear exactly 
how much care hospitals were required to provide (i.e., what was a 
^'reasonable volume") and to whom they were to provide it. In 1970, 
a federal district court found that a private civil action could be implied 
under the Hill-Burton Act because the Act was designed in part to 
benefit directly those persons unable to pay for medical services. ^^^ Upon 
review, the circuit court held that individual hospitals could not be 
expected to supply all the services needed by indigents in their states. ^^^ 

Accordingly, the Secretary of Health, Education, and Welfare (now, 
the Secretary of Health and Human Services) issued clarifying regulations 
on what amount of uncompensated services provided by a hospital would 
constitute comphance with the ''reasonable volume" requirement of the 
Hill-Burton Act. Even with continued litigation in the 1970's and the 
revised regulations,'^"^ the Hill-Burton Act has proven difficult to en- 
force. '^^ Although the regulations and cases tend to interpret the Hill- 



"«See e.g., Hiser v. Randolph, 126 Ariz. 608, 617 P. 2d 774 (Ariz. Ct. App. 1980); 
Wilmington Gen. Hosp. v. Manlove, 54 Del. 15, 174 A. 2d 135 (1961); Mercy Medical 
Center of Oshkosh, Inc. v. Winnebago County, 58 Wis. 2d 260, 206 N.W.2d 198 (1973). 

"^See, e.g., Campbell v. Mincey, 413 F. Supp. 16 (N.D. Miss. 1975) (dictum noting 
that Manlove not universally followed; held, no emergency, so hospital not liable under 
own rules). 

^^^See, e.g., Perth Amboy Gen. Hosp. v. Board of Chosen Freeholders, 158 N.J. 
Super. 556, 386 A. 2d 900 (1978); Fabian v. Matzko, 236 Pa. Super. 267, 344 A.2d 569 
(1975). Compare K. Wing, The Law and the Public's Health 234-45 (2d ed. 1985) 
(hospital duty in emergency not settled law) with A. Southwick, supra note 101, at 185- 
89 ("[m]ost observers" think holding that emergency room creates duty "should now be 
accepted as the rule." Id. at 187). 

'^'42 U.S.C. § 291(c)(e) (1982) (The Hospital Survey and Construction Act of 1946). 

'^^Cook V. Ochsner Found. Hospital, 319 F. Supp. 603 (E.D. La. 1970), aff'd, 559 
F.2d 968 (5th Cir. 1977). 

'^'Cook, 559 F.2d at 971. 

'^42 C.F.R. § 124.503 (1979). 

'^^C/. Blumstein, Court Action, Agency Reaction: The Hill-Burton Act as a Case 
Study, 69 Iowa L.Rev. 1227 (1984); Wing, The Community Service Obligation of Hill- 
Burton Health Facilities, 23 B.C.L. Rev. 577 (1982). 



880 INDIANA LAW REVIEW [Vol. 19:857 

Burton Act as creating entitlements for specific classes of patients/^^ no 

individual patient has a claim to free services. '^^ Furthermore, even though 

the regulations define persons "unable to pay," each hospital may develop 

its own plans for distributing charity care.^^^ 

Some $571 million of free care met Hill-Burton obligations in 1984,^^^ 

a figure well below the uncompensated care burden^ ^° and dwarfed by 

apparent need. Even this amount of charity care is likely to diminish 

in the future because Hill-Burton "free care" obligations normally last 

for twenty years and the grant program was virtually eliminated in 
1974.131 

C Obligations of States and Localities 

All states and a great many political subdivisions (counties, towns, 
or cities) voluntarily provide or finance a variety of health services. The 
largest program by far is the federal-state Medicaid program. Participating 
states, by federal requirement, must cover certain categorically eligible 
poor people and must provide certain mandatory benefits. Additional 
coverage may be added at a state's option within the limits of federal 
financial participation. ^^^ Medicaid's contribution to preventing medical 
indigency is well known. Medicaid programs have by and large ceased 
to expand to cover many additional people. ^^^ Consequently, this Article 
does not further describe Medicaid at this point. 

All levels of government provide many specialized health services 
for the general population and general services for specialized populations. 
Classic examples are treatment or immunizations for communicable dis- 
eases and care for handicapped children. ^^^^ Poor people often receive 



'^Blumstein, supra note 125. 

'^^Newsom v. Vanderbilt Univ., 653 F.2d 1100, 1121 (6th Cir. 1981). 

'2«42 C.F.R. § 124.507 (1979). 

'^^State and Local Government Responsibilities, supra note 93, at 35. 

'3°Sloan, Valvona & Mullner, supra note 31, at 19 ($1.7 billion of hospital-denominated 
charity care is included in the $6.2 biUion of uncompensated care). 

'^'U.S. Off. OF Mgmt. & Budget, The Budget of the United States Government, 
Fiscal Year 1975, Appendix 415 (1974). 

^^^See generally R. Bovbjerg & J. Holahan, supra note 18. 

'"5ee generally J. Holahan & J. Cohen, supra note 18. An exception is limited 
expansions targeted at needy children and young mothers, including expectant mothers, 
authorized by 1986 federal legislation. See infra note 224. 

'^^See generally F. Grad, Public Health Law Manual (1973); Role of State and 
Local Governments in Relation to Personal Health Services (S. Jain ed. 1981) [here- 
inafter Role of State and Local Governments] (reprinted from 71 Am. J. Pub. Health 
1 (Supp. Jan. 1981)). State and Local Government Responsibilities, supra note 93, cites 
statutory authority for many of these programs. The Association of State and Territorial 
Health Officials (ASTHO), through its Public Health Foundation, publishes several annual 
compilations of data on public health activities reported by 57 state health agencies and 
estimated for some 3,000 local health departments. See, e.g.. Public Health Foundation, 
1984 Public Health Chartbook (1986). 



1986] CARE FOR MEDICALLY INDIGENT 881 

particular emphasis in such programs, but they are not the focus. More- 
over, this type of pubhc health activity tends to be quite restricted, both 
in the scope of the care provided and in the level of financing made 
available. ^^^ Consequently, this Article also skips over programs such as 
these to consider in depth only direct efforts to curb medical indigency. 

1. Sources of State Power to Provide Indigent Health Care.^^^ — All 
but three states either authorize or require state or county governments 
to provide for * 'relief and support" of the poor.'^^ Many of these laws 
date from 19th century *'poor laws."^^^ The older statutes do not always 
expressly mention medical care, but several have been interpreted to 
cover at least some level of medical services. '^^ State authority to provide 
or finance health care is derived from the general police power. ^"^^ Counties 
(or other substate jurisdictions) have such power by virtue of delegation 
from their states. ^"^^ 

2. Types of Local Indigent Health Programs. — Existing indigent 
care programs can be divided into four different types: The first is the 
public hospital model, most typically run by counties or cities, sometimes 
with state aid. States using this approach operate hospitals themselves 
or authorize counties to do so. These public hospitals are generally 
required to serve the poor free or at a discount. ^"^^ In 1984, there were 

'"In fiscal year 1984, for example, state and local public health spending totaled 
some $6.5 billion. Public Health Foundation, supra note 134, Fig. 1. A few state health 
agencies administer Medicaid in their states, but the latter expenditures are not included. 
By way of comparison, federal-state expenditures for Medicaid in 1984 totalled $34.5 
billion (provider payments only). J. Holahan & J. Cohen, supra note 18, at 9. 

'^*The following discussion owes much to three legal and programmatic compilations 
of information on assistance for the medically indigent. Butler, Legal Obligations of State 
and Local Government for Indigent Health Care, in Academy for State and Local 
Government, Access to Care for the Medically Indigent: A Resource Document 
FOR State and Local Officlals 13-44 (R. Curtis & S. White eds. 1985) [hereinafter Aca- 
demy] provides the most readable review. State and Local Government Responsibilities, 
supra note 93, thoroughly documents existing programs from the perspective of legal enforce- 
ment; it gives numerous state-by-state listings, extracts and commentaries. Inter- 
governmental Health Policy Project, George Washington Univ., State Programs of 
Assistance for the Medically Indigent (1985) [hereinafter IHPP] also gives state-by-state 
profiles from the program point of view, as well as some fiscal data. This Article would 
not have been possible without the kind of background provided by such data sources. 

'"Kentucky, North Carolina, and Tennessee have no unit of government legally 
responsible for indigent health care. Butler, supra note 136 at 17, Table I. 

•38New Hampshire's General Assistance program, for example, originated from English 
Poor Laws. Baker-Chaput v. Cammett, 406 F. Supp. 1134, 1137 (D.N.H. 1976). See also 
R. Stevens & R. Stevens, Welfare Medicine in America (1974). 

''^E.g., Jerauld County v. St. Paul-Mercury Indem. Co., 76 S.D. 1, 71 N.W.2d 571 
(1955); see, e.g., Butler, supra note 136, at 16. 

'""Jacobson v. Massachusetts, 197 U.S. 11 (1905); Industrial Comm'n v. Navajo 
County, 64 Ariz. 172, 167 P.2d 113 (1946); Jerauld County, 76 S.D. 1, 71 N.W.2d 571. 

^*^Jacobson 197 U.S. 11; F. Grad, supra note 134. 

'"^States that have used this method include Arkansas, Colorado, Florida, Iowa, 
Maine, Michigan, Missouri, Nevada, North Carolina, South Carolina, West Virginia, and 
Wisconsin. Butler, supra note 136, at 19 n. 25. 



882 INDIANA LAW REVIEW [Vol. 19:857 

some 1,622 state and local government hospitals, of a national total of 
5,759 community hospitals. ^"^^ These hospitals are important not merely 
for inpatient care but also for outpatient care in emergency rooms and 
outpatient clinics, especially in the nation's large urban areas. 

A second approach is for government to contract for indigent care 
with specific private providers, mainly hospitals and community health 
centers but occasionally individual practitioners as well. Several levels 
of government may share financing. '"^ Contracting is common for pubUc 
health and mental health services and is sometimes used for general 
health care to the indigent. ^"^^ States that have used this approach include 
Colorado, Delaware, Florida, Idaho, and Indiana. 

The third and fourth methods are both more insurance-style medical 
programs, under which eligible indigent enrollees can get specified services 
from many providers, not merely one or a few contracting providers. 
Model number three is a rather limited "vendor-payment" program 
under which eligibles do not enroll in advance. Medical providers bill 
the county or state for care to the indigent and are reimbursed at some 
rate on a case-by-case basis. '"'^ The benefits available and the indigency 
standards for such programs vary greatly from place to place. Often, 
only hospital care is covered. 

Model four is the more familiar style of insurance program that 
resembles Medicaid or private insurance: Once eHgible persons enroll, 
they may seek any covered service (typically well beyond hospital care) 
from any participating provider. A few states provide full Medicaid 
benefits to the medically indigent, wholly at their own expense, without 
federal matching support. ^"^"^ More commonly, these insurance-style pro- 
grams for indigent care are far more restricted than Medicaid, both in 



'"♦^Am. Hosp. Ass'n, Hospital Statistics 7, Table 1 (1985) (data from 1984 survey). 
An additional 700-odd institutions were federal or long-term hospitals. Although state and 
local hospitals thus constituted 28% of the total, they contributed a smaller share of total 
hospital beds, some 2097o in 1984. On public hospitals' contributions to indigent care, see 
e.g., Dallek, The Continuing Plight of Public Hospitals, 16 Clearinghouse Rev. 97 (1982); 
Feder, Hadley & Mulliner, Poor People and Poor Hospitals, 9 J. Health Pol. Pol'y & 
L. 237 (1984). 

"^Community health centers often receive a mix of federal block grant, state, and 
local funding to supplement earnings from charges to patients and their insurers, if any. 
See, e.g., G. Peterson, supra note 63; R. Price, Health Block Grants (1981). 

'"'On pubhc health contracting, see, e.g., Jain, supra note 134. Iowa contracts with 
the University of Iowa Hospitals and Clinics to provide non-Medicaid indigent health care 
statewide. IHPP, supra note 136, at 139. For a list of citations to states using this 
approach, see Butler, supra note 136, at 20 nn. 28-30. 

^'^^See Butler, supra note 136, at 28-30; State and Local Government Responsi- 
bilities, supra note 93. 

"•^Maryland's indigent care program is its Medicaid program, for example. IHPP, 
supra note 136, at 157. 



1986] CARE FOR MEDICALLY INDIGENT 883 

benefits and in provider payment levels. ^"^^ Eligibility for these indigency 
programs may be tied to receipt of state "general assistance*' (welfare), 
just as Medicaid categorical eligibility is based on welfare (Aid to Families 
with Dependent Children or Supplemental Security Income Assistance). 
This subtype of insurance program is often called a "GA-medical" 
program.''*^ Administrative and funding responsibilities for these insur- 
ance-style programs are often shared among state and local authorities. '^^ 

This brief discussion illustrates how widely the method of providing 
indigent care and coverage varies nationwide. In addition, the states 
differ in the amount of discretion they give to the financing or admin- 
istrative agency. Some programs provide little administrative structure 
and few operational guidelines, whereas others are quite detailed and 
specific, and their diversity is enormous. '^^ 

From the point of view of the otherwise uninsured medically indigent, 
what matters about these state and local efforts is how much access to 
care they provide. The medical access that a program achieves depends 
on its legal requirements, the funding provided, and the administrative 
discretion given to allow funding to be matched to indigents' require- 
ments. The administrator's discretion may be guided only by general 
statutory principles; or specific statutory or administrative provisions 
may govern eligibility, benefits, and level of provider payments. 

3. Nature of State-Local Duty. — Although almost all states have 
statutes permitting publicly provided indigent health coverage or care,'^^ 
few seem to mandate such aid. It has been argued that two states' 
constitutions require those states to provide for the poor, while three 
others require counties and hospital districts to do so.^" But even these 
apparent constitutional mandates are open to interpretation about the 
nature of duty created. ^^'^ In addition to constitutional provisions, some 
state statutes purport to impose duties on the state, ^^^ but these apparent 
"mandates" seem binding only so long as the state voluntarily accepts 
that duty. The state remains free to repeal a statute, even if by its terms 
it does not seem to allow administrative or budgetary cutbacks. Thus, 



'"^/c?. passim. 

^'^^Id. at 26 (also called general relief, home relief, or poor relief). 

'^"Butler, supra note 136, at 19. 

'^'IHPP, supra note 136, at 67-292; see also State and Local Government Re- 
sponsibilities, supra note 93. 

•"See, e.g., La. Rev. Stat. Ann. § 40:2017 (West 1977) (state department of health 
"may" provide for indigent care in private hospitals). 

'"Butler, supra note 136, at 16 nn.8, 9 (citing Ala. Const, art. IV, § 88, Kan. 
Const, art. 7, § 4, Mont. Const, art. XII, § 3(3), N.Y. Const, art. VIII, § 1 (states); 
Tex. Const, art. 9, §§ 4,5,9. (counties or districts)). 

''■*See, e.g., Mont. Const, art. XII, § 3 (state must estabhsh institutions but only 
such as the public interest may require). 

'"See, e.g., Del. Code Ann. tit. 31, § 505(6) (1985) (general assistance program). 



884 INDIANA LAW REVIEW [Vol. 19:857 

it seems fair to conclude that there is no fundamental state right to 
health care; some courts have so held.^^^ 

On the other hand, state statutory mandates on lesser jurisdictions 
can be truly binding.'" Some state courts have interpreted even ostensibly 
permissive statutes to mandate local government to fund care for the 
indigent. The Arizona Supreme Court, for example, read two statutes 
authorizing counties to care for the sick as imposing a duty to provide 
medical care for the indigent sick.'^^ The obligation to provide some 
variety of indigent medical care may even appear in a city charter'^^ 
and may apply even though an area is otherwise granted "home rule."'^° 
In some thirty-seven states, counties or towns are to some degree re- 
sponsible for indigent care (often shared among levels of government); 
in four other states, counties are responsible for care only if they operate 
county hospitals.'^' 

Public hospitals are generally required to serve the poor at a discount 
or at no charge. An interesting issue arises where administration of the 
public hospital is contracted out to a private firm (as increasingly occurs 
for cost containment reasons) or where the entire hospital is sold to 
private interests. Of course, the private administrators or new owners 
may be obligated by contract to provide some level of indigent care. 
North Carolina has gone even further, enacting a provision requiring 
both purchasers and lessees of public hospitals to continue indigent 
care.'^^ In any event, enforcement of any such obligation may pose a 
problem.'" 

4. Extent of State-Local Duty. — Exactly what limits exist or may 
be set on any public duty or undertaking to provide or finance care is 
not settled by current case law.'^"* If a provision is not mandatory, the 
government can revoke it by ceasing to provide or to finance care. 



^^^See, e.g., Mary Lanning Memorial Hosp. v. Clay County, 170 Neb. 61, 101 N.W.2d 
510 (1960). 

'''See. e.g., Ind. Code §§ 12-2-1-1 through -39 (1982 & Supp. 1986) ("Township trustee 
must promptly provide medical and surgical attendance for all the poor . . , not ... in 
public institutions."). 

'=«Industrial Comm'n v. Navajo County, 64 Ariz. 172, 167 P. 2d 113 (1946); see also 
Memorial Hosp. v. Maricopa County, 415 U.S. 250, 252 (1974) (notes "mandatory" duty 
of counties). 

^'^See, e.g., F. Grad, supra note 134. 

'"^See, e.g., Ill Ann. Stat. ch. 34, para. 5011-5029 (Supp. 1986) (Cook County is 
obligated to finance care for poor). 

'^'Calculated from Butler, supra note 136, at 17, Table I. See also State and Local 
Government Responsibilities, supra note 93. 

'"N.C. Gen. Stat. § 131E-13 (Supp. 1985). 

'"Andrulis, Survival Strategies for Public Hospitals, Bus. & Health, June 1986, at 
31, 34. 

'^^Interestingly, most cases are brought not by the poor themselves but by hospitals 
that have provided care to indigents and are requesting compensation for that care. 



1986] CARE FOR MEDICALLY INDIGENT 885 

Courts generally will not obligate a government to undertake a function 
that is permissive rather than mandatory. '^^ 

Occasionally, a state or county may operate an indigent health care 
program simply by appropriating funds without a statutory mandate or 
even express statutory authority. When such appropriated funds are 
exhausted, the state or local agency would seem to have no lingering 
obHgation to continue covering care for the indigent. '^^ 

Where specific statutory language governs indigent care, budgetary 
discretion may be more circumscribed. Programs vary widely in the 
discretion granted to control the scope of support through ehgibility, 
benefits, and payment provisions. For example, Iowa gives its county 
boards of social services broad control over the form and amount of 
support. ^^^ CaUfornia also gives broad discretion to its county supervisors 
to determine eligibility for, amount of, and conditions attached to indigent 
rehef.'^^ However, a county's exercise of discretion must remain consistent 
with the language and purpose of California's General Assistance statutes. '^^ 
Other states have given local authorities much less discretion. For ex- 
ample, Michigan's GA-medical program sets very precise standards and 
fixes the local share of resultant spending. '^° Even when counties are 
given broad administrative discretion, state courts have held that county 
regulations must bear a reasonable relationship to the intended purpose 
of the state statute. 

A county's obligation to deliver indigent health care does not nec- 
essarily change if the state establishes an additional program, such as 
Medicaid. '^^ Similarly, establishing a public medical facility within the 
county does not necessarily relieve the county's responsibility for indigent 
care rendered elsewhere. The Nevada Supreme Court, for example, held 
a county responsible for emergency care rendered at a private hospital 
even though the county operated its own facility. ^^^ In contrast, California 
courts have held that counties were responsible only for care given at 



'"See, e.g., Perth Amboy Gen. Hosp. v. Board of Chosen Freeholders, 158 N.J. 
Super. 556, 386 A. 2d 900 (1978) (statute which authorized counties to make payments to 
hospitals providing care to indigents did not require counties to do so). 

^^See generally Butler, supra note 136, at 18. 

'^^Collins V. Hoke, 705 F.2d 959 (8th Cir. 1983). 

'^«City & County of San Francisco v. Superior Court, 57 Cal. App. 3d 44, 47, 128 
Cal. Rptr. 712, 714 (1976). 

'*'Bay Gen. Community Hosp. v. County of San Diego, 156 Cal. App. 3d 944, 203 
Cal. Rptr. 184 (1984); Patten v. San Diego County, 106 Cal. App. 2d 467, 235 P.2d 217 
(1951). 

''"Mich. Comp. Laws Ann. § 400.66a (West 1976); see IHPP, supra note 136, at 
171-74. 

'^'Madera Community Hosp. v. County of Madera, 155 Cal. App. 3d 136, 201 Cal. 
Rptr. 768 (1984); Hall v. County of Hillsborough, 122 N.H. 448, 445 A.2d 1125 (1982). 

'^^Washoe County v. Wittenberg, 100 Nev. 143, 676 P.2d 808 (1984). 



886 INDIANA LAW REVIEW [Vol. 19:857 

a county facility or by a provider already under contract with the 
county.'"'^ 

5. Funding Limitations and Obligations. — The state of Washington 
statutorily limits public obligations to the appropriated amounts/^"^ whereas 
Ohio positively obligates the county to appropriate needed funds. ^^^ Some 
states have given counties specific authority to levy taxes in order to 
care for the indigent. Idaho, for example, allows counties to levy an 
ad valorem tax on property. '^^ Nevada allows indigent health spending 
to raise county property taxes above an otherwise binding ceiling per- 
centage on assessments. ^^^ A public hospital or cHnic or a private con- 
tractor may simply reach the limit of its resources and then shut down 
certain services or turn away certain people (or postpone serving them). 
Presumably, in so doing, it would use accepted principles of medical 
triage, serving the medically neediest first. Whether a disappointed patient 
or the provider can then sue the responsible jurisdiction(s) for more 
than the budgeted funds is not clear. ^^^ Presumably, a great deal would 
turn on the precise statutory wording of the institution's duty and the 
extent of discretion authorized. 

6. Specific Terms of Assistance. — Any program of medical assist- 
ance requires some operating definitions as to (a) eligible recipients, (b) 
benefits available (including which providers and what services are cov- 
ered), and (c) payment levels. As for other aspects of program admin- 
istration, local administrators generally are given broad discretion, although 
courts have sometimes hmited the exercise of this discretion. '"^^ For 
example, a New Jersey court held that a municipality must conform to 
statewide rules and regulations of public assistance. *^^ In a case from 



'''Bay Gen. Community Hosp., 156 Cal. App. 3d 944, 203 Cal. Rptr. 184; Union 
of Am. Physicians & Dentists v. County of Santa Clara, 149 Cal. App. 3d 45, 196 Cal. 
Rptr. 602 (1983). 

'^^Wash. Rev. Code Ann. § 74.09.035 (Supp. 1987); see also Ga. Code Ann. § 31- 
8-36(b) (1985). 

'"St. Thomas Hosp. v. Schmidt, 62 Ohio St. 2d 439, 406 N.E.2d 819 (1980); Ohio 
Rev. Code Ann. § 5101.161 (Anderson Supp. 1985). 

'^^IDAHO Code § 31-3503 (1983); see also Idaho Falls Consol. Hosp. Inc. v. Bingham 
County Bd. of County Comm'rs, 102 Idaho 838, 642 P.2d 553 (Idaho 1982). 

'^^Nev. Rev. Stat. § 428.050 (1985). 

''«Some courts have held that counties may not be liable for indigent health care 
beyond their budgets. See, e.g.. Board of Directors of Memorial Gen. Hosp. v. County 
Indigent Hosp. Claims Bd., 77 N.M. 475, 423 P.2d 994 (N.M. 1967); Board of Comm'rs 
V. Ming, 195 Okla. 234, 156 P.2d 820 (1945); Cache Valley Gen. Hosp. v. Cache County, 
92 Utah 279, 67 P. 2d 639 (1937). Other courts have held that obligations must be met 
even if they exceed the county's budget hmitations. City & County of San Francisco v. 
Superior Court, 57 Cal. App. 3d 44, 128 Cal. Rptr. 712 (1976); Hall v. County of 
Hillsborough, 122 N.H. 448, 445 A.2d 1125 (1982). 

""^See supra text accompanying notes 167-70. 

•«°Ricker v. Lawson, 155 N.J. Super. 536, 382 A.2d 1183 (1977). 



1986] CARE FOR MEDICALLY INDIGENT 887 

New Hampshire, a United States district court held that a town must 
administer its assistance program pursuant to written, objective, and 
ascertainable standards. ^^^ 

To determine eligibility, administrators of indigent health care must 
define "indigent." The majority of states do not provide a definition 
within the statute itself, although some statutes include a very general 
definition. For example. New Hampshire defines those who are entitled 
to free health care as those who are "poor" and unable to support 
themselves. ^^^ Idaho defines the medically indigent as "persons needing 
hospital care without income or resources sufficient to pay for necessary 
medical care."'^^ Some states have included within their statutes more 
precise definitions of "indigent." Arizona, for example, estabUshes spe- 
cific income and resource standards. '^"^ Oklahoma defines an indigent as 
a person with income under the federal poverty level, with resources 
insufficient for self care, and with a need for hospital care.'^^ 

Where statutes have provided no definition of indigency or only a 
general definition, state courts have often played an active role in 
interpreting the statute. The Supreme Court of Montana, for example, 
held that the counties must have flexible eligibility standards that take 
into consideration not only income but also family debts and outstanding 
medical bills. ^^^ 

In defining indigency, most state statutes contain residency or cit- 
izenship requirements. However, in 1974, the United States Supreme 
Court held that an Arizona statute requiring a year's residence in a 
county as a condition of indigent care was unconstitutional under the 
equal protection clause. '^^ Since this ruHng, several state courts have 
invalidated other similar durational residency requirements. More recent 
statutes simply require the indigent to be domiciled in the state with an 
intent to reside there. '^^ This type of residency requirement would seem 
to answer the equal protection concerns stated by the Supreme Court. '^^ 



'^■Baker-Chaput v. Cammet, 406 F. Supp. 1134 (D.N.H. 1976). 

'«2N.H. Rev. Stat. Ann. § 165:1 (Supp. 1986). 

'^^IDAHO Code § 31-3503 (1983). 

'«^Ariz. Rev. Stat. Ann. § 36-2905 (Supp. 1986). 

•«'Okla. Stat. Ann. tit. 56, § 58 (West Supp. 1987). 

'«^Saint Patrick Hosp. v. Powell County, 156 Mont. 153, 477 P. 2d 340 (1970); see 
also Hall v. County of HUlsborough, 122 N.H. 448, 445 A.2d 1125 (1982); Sioux Valley 
Hosp. Ass'n V. Davison County, 319 N.V^.2d 490 (S.D. 1982). 

'^^Memorial Hosp. v. Maricopa County, 415 U.S. 250 (1974). 

'^^See, e.g., Mont. Code Ann. § 53-3-315 (1985). 

'^^In 1982, the United States Supreme Court held unconstitutional a Texas statute 
which prohibited illegal aliens from enrolling in public schools. Plyler v. Doe, 457 U.S. 
202 (1982). This case would seem to indicate that states could not deny indigent health 
care to undocumented aliens. However, language in the opinion can be interpreted as 
limiting the holding to educational rights of minor children. 



888 INDIANA LA W REVIEW [Vol. 19:857 

States have differed in their treatment of undocumented aliens. The New 
Mexico Supreme Court held undocumented aliens were "residents" for 
purposes of the indigent care statute. '^° However, a California court 
recently held that counties were not required to reimburse private hospitals 
for care of undocumented aliens because the statute required indigents 
to be "lawful" residents. ^^^ 

Most state statutes do not specify which providers or what services 
are covered under their indigent health care laws.^^^ Thus, the counties 
often have considerable discretion in determining the type of care covered 
and who may be paid as providers. Although state courts generally have 
upheld this broad discretion, California courts have held that a county 
has no obligation to pay for indigent care delivered at a facility other 
than its own or one with which it has contracted. ^^^ In contrast, the 
Idaho Supreme Court required an Idaho county to pay a hospital that 
was neither under contract nor even within the state. ^^"^ (The case involved 
an Idaho resident's going to nearby Salt Lake City, a logical and common 
pattern; query whether more distant hospitals would be paid.) Even those 
states that require a contractual relationship with the provider often 
allow recovery by noncontractors in emergency situations. ^^^ 

The particular services covered by indigent health care programs also 
vary widely from state to state. '^^ Most state indigent statutes cover at 
least emergency care. Some states cover a broader range of health care 
needs. Arizona, for example, provides for hospitalization and medical 
care, including long-term care and home health services. ^^^ 

Judicial interpretations of coverage provisions have been important. 
The Indiana courts, for example, have construed an Indiana provision 
that covers indigents suffering from a "disease, defect, or deformity" 
to exclude normal pregnancy. '^^ In a later case interpreting the same 



'^Perez v. Health & Social Servs., 91 N.M. 334, 573 P.2d 689 (1977). 

'^'Bay Gen. Community Hosp. v. County of San Diego, 156 Cal. App. 3d 944, 203 
Cal. Rptr. 184 (1984). 

'^^See, e.g., Cal. Welf. & Inst. Code § 17000 (West 1980); Cal. Gov't Code 
§ 29606 (West 1968). California's statute directs counties to "relieve and support" the 
incompetent, poor and indigent, and "necessary expenses" incurred in this support are 
charged to the county. See also Neb. Rev. Stat. § 68-104 (1984). Nebraska's statute 
directs counties to provide "medical and hospital care" to "the poor". 

'""'E.g., Bay Gen. Community Hosp. 156 Cal. App. 3d 944, 203 Cal Rptr. 184. 

'^"University of Utah Hosp. & Medical Center v. Bethke, 101 Idaho 245, 611 P. 2d 
1030 (1980). 

'^^County Dep't of Public Welfare v. Trustees of Indiana Univ., 145 Ind. App. 392, 
251 N.E.2d 456 (1969); Washoe County v. Wittenberg, 100 Nev. 143, 676 P.2d 808 (1984). 

'^See generally IHPP, supra note 136, at 67-292 (state-by-state profiles). 

"^Ariz. Rev. Stat. Ann. § 11-291 (Supp. 1986). 

'9»Lutheran Hosp. of Fort Wayne, Inc. v. Department of Public Welfare, 397 N.E.2d 
638 (Ind. Ct. App. 1979) (construing Ind. Code § 12-5-1-1 (1982)). 



1986] CARE FOR MEDICALLY INDIGENT 889 

Statute, an Indiana court held that a county may not restrict the number 
of inpatient days.^^^ 

Few indigent care programs set the type of particularized limits or 
conditions on services that have become common in conventional private 
group health insurance and in Medicaid, such as pre-admission screening 
for nonemergency hospital admissions. ^^ Indigent programs that are 
integrated with Medicaid present an exception. ^^^ Thus, the validity of 
controls of this kind seems not to have been litigated. 

Program specifications, or the lack thereof, also govern payment 
levels, an important indirect influence on access to care. Medicaid- 
integrated programs generally pay Medicaid rates, and contractual prov- 
iders receive the contracted-for amounts. Many older-style indigent ven- 
dor-payment programs, however, pay hospitals flat, per-day amounts. ^°^ 
Two older state statutes oddly prohibit price setting through bids^^^ — 
quite contrary to recent innovations in practice, notably in Arizona and 
California. ^^"^ One early Nebraska case disqualified counties' prepayment 
for services as * 'insurance, "^°^ but this holding seems obsolete in light 
of recent trends toward prepayment in Medicare and Medicaid. 

Most states or counties have established varied procedural require- 
ments that providers or patients must follow to receive payment for 
indigent health care. Many states require prior governmental approval 
or a contractual agreement before a provider renders care to an indigent. 
However, this requirement may be waived in emergency situations. ^°^ 



'^Welborn Memorial Baptist Hosp., Inc. v. County Dep't of Public Welfare, 442 
N,E.2d 372 (Ind. Ct. App. 1982). 

^^See, e.g., J. Califano, supra note 22; P. Fox, W. Goldbeck & J. Spies, supra 
note 22; J. Holahan & J. Cohen, supra note 18. 

^"'Maryland, for example, simply includes indigents not eligible for federal Medicaid 
assistance within the same state-federal Medicaid program, but wholly at state expense. 
See IHPP, supra note 136, at 157-59. 

^^See, e.g., Massachusetts Gen. Hosp. v. Cambridge, 347 Mass. 519, 198 N.E.2d 
889 (1964) (hospital rate for voluntarily treated indigents is purely statutory and can be 
below actual incurred expenses); Del. Code Ann. tit. 29, § 7204 (1983); see also Springfield 
Hosp. V. Comm'r of Public Welfare, 350 Mass. 704, 216 N.E.2d 440 (1966) (hospital rate 
for old age assistance patient below actual cost is valid; hospitals are "greatly affected with 
the public interest" and have a "civic obligation" to serve patients), 

^^CoNN. Gen. Stat. Ann. § 17-274 (West Supp. 1986); Utah Code Ann. § 17-5- 
55 (Supp. 1986). 

^See, e.g., J. Christianson & D. Hillman, Health Care for the Indigent and 
Competitive Contracts: The Arizona Experience (1986); L. Johns, R. Serzan & M. 
Anderson, Selective Contracting for Health Services in Californla, Final Report 
(1985). 

^^Hustead v. Richardson County, 104 Neb. 27, 175 N.W. 648 (1949) (counties not 
authorized to engage in business of insurance). 

2o*University of Utah Hosp. & Medical Center v. Bethke, 101 Idaho 245, 611 P.2d 
1030 (1980). 



890 INDIANA LAW REVIEW [Vol. 19:857 

D. Obligations of Private Health Insurers 

Would-be insureds have no general legal right to private health 
coverage, and there is little tradition of providing free or below-cost 
insurance as there has long been for providing hospital care. Insurance 
is a private contract, only partially regulated, available to those who 
can afford it and not to others. Several quahfications to this "no rights" 
generalization deserve mention. 

First, if workers or their dependents are covered through a workplace 
group and they cease to be group members, because of layoff or wid- 
owhood, for example, they are entitled to continue on the group policy 
at their own expense for a certain period. ^^"^ 

Second, in most states, Blue Cross/Blue Shield plans in theory must 
allow open enrollment in their nongroup plans. ^^^ This is one regulatory 
stricture that can be seen as a pubUc quid pro quo for granting the 
Blues tax exemption. Moreover, such nongroup Blues rates may be kept 
low by direct or indirect subsidy from the Blues' group business if their 
group market share is strong enough to permit this;^°' they also often use 
a version of "community rating" principles. Community rating charges 
all insureds in a large pool the same price (based on the pool's average 
cost), rather than basing rates on the specific experience of subgroups. 
PooHng experience arguably helps the poorest and sickest, whose ex- 
perience is the worst, at the expense of lower-risk insureds. ^^° 

Finally, ten states now guarantee otherwise uninsurable people the 
right to conventional insurance at a subsidized rate.^'^ Coverage is rea- 

^°^This "continuation" privilege (or the ability to "convert" to a relatively generous 
individual policy) arose first through industry custom, then through state and federal law. 
On custom, see Health Ins. Ass'n of Am., Group Health Insurance 1-17 (1976); for 
state rules as of Spring 1985, see IHPP, supra note 136, at 294-95; for new federal rules 
from COBRA legislation, extending the right to coverage to a period up to three years 
in some cases, see Bovbjerg, supra note 24, at 405-06 nn. 12 & 13. 

"^^See, e.g., Ind. Code § 27-8-11-3 (Supp. 1986). It is thought that in recent years, 
the Blues' commitment to open enrollment has waned under competitive pressure. Cf. 
U.S. Gen. Acct. Off., Pub. No. HRD-86-110, Health Insurance: Comparing Blue Cross 
AND Blue Shield Plans with Commercla.l Insurers (July 1986) (Blues' differences from 

commercials described as minor). 

^"'In Massachusetts, for example, by order of the Insurance Commissioner, one percent 

of group premiums helps defray nongroup expenses. Indirect subsidies may be achieved 

by regulatory accounting rules that attribute the same administrative loading factor to 

group coverage as to nongroup, when in fact group practice could normally be expected 

to achieve economies of scale in sales and operations. Cf. Bovbjerg, supra note 24, at 

409. 

2'°Under competition from more experience-rated policies, largely in the group market, 
community rating pools tend to fragment, as low-risk groups insure on their own rather 
than remain in the community pool. For a description of how such competition ended 
early community rating in the group market, see P. Starr, The Soclal Transformation 
OF American Medicine 329-31 (1982). 

^"In one of the ten, Connecticut, the pool is not restricted to persons rejected by 
conventional insurers. See Bovbjerg & Koller, State Health Insurance Pools: Current 



1986] CARE FOR MEDICALLY INDIGENT 891 

sonably generous by non-group standards, but enrollments are very low, 
even as a fraction of the tiny percentage of uninsurables.^^^ Even with 
considerable subsidy, policies cost 150% or more of the price of standard 
coverage. 

These various insurance rules all help would-be insureds, but do 
require them to pay for their own coverage, albeit at relatively favorable 
rates. Thus, they probably do not reach many or most of the medically 
indigent, who are relatively poor or unemployed or both. They may, 
however, help prevent medical indigency among the nonpoor caused by 
large medical bills that exceed ability to pay. 

One common type of state insurance regulation tends to make in- 
surance relatively less affordable, namely * 'mandatory benefits" rules 
that require all health insurance policies to cover certain services, notably 
mental health care. Mandated benefits "upgrade" insurance protection 
for those who can afford it, but disproportionately burden poorer insureds 
and their employers and tend to make it more difficult for those less 
able to pay to buy any coverage at all.^'^ 

IV. Private and Public Approaches Toward Improvement 

A. Introduction: Where We Stand 

The problems of the uninsured and of the uncompensated care they 
generate are increasing. Legally, there is tenuous support for a right to 
care or coverage in the constitutional or statutory sense, as just noted. 
Most of the obligations are conditional: that is, if a provider, an insurer, 
or the government assumes to provide care or coverage for someone, 
then it must provide care or coverage of a certain standard. In any 
event, this branch of the law appears to be poorly developed in terms 
of the jurisprudence of rights. Indeed, for the most part, cases on 
indigent coverage do not even cite one another. As a result, the body 
of case law provides little guidance. 



Performance, Future Prospects, 23 Inquiry HI (1986) (experience of six pools operating 
before 1984). The states are Connecticut, Florida, Indiana, Iowa, Minnesota, Montana, 
Nebraska, Ohio, Rhode Island, Tennessee, and Wisconsin. As of late 1986, ten states 
now have risk pool legislation, according to the National Governors' Association. G. 
Claxton, Concept Paper: Facilitating Health Care Coverage for the Working 
Uninsured 14 (Nat'l Governor's Ass'n, Pre-Conference Draft, Dec. 1986). 

^'^Bovbjerg & Koller, supra note 211. About one percent of the population is thought 
to be uninsurable. Id. See also supra note 26 and accompanying text. 

^^^See Demkovich, supra note 50. Such rules disproportionately burden small group 
and nongroup coverage because large workplace groups very often "self-insure" precisely 
so as to escape such state insurance mandates and achieve other economies. See Bovbjerg, 
supra note 24, at 408. Over half of large employment groups are now thought to self- 
insure. See infra note 273. 



892 INDIANA LAW REVIEW [Vol. 19:857 

Any effective solution will require at least some government in- 
volvement, although the nature of that involvement may vary considerably 
according to circumstances. Past political responses to the problems of 
the poor have varied enormously, and there is considerable disagreement 
about the approach that should be taken. 

B. Private Sector Approaches 

"Leave it to the private sector" is the understandable response of 
many people to medical indigency. After all, most of the progress in 
past generations was due to the astonishing success of private group 
health coverage. It is largely responsible for bringing health coverage to 
approximately ninety percent of American workers and their depend- 
ents. ^'"^ Moreover, "mainstream" employment group coverage prepays 
for most typical medical and dental services from almost any licensed 
provider at little out-of-pocket cost to the insured — thus guaranteeing 
access to care while also protecting against poverty-inducing catastro- 
phe.2^^ 

The spread of workplace group insurance, however, seems to be 
reaching its natural limit. ^'^ Under current economic conditions, it ap- 
pears that a relatively high level of "structural uninsurance" will remain. 
Of course, this level will vary from place to place depending upon 
economic conditions, the employment structure of the economy, existing 
tax incentives, and so on. 

Relying on private efforts to increase insurance can only partly 
address the problem of medical indigency. Private coverage can reach 
only those with the wherewithal to pay for coverage. It thus bypasses 
the indigent, although more coverage would tend to prevent the type 
of medical-financial catastrophe that can cause people to become med- 
ically indigent. 

Most employed people who do not have "proper" coverage and 
who might expect to benefit from private solutions are in small em- 
ployment groups. Of employees in larger groups (100 or more employees), 
nearly 100% have coverage, whereas fewer than half of the people in 
smaller employment groups have health coverage. ^'^ The plain fact is 
that existing forms of coverage sold through existing organizational 
arrangements simply cost more than many of these workers and their 



^'"See, e.g., Moyer & Cahill, supra note 24; see also supra notes 12-15 and accompany- 
ing text. 

^' ^Medicare and Medicaid are similar to private coverage in this regard; they have 
essentially adopted the workplace model of middle class style coverage for their particular 
populations. 

^'*See supra text accompanying notes 46-52. 

^''See, e.g., Moyer & Cahill, supra note 24. The problem is thought to be still worse 
for very small groups, those with twenty, ten, or fewer employees. 



1986] CARE FOR MEDICALLY INDIGENT 893 

employers are willing to pay. For smaller, poorer workplaces and for 
individuals, covering the same medical expenses costs more per capita 
in absolute terms, costs much more as a relative share of earnings, and 
receives considerably less government "subsidy" in forgone taxes. ^^^ 

For large groups, medical experience is more predictable (and hence 
more insurable), and economies of scale make coverage cheaper to sell 
and to administer. Relative costs of sales, administration, claims settle- 
ment, and regulation all rise as group size declines; and many of the 
economizing methods of large groups are not available to smaller ones, 
at least not to the same degree — including, for instance, self-insurance, 
sophisticated protocols for screening and reviewing care, and negotiating 
favorable rates with medical providers. Smaller groups can combine into 
larger ones, but artificially created large groups do not act like naturally 
existing groups. ^^^ Finally, the tax-free status of workplace health benefits 
provides a greater benefit to higher income workers than to poorer ones 
because income taxes are progressive. Those working poor most in need 
of assistance pay no income tax at all but likewise receive no tax benefit 
from buying medical care through workplace coverage, unlike their middle 
class counterparts. 

Some private initiatives offer opportunity for improvement, notably 
in underwriting and pooling smaller groups and in developing attractive 
plans with better cost-containment features. ^^° Attitudes about the im- 
portance of insurance may also change. However, substantial changes 
in the extent of purely private coverage look implausible in the near 
future. Clearly, more fundamental changes will require more government 
involvement, either through direct or indirect subsidies or through some 
form of mandates or coercion. Again, this should not be surprising. 
If the poor and near poor cannot or do not cover themselves voluntarily, 
someone else must pay for their care, at least in part. 

C Public Sector Approaches 

Any model of coverage and care for the medically indigent must 
address four basic questions: who should be eligible; what should be 
the nature of the product or program; how should it be financed; and 
how should it be administered.^^' This Article next examines a number 



^•*On the problems of small versus large groups in insurance markets, see Bovbjerg, 
supra note 24. 

^'^Differences stem mainly from adverse selection, increased sales and administrative 
expenses, and instability over time. See generally id. 

^2'There are many ways to characterize options for indigent coverage and care, and 
each author tends to develop his own. These four issues cover the fundamental choices. 
For somewhat different categorizations, see, e.g., IHPP, supra note 136; State and Local 
Government Responsibilities, supra note 93; Bartlett, Overviev/ of Public Policy Options 



894 INDIANA LAW REVIEW [Vol. 19:857 

of models and the different ways they attempt to answer these questions. 

1. Eligibility for Assistance. — The uncertain nature of medical in- 
digency makes it difficult to determine who should be eligible. One 
problem is the difficulty of deciding what constitutes "need." Taxpayers 
and the political systems that represent them are unwilling to finance 
unlimited amounts of everything called "medical care" for all those who 
cannot or do not provide for themselves. From a policy perspective, it 
is clearly inappropriate to undercut incentives for self-help and to promote 
"free riding" by many people who would normally insure themselves 
but who would happily take free public assistance instead. 

Another problem with defining eligibility in advance is that relevant 
circumstances are not fixed: employment status changes, and people's 
incomes go up and down, as does their medical spending. The inability 
to foresee such changes compHcates the operation of an insurance-style 
program, which contemplates coverage for a defined population over a 
preset time period. The uninsured, in notable contrast, are a constantly 
shifting and unstable grouping. 

Nonetheless, some ehgibility guidelines must be created, using income, 
assets, medical status, and other characteristics of potential eligibles. 
One way to deal with shifting circumstances is to allow administrators 
discretion to reevaluate ehgibility on a continuous basis (for each hospital 
admission, for example). A major legal question is to what extent 
administrators will be allowed discretion to grant or deny eligibility for 
unusual circumstances; indeed, existing medical indigency programs often 
have extremely vague standards. These standards could be difficult to 
sustain against an attack on due process grounds. ^^^ A major practical 
concern is that constant reconsideration is not only expensive for public 
administrators but also a deterrent to private actors who may be at risk 
as a result of a finding of non-eligibility. Vagueness makes it difficult 
for both eligibles and providers who deal with them to know where 
they stand; this uncertainty must hurt access to care for these uncertain 
eligibles. 

At any given level of public spending, there is a clear trade-off 
between covering more people and providing more benefits: the more 
people covered, the higher the expense. Indeed, of any design decision, 
eligibility has the greatest impact on total program spending. The quickest 
way to increase or decrease spending is to add to or subtract someone 



to Improve Access for the Medically Indigent, in Academy, supra note 136, at 47; Butler, 
supra note 136; Hughes, Local Anesthetics: A Look at States' Programs for the Uninsured, 
Health/PAC Bulletin, November 1986, at 11; Lewin & Lewin, Health Care for the Unin- 
sured, Bus. & Health, September 1984, at 9; Wilensky, Underwriting the Uninsured: 
Targeting Providers or Individuals, in Uncompensated Hospital Care, supra note 30, at 148. 
"^5ee Butler, supra note 136; State and Local Government Responsibilities, supra 
note 93, at 19-22. 



1986] CARE FOR MEDICALLY INDIGENT 895 

from the rolls. Other program adjustments have a much smaller fiscal 
impact than completely dropping or adding an additional person. 

One way to avoid having to make an all-or-nothing eligibility decision 
is to require people to contribute something on their own on an income- 
related basis, even if they receive public assistance. Public assistance 
then subsidizes self-help rather than wholly replacing it. This can be 
done in advance by making beneficiaries share in premium payments, 
or after the fact, by making them co-pay for incurred medical expenses. 
Nevertheless, requiring even partial payments from poor people in need 
of care is distasteful to many; cost sharing under Medicaid has met 
with considerable political reluctance. ^^^ Moreover, it has often proven 
difficult for providers to be very vigorous or effective in collecting their 
unpaid share of bills from a relatively poor population. 

Another possibility is to target specific groups seen as fiscally or 
medically needier than others or those for whom the public investment 
in care is perceived to have the largest benefit. The most obvious group 
on both these counts is composed of low-income children and expectant 
and recently delivered mothers. Numerous states are beginning to target 
Medicaid expansions in this manner; the same could hold true for other 
public efforts to aid the indigent. ^^"^ 

Of course, setting eligibility standards to aid the medically indigent 
is more easily described in the abstract, as here, than actually imple- 
mented. As already noted, the concept of medical indigency is itself not 
easy to define. ^^^ Numerous programmatic problems arise in defining 
what support to provide to people at what levels of income and assets: 
For example, over what period of time is income measured? What assets 
count, including those of family members, and how are they to be 
valued? What "spend down" of income or assets (to meet large, un- 
covered medical bills) makes an otherwise non-indigent person eligible?^^^ 
Once an operational definition of medical indigency is created, including 



^^^Traditionally, Medicaid programs have not been allowed to charge co-payments, 
although this has changed somewhat of late. See Cost Sharing by Recipients, 3 Medicare 
& Medicaid Guide (CCH) 1 14,731 (March 1983). 

^^See, e.g., Dallek, States Study Health Care for the Uninsured Poor, 18 Clear- 
inghouse Rev. 740, 743 (1984); Kosterlitz, Concern About Children, Nat'l J., Sept. 20, 
1986, at 2255 (state task forces have recommended special attention to children in Colorado 
and Texas, for example). Recent federal legislation has allowed expanded coverage. See 
infra note 237. 

^"See supra note 9. 

^^^Medicaid has of course had to create numerous rules and administrative mechanisms 
to decide eligibility; eligibility is generally conceded to be the most complex and difficult 
part of Medicaid to describe or understand. See, e.g., Joe, Meltzer & Yu, Arbitrary Access 
to Care: The Case for Reforming Medicaid, Health Aff., Spring 1985, at 59. Complexities 
make it difficult even to know how many people are eligible for any Medicaid program 
at a particular time; hence reliable program statistics focus on the number of known 
"recipients" of covered care. See, e.g., J. Holahan & J. Cohen, supra note 18, at 45. 



896 INDIANA LAW REVIEW [Vol. 19:857 

of necessity lack of adequate health insurance, it becomes difficult to 
avoid "free riding" by eligible beneficiaries who, absent pubUc aid, 
would cover themselves through their own or their employers' efforts. 
Even many low-income people have some insurance. Various strategies 
exist to address this problem, but none is perfect. ^^^ 

2. The Product: Hospital Payment vs. Insurance. — What is to be 
provided to those who are eUgible? Should public aid focus only on 
hospital services, or should it instead provide for broader availability 
of medical services, typically through an insurance-like mechanism? Either 
approach can use public or private hospitals or insurance plans. 

a. Hospital-based programs. — Three basic program models focus 
on hospitals. The first is to operate a public hospital or, increasingly, 
to contract with a private entity to operate it. Under the pubHc hospital 
model, the hospital not only provides services but also determines eH- 
gibility and benefits, since it is typically left to the hospital to decide 
whom to serve, in what order, and how much care to give. It can be 
difficult to establish good pubhc budgetary control over these hospital 
choices. Public hospitals have been an important source of care for the 
medically indigent, but the trend is toward reducing rather than increasing 
the public role in this area.^^^ 

A second possibility is to contract with a number of hospitals, pubhc 
and private, for the delivery of particular care to a particular population. 
This model is often followed for small, specific public health programs, ^^^ 
but is less often used for general medical care for the medically indigent. ^^^ 
Its use could be expanded, A major advantage of contracting over the 
public hospital approach is that it may provide some competition among 
hospitals for the contract(s). In any event, in many areas there is no 
public hospital, and the contract approach offers a simple way to pay 
for care. 



"^Eligibility standards can be set very stringently to cover only the desperately poor, 
who can seldom contribute to their own coverage in any case. But this eliminates the 
working poor, with some income, who contribute large numbers of uninsured. A "sliding 
scale" of income-related assistance is a promising alternative, but requires ongoing ad- 
ministrative complexity either to bill beneficiaries for their share of public premiums or 
to give them "vouchers" to buy private coverage. Another mechanism is to offer assistance 
to only the "hard core" uninsured, for example, by requiring that beneficiaries have gone 
two years without any private coverage. This discourages free riding but again leaves 
uncovered many otherwise deserving potential eligibles. Requiring "maintenance of effort" 
in terms of employers' buying private insurance is another possibility, but is administratively 
complex: monitoring and enforcement for hundreds of thousands of small workplaces 
would be needed, more if individual self-help were required. 

^^^See supra notes 57, 58, 142 & 143 and accompanying text. 

^^"^See supra note 145 and accompanying text. 

"°An exception is Iowa where, with state funds, the University of Iowa Hospital and 
Clinics provide "free" care to all county-certified indigents (up to a preset quota) from 
all over the state. See IHPP, supra note 136, at 139. 



1986] CARE FOR MEDICALLY INDIGENT 897 

A third model, already in use in many states, is to cover a group 
of qualifying hospitals under a ''vendor payment" program. ^^i Under 
this model, eligibility standards may be defined by the program, with 
hospitals put at risk to obtain verification of patients' eligibility before 
delivering nonemergency services. 

These options have been aggregated under the rubric of hospital- 
based approach because by far the bulk of such programs' spending 
normally goes to hospitals. A Hmited amount of non-hospital outpatient 
care could also be provided through direct dealings with non-hospital 
providers, primarily those affiliated with public health systems. Public 
health systems provide various primary, preventive, and other medical 
services through pubhc health clinics operated by local governments and 
staffed with public health nurses, doctors, and others. ^^^ 

The major advantage of the hospital-based approach is that it builds 
on the existing system. After all, hospitals deliver the most crucial care, 
receive the bulk of current spending on the medically indigent, and 
provide the most uncompensated care. The other advantage of a hospital- 
oriented approach is its relative ease of operation and finance. The 
number of hospitals, especially public hospitals, is relatively small, which 
facilitates dealing with them. It would be far more difficult to deal on 
the same basis with physicians or other more numerous providers. 

b. Medicaid and lesser * 'insurance" programs, (i.) Advantages of 
insurance. — The second basic approach is not hospital-oriented but rather 
recipient-oriented — in short, insurance or something very much like it. 
Insurance-style programs cover a broader spectrum of care and determine 
eligibility not merely for one hospital episode, but for a set period of 
time, much as private insurance enrolls people for a year or for some 
other term of coverage. 

Paying only for hospital care means covering only the most expensive 
care and forgoing whatever possibilities exist to treat medical problems 
before they become sufficiently serious to warrant institutionalization. 
It also delegates to hospitals considerable control over who is to receive 
care and to what extent. Moreover, if only public hospitals or a limited 
number of private hospitals specialize in care to the poor, a hospital- 
oriented approach also fails to promote quality competition, which may 
be important in assuring that poor people get adequate care. There is 
also some danger that any hospitals designated under a hospital-only 
approach would be at least perceived as being lower quality, welfare- 
style hospitals and hence would be shunned by the insured middle class. 

In contrast, an insurance entitlement empowers the patient rather 



^^^See, e.g., Butler, supra note 136, at 19-20; see supra text accompanying notes 146 
& 147. 

"^See, e.g.. Role of State and Local Governments, supra note 134; Public Health 
Foundation, supra note 135. 



898 INDIANA LAW REVIEW [Vol. 19:857 

than the provider.^" Giving people control over their own insurance 
money gives them a measure of dignity in contrast to shunting them to 
a "charity" hospital. It also allows both patients and providers to plan 
for medical care to a greater extent. Moreover, giving people the resources 
with which to "shop around" may promote desirable quality competition. 

Quality is also enhanced by hospitals' and doctors' serving the 
medically indigent alongside better funded and possibly more demanding 
patients. Covering more than hospital services promotes health main- 
tainence and thus avoids some needs for inpatient care. This method 
may or may not save money overall, but it certainly makes people better 
Qff 234 Finally, under an insurance plan, a partial public subsidy is more 
feasible because the beneficiaries' share is collected in advance, when 
they are more likely to be healthy and employed. Collecting at the time 
of medical need or thereafter, as with the hospital-based plans described 
above, is more difficult. For all of these reasons, this Article strongly 
supports insurance-style programs for the medically indigent, to the fullest 
extent that they are politically and economically feasible. 

Economic feasibility is, of course, the Achilles' heel of this insurance 
approach. Broad coverage can be far more expensive than simply relying 
on public hospitals, both because the price per unit of service may be 
higher and because a great deal more care may be delivered and con- 
sumed. ^^^ The great challenge, then, for those who favor an insurance- 
style approach is to find ways to provide coverage that is less expensive 
than conventional approaches or to persuade the electorate that expansion 
of existing programs is fiscally prudent and a good medical value. 

(ii.) Options for expanding Medicaid. — The best known and by far 
the largest insurance-style approach is Medicaid. Indeed, the most 
straightforward way to expand coverage for the medically indigent would 
be to cover more poor people under Medicaid. For states, Medicaid is 
a good insurance "buy" because the federal government pays half or 
more of program spending on an open-ended basis. Medicaid coverage 
could be expanded by raising the income standards for eligibility, by 
choosing to cover people in optional categories such as two-parent families 
or children aged 18-21 or by operating "medically needy" programs that 
allow people to "spend down" to eligibility. ^^^ Additional expansions 

"^For one view of the importance of empowering patients, see Bovbjerg & Held, 
Ethics and Money: The Case of Kidney Dialysis and Transplantation, Topics in Hosp. 
L., Sept. 1986, at 55. 

^^"♦It is poorly appreciated that much so-called "preventive" medical care is not cost- 
effective, that is, does not save a dollar in prevented care for every dollar invested in 
prevention. See generally L. Russell, Is Prevention Better Than Cure? (1986). 

^"People without insurance now get much less care even though they are sicker. 
Giving those people coverage can thus be expected at least to double the amount of care 
that they get in hospitals and perhaps similarly for outpatient services. See supra Table 
4 & note 27. 

236pg^ states maximize federal financial participation in Medicaid by setting the highest 
allowable income limits and covering all optional eligibility categories. See generally J. 



1986] CARE FOR MEDICALLY INDIGENT 899 

would be possible if federal requirements for categorical eligibility as 
well as low income were eased.^^^ However, the fact that states have 
not expanded Medicaid eligibility indicates that they think it is too 
expensive to cover more people in this way— even with federal subsidies. ^^^ 
The one major area of program expansion in recent years has been to 
add coverage for poor children and their mothers. ^^^ Of course, states 
are free to cover others as they please, without federal assistance. 

(Hi.) New economizing options.— U Medicaid and other traditional 
programs are perceived as too expensive, what alternatives exist? The 
keys to economizing are to hold down the price and utilization of medical 
care. This must be accomplished without leaving uncovered large expenses 
for catastrophic care, a central goal of good coverage. It is especially 
important to limit expensive hospital care, through some combination 
of provider and patient incentives, prescreening of admissions, reviews 
of care given, and judicious substitution of outpatient for inpatient care. 

The other critical element is to lower prices paid to providers, 
particularly hospital payments. ^^^ From the standpoint of the hospitals, 

HoLAHAN & J. Cohen, supra note 18. This is one reason that only about AO^q of poor 
people are Medicaid eligible. Id. For a good short review of Medicaid eligibility options, 
see Reymer, Medicaid Eligibility Options, in Affording Access to Quality Care I (R. 
Curtis & I. Hill eds. 1986). 

"'Recent federal amendments have taken a first step toward easing categorical re- 
quirements by allowing coverage of expectant mothers and poor children not receiving 
AFDC cash assistance. See Consolidated Omnibus Budget Reconciliation Act of 1985, 
Pub. L. No. 99-272, §§ 9501, 9511, 100 Stat. 82, 201, 212; Omnibus Budget and Recon- 
ciliation Act of 1986, Pub. L. No. 99-509, 100 Stat. ; see also Kosterlitz, Breaking 

Medicaid's Link with AFDC, Nat'l J., Sept. 20, 1986, at 2256. But more significant expan- 
sions seem unlikely. The current administration has sought to cap federal Medicaid obliga- 
tions rather than allowing states to expand them yet further. R. Bovbjerg & J. Holahan, 
supra note 18, at 7-10, and budget deficits make congressional initiative unlikely as well. 
See also supra note 63. 

"*The number of Medicaid recipients has remained stable in the 1980's, despite 
increased need for coverage. See supra notes 18-19 and accompanying text. See also J. 
Holahan & J. Cohen, supra note 18, at 40-43. 

"^The 1981 Medicaid amendments gave states the authority to target children's care 
without having to provide full medically needy benefits for the elderly and disabled, who 
consume far greater resources for less obvious returns in avoiding other long term medical 
costs. R. Bovbjerg & J. Holahan, supra note 18, at 33-35. In the case of children, it 
is possible to provide cost-effective care by expanding preventive and prenatal services 
and thus to avoid many of the very large bills which can accompany difficult deliveries 
and disabled or crippled children. Subsequent federal changes have both required and 
allowed more coverage of children. See supra note 237. 

^^°Of course, a key feature of any such program for the indigent would be a requirement 
that the provider accept payment from the program as payment in full, except perhaps 
for specified cost sharing by patients. That is currently done in both Medicare and Medicaid 
with regard to hospitals. See Admissions and Quality Review, 1 Medicare & Medicaid 
Guide (CCH) t 4227 (Nov. 1984); and Reimbursement in General, 3 Medicare & Medicaid 
Guide (CCH) 1 14,723 (Oct. 1984) (Medicare); Limitations on Charges to Beneficiaries, 
3 Medicare & Medicaid Guide (CCH) t 20,883Q (Oct. 1985); dind Acceptance of State Pay- 
ment as Payment in Full, 4 Medicare & Medicaid Guide (CCH) 1 21,833 (June 1985) 
(Medicaid). 



900 INDIANA LAW REVIEW [Vol. 19:857 

this may not be disadvantageous if it helps reduce the total amount of 
uncompensated care and increase the number of paying patients. Of course, 
one must take care not to reduce payments so far as to deny beneficiaries 
desired access to care.^'*^ Prices can be held down either by setting prices 
administratively for public programs, by regulating prices of providers, 
or by using bidding or negotiation to select providers who are willing 
and able to accept lower prices for a higher volume of patients. ^''^ Benefits 
redesign — better targeting of benefits to needs — may also be helpful; the 
optimal mix of benefits is probably not provided in the traditional 
insurance policy. ^''^ 

What new arrangements embody these principles? Perhaps the best 
known example is the Health Maintenance Organization (HMO). HMO's 
use restricted panels of physicians and hospitals to deliver care and are 
thought to be less costly than conventionally provided insurance on a 
fee-for-service basis with open access to all providers of the patient's 
choice.^ Many state Medicaid programs now promote HMO's for their 
eligible participants; programs in California and Michigan have long 
advocated this approach. ^"^^ Unfortunately, HMO's do not exist in all 
parts of the country. 

Using HMO's to care for the medically indigent presents other 
problems as well. First, existing HMO's would want to be prepaid on 
a monthly basis and guaranteed enrollment for six months or more, as 
is possible under Medicaid. ^"^^ However, the medically indigent can be 
a floating population; some are transient, others are only intermittently 
uncovered by private insurance or Medicaid. Second, HMO's are geared 
to provide comprehensive, high quality care at a price not unlike that 
charged by private conventional insurance. As a result, HMO's cost 
considerably more per capita than what a state might pay for a public 
hospital or for a limited vendor payment program. 

^'The same holds true for physicians: It is desirable not to overpay physicians, but 
if physicians are underpaid, they will not provide enough of the services needed to keep 
people healthy and out of hospitals. This has been an endemic problem for states' Medicaid 
programs. Low physician payment often results in people going to hospital emergency 
rooms or outpatient departments for primary care that would have been much more 
cheaply provided in physicians' offices. See generally J. Holahan & J. Cohen, supra 
note 18, at 62. 

^^See generally Bovbjerg, Held & Pauly, supra note 58; infra text accompanying 
notes 253-56. 

^^Long distance transportation (e.g., to less expensive outlying institutions) or non- 
traditional providers for chronic-care services are two services not conventionally covered 
but which could be cost-effective if implemented on a controlled basis. 

^The extent of HMO savings has long been debated. It is clear that people in HMO's 
use significantly less hospital care than others. H. Luft, Health Maintenance Orga- 
nizations: Dimensions of Performance (1981). It is not clear to what extent this is due 
to HMO economies rather than to self-selection by enroUees. 

^'R. Bovbjerg & J. Holahan, supra note 18, at 57. 

^*M at 58. 



1986] CARE FOR MEDICALLY INDIGENT 901 

Another possibility is the so-called Preferred Provider Organization 
(PPO).^^ Using existing hospitals and doctor practices, PPO's operate 
like a cross between conventional insurance, covering all providers, and 
HMO's, with a limited Hst of covered providers. PPO's encourage 
enrollees to use one of a selected group of so-called preferred providers, 
who have agreed to hold down spending either by discounting their 
normal fees or by agreeing to utilization reviews or other cost-containment 
measures. 

PPO beneficiaries have fewer cost sharing requirements for using 
preferred providers than for using other providers, who are still covered 
but at a lower rate. Both beneficiaries and preferred providers profit 
from this approach. Beneficiaries receive full benefits from a restricted 
Hst of providers, yet retain the ability to go to anyone at some additional 
expense. Preferred providers benefit, despite lower fees or restrictions, 
because they can expect to receive additional patients from the PPO or 
at least to retain patients they might otherwise have lost. Since their 
inception in the early 1980's,^'^^ PPO's have grown rapidly, but have 
only recently expanded their marketing to include small groups and 
individuals. It is not known whether any states or localities have attempted 
to contract with private PPO's to enroll the medically indigent. As with 
HMO's, PPO's currently compete primarily in the employment group 
market and provide relatively complete benefit packages and high quality 
care. 

Another cost containment approach, which can be used in con- 
junction with either conventional insurance or alternative systems like 
HMO's and PPO's, involves "managed care." Management means in- 
creased control over care by physician or nonphysician reviewers. One 
common approach is "case management" by a primary care physician, 
an internist, or a family physician. These physicians act as the patient's 
point of entry for all care, controlling referrals to specialists and hospitals 
and often reviewing the latters' care and charges. Traditional medical 
practice has long been conceived as similarly beginning with a primary 
care provider who then makes appropriate referrals, but in practice, 
many patients have gone directly to high-priced specialists or hospital 
care on their own. Moreover, even transfers from primary care physicians 
have not normally involved fiscal management, although some medical 
follow-up may exist. In contrast, case managers act like true "gatekeep- 
ers" by controlling access to and use of care on both economic and 
medical grounds. Various models exist, not all of which have been 
successful. ^"^^ 

^^See, e.g., Gabel & Ermann, Preferred Provider Organizations: Performance, Prob- 
lems, and Promise, Health Aff., Spring 1985, at 24. 

^^See Bovbjerg, supra note 24. 

^'It is possible, for example, to put financial risk on managing physicians, or merely 
to reward them for being parsimonious in their patients' use of medical resources. 



902 INDIANA LA W REVIEW [Vol. 19:857 

A number of areas are experimenting with case management as a 
way of holding down medical costs while providing broad access to well 
integrated medical care. Thus, management can potentially have positive 
effects on health as well as on spending. The state of Kansas, for 
example, has made some progress in using case management for the 
medically indigent population, ^^^ as has the state of Michigan through 
its Medicaid program. ^^^ 

Outside reviewers can also "manage" care indirectly through such 
mechanisms as prescreening of hospital admissions, concurrent evalua- 
tions of the necessity for prolonged hospital stays, or retrospective review 
of utilization and claims. These practices are now common in large 
private health insurance plans, but less so in public plans. ^^^ 

Of course, achieving improvements through case management de- 
pends on there being something to manage. Savings are possible where 
disjointed and perhaps over-generous coverage has led to previous over- 
spending, so that cutbacks are not deleterious. But the main problem 
for the uninsured is prior lack of care, not over-service. One could 
implement managed care for a previously uncovered population, but the 
manager must be able to provide a minimum set of benefits — both 
primary care and necessary specialists, in addition to hospital care — well 
beyond what is currently available to many or most of those now 
medically indigent. Such management should make coverage less expensive 
than traditional open access insurance, but it will almost surely cost 
more than the patchwork of care now available to the uninsured — 
because more care will be dehvered. 

Mention should be made of two other major cost-containment ideas: 
provider and patient incentives to economize. Providers can be motivated 
to reduce their use of medical resources if they are prepaid some fixed 
amount, rather than being "reimbursed" for their incurred costs or 
charges as under the traditional practice of Medicare, Medicaid, and 
private plans ahke. The 1980's have seen a virtual "buyer's revolution" 
of refusal to accept provider-dictated spending.^" 



^^^See Hansen, Kansas' Medical Coverage Programs for the Poor: A Targeted Approach 
Through State-Financed and State-Administered Programs, in Academy, supra note 136, 
at E-1. 

^^'See, e.g., McDonald & Fairgrieve, Michigan's Experiment with Case Management, 
20 Clearinghouse Rev. 423 (Special issue, Summer 1986). 

^"For private developments in managing health spending, see, e.g., J. Califano, 
supra note 22; P. Fox, W. Goldbeck & J. Spies, supra note 22. Efforts are too numerous 
and varied to catalog here; many are reported regularly in such newsletters as Coalition 
Report (U.S. Chamber of Commerce, Clearinghouse on Business Coalitions for Health 
Action, Washington, D.C.) and Medical Benefits (Kelly Communications, Charlottesville, 
Va). For public-plan developments, see, e.g.. Affording Access to Quality Care, supra 
note 236, especially chapter 5 at 127 (Bartlett, The Management of Medicaid Inpatient 
Hospital Expenditures) and Chapter 8 at 201 (Neuschler, Alternative Financing and Delivery 
Systems: Managed Health Care). 

^"See, e.g., J. Califano, supra note 22. 



1986] CARE FOR MEDICALLY INDIGENT 903 

Prepayment can result from several approaches. First, plans may 
simply set prices administratively and offer them to providers on a 
"take it or leave it" basis, as does Medicare with its prospective payment 
system for hospitals based on Diagnosis Related Groups (DRG's).^^"* 
Alternatively, preset prices can be arrived at voluntarily through bidding 
or negotiation, or set on a mandatory basis by economic regulation, as 
are hospital rates in a number of states. ^^^ Referral or admitting physicians 
can also be encouraged to economize on specialists' treatment or hospital 
care by sharing savings with them.^^^ One concern about economizing 
incentives is naturally that providers may undersQTVQ, just as generously 
rewarded fee-for-service practitioners may overserve. 

Finally, patients may be encouraged to save in similar fashion — 
either by having to share in spending (cost-sharing through deductibles, 
co-payments, or co-insurance) or by being allowed to share in savings 
below expected amounts. However, as previously discussed, patient- 
oriented strategies are generally considered less desirable for poverty 
populations than for the insured middle class. A payment requirement 
to pay X dollars per visit may help insured patients weigh the cost 
versus the value of care without preventing them from proceeding; for 
poor people, the burden looms larger relative to their other needs and 
may deter them from getting care altogether. 

3. Financing, a. Fiscal requirements. — How much financing is needed 
to cover the medically indigent? That obviously depends on one's def- 
inition of the problem and on how generous one is in addressing it. 
The potential range is $5-50 billion, with $15-20 billion a reasonable 
estimate for moderate initiatives. A minimal program might cover only 
the cost of non-elective, uncompensated hospital care that is already 
provided to "charity" patients. Such care totalled about $4-5 billion in 
1986.^^^ Funding such care through a pubhc program would be the 



^^'*See, e.g., Bovbjerg, Held & Pauly, supra note 58. 

^^^See, e.g., id. 

^^^Some case management strategies do this, as noted supra notes 249-52. Similarly, 
some HMO's give their doctors performance bonuses. And some hospitals prepaid by 
Medicare have sought to reward physicians for holding down hospital spending. See U.S. 
Gen. Acct. Off., Pub. No. HRD-86-103, Medicare: Physician Incentive Payments by 
Hospitals Could Lead to Abuse (1986). Congress has acted to ban under Medicare and 
Medicaid any payment incentives to physicians from hospitals or risk bearing HMO's to 
reduce or limit services to patients. Omnibus Budget ReconciUation Act of 1986, Pub. L. 
No. 99-509, § 9313, 100 Stat. , . 

^"The figure is the authors' rough estimate, with the following assumptions: The 
1986 cost of uncompensated hospital care is $13 bilhon. Cohodes, supra note 36 (citing 
estimates by American Hosp. Ass'n). About one-third of such care goes to charity patients, 
as designated by hospitals themselves. Sloan, Valvona, & Mullner, supra note 31, at 19. 
Approximately two-thirds of such care is for non-elective services. Cf. id. at 30 (fully 
42% of relevant hospital charges comes from two categories, childbirth and accidents — 
both non-elective services). Note that the estimate of $4-5 billion does not allow for an 
increase in hospital service generated by the knowledge among hospitals and indigents 



904 INDIANA LAW REVIEW [Vol. 19:857 

minimal response to the problems of the medically indigent. 

The highest reasonable estimate comes from assuming coverage for 
all of the uninsured and underinsured for a broad range of services to 
a very high level of medical spending — on the ground that in-depth 
coverage for all is needed to prevent catastrophic medical expenses from 
rendering anyone medically indigent. Full coverage implemented on a 
national basis could easily cost $50 billion dollars more a year than is 
now spent, depending on how rich a benefit package were provided. ^^^ 
This approach would constitute national health insurance, although it 
might not closely resemble the ambitious federal plans of the 1970's in 
design or implementation. 

More reasonable estimates of a program to cover the medically 
indigent surely lie between the $5 and $50 billion extremes. As a rough 
guess, spending $50 a month only for those now uninsured who are 
below the poverty Une would cost "only" about $6 billion the first year, 
whereas spending $80 a month for those with family incomes under two 



alike that more funds were available to cover charity care. Depending on the eligibility 
and payment rules applied under a new system, such an increase could be substantial. 

2^^The $50 billion figure derives from assuming that an equivalent of 30 million 
uninsured person-years currently exist, with an additional 20 million underinsured (i.e., 
not protected against catastrophe). Benefits are estimated at $100 per month for the 
uninsured, half that for the underinsured: ($100/month/person x 12 months/year x 30 
million person-years) + ($50/month/person x 12 months/year x 20 miUion person-years) 
= $48 billion. No allowance is made for increased spending due to people cutting their 
own coverage to rely on government help. Discussion: Some 35 miUion people were 
uninsured in March 1984, probably two-thirds of them for the entire year, one-third for 
part of the year, perhaps averaging six months, for a total of about 30 milUon person- 
years. Calculated from M. Sulvetta & K. Swartz, supra note 16, at 3. At least an 
additional 20 million are underinsured. This estimate is from the finding that in 1977 
24*^0-37% of population was underinsured overall, id. at 19, whereas only 11% was 
uninsured at the time of survey, id. at 3. See also Farley, supra note 11. The $100 and 
$50 figures are reasonable guesses for moderate coverage. Average per capita personal 
health spending for the entire population for 1986 is estimated at $146 per month. Calculated 
from data in Arnett, McKusick, Sonnefeld & Co well. Projections of Health Care Spending 
to 1990, Health Care Festancing Rev., Spring 1986, at 1, 3, 12. Spending of course 
varies greatly according to characteristics of the insured and of the benefits covered. See, 
e.g., id. at 20-32. Medicare, for an aged and disabled population, currently spends some 
$180 per month for each beneficiary, not counting beneficiaries' own spending. U.S. Office 
OF Management & Budget, The United States Budget in Brief 46-47 (1986) ($67 
billion in federal fiscal 1986 for some 31 milhon beneficiaries). Medicaid spends about 
$159 per month per recipient overall, although nearly half goes to a small fraction of 
eligible recipients receiving long term care. Id. at 44 ($23,7 billion federal, $19.3 billion 
state for 22.5 million FY 1986 recipients). Not all of these people are covered for the 
entire year, so the estimate is biased low. Federal spending in 1986 for the Federal 
Employees Health Benefits Plan averaged fully $221 per month per covered employee 
(each with an unknown number of dependents), not counting employees' share of premiums 
(about 25% of the total or 33% more than the federal share) or required cost sharing. 
U.S. Office of Management & Budget, Budget of the United States Government, Ap- 
pendix, Fiscal Year 1986 I-V 7 (1986) [hereinafter U.S. Budget]. 



1986] CARE FOR MEDICALLY INDIGENT 905 

times the poverty level would cost some $20 billion.^^^ In practice, it 
would not be sensible to cover everyone below some arbitrary level for 
100% of the cost and no one above it at all. Such abrupt breaking 
points (or ** notches," as they are often called) are unfair to those just 
above them, discourage beneficiaries from earning more (or reporting 
earnings), and encourage non-beneficiaries to drop to covered levels. An 
intermediate method is to provide graduated support in the boundary 
zone (often called "shding scale'' support), which probably would increase 
spending. 

In comparison, states now spend about $20 billion a year in 
Medicaid, ^^^ and almost all are working hard to cut back its scope. ^^^ 
Moreover, states spent an additional $24 billion on hospitals and other 
health care in 1985.^^^ Cities and counties together contributed somewhat 
less, about $18 biUion on health care in 1984.^" New funding for the 
indigent could displace some existing spending; this small "savings" 
would likely be overwhelmed by new spending generated by almost any 
new entitlement. 

b. Funding sources and limitations, (i.) State taxes and federal 
preemption. — States and localities have numerous funding options through 
taxation or mandates on individuals, employers, providers, and insurers. 
In principle, any existing state tax could be used to fund programs for 
the medically indigent, whether they were public programs, like Medicaid, 
or private programs, like those considered in the next subsection. Tra- 
ditionally, these taxes include the state income tax (for most states), 
city, county, and state property taxes, and sales and excise taxes. Any 
or all could be used for these purposes. States could appropriate general 
fund monies or they could dedicate a particular tax levy to help meet 
the needs of the medically indigent. Because state budgets are already 
hard pressed, new revenues are probably needed, and many people prefer 
to raise new revenue in some way related to health — by raising so-called 
"sin taxes" on tobacco and alcohol, for example. Nevertheless, it is 
clear that such taxes by themselves probably will not produce sufficient 



^^'About one-third of the uninsured are uncovered only during part of the year, 
Farley, supra note 11, so that they would not need new assistance for the full year. Also, 
the estimates do not include newly uninsured people taking advantage of new assistance. 

^^See U.S. Budget, supra note 258. 

^^See generally Affording Access to Quality Care, supra note 236; J. Holahan 
& J. Cohen, supra note 18. 

^^^U.S. Bureau of the Census, Series No. GF84, No. 3, State Government Finances 
IN 1984, at 2 (1985). Not all of such spending covers medical indigents, of course; much 
goes to particular classes of patients not based on income, e.g., victims of tuberculosis, 
crippled children. 

^"U.S. Bureau of the Census, Series No. GF84, No. 4, City Government Finances 
in 1983-84 (1985) and Series No. GF84, No.8, County Government Finances in 1983- 
84, at 2 (1985). 



906 INDIANA LAW REVIEW [Vol. 19:857 

revenue, ^^"^ and there is, of course, considerable political resistance to 
general tax increases. ^^^ 

Therefore, funding that does not require direct taxation of individuals 
attracts considerable interest. Public funding can be provided, in part, 
by a tax or assessment on hospitals not providing a specified minimum 
amount of charity care. Under this approach, all hospitals could be 
required to provide a certain percentage of, say, their gross revenue as 
charity care. Hospitals providing less would be required to pay the 
difference into the fund.^^^ Public policy makers may find such taxation 
by regulation attractive because it is *'off budget," or at least off their 
budgets. 

Adopting this concept would have the added benefit of eliminating 
* 'dumping" of non-paying patients as a way to hold down prices in the 
increasingly competitive hospital market. Although expensive, it would 
promote access to inpatient care for poor people, and the expense would 
be spread among paying hospital patients, largely insured patients. Of 
course, a standard definition of charity care, as compared to uncom- 
pensated care, would be needed to exclude bad debts of those capable 
of paying. And administration of this "program" would have to be left 
mainly to hospitals themselves. ^^^ 

One might also attempt to reduce the number of uninsureds gen- 
erally — not only the medically indigent — by mandating that employers 
provide health insurance to their employees. The state of Hawaii currently 
has such a program. However, a legal obstacle prevents other states 
from enacting similar programs. The federal Employee Retirement In- 
come Security Act of 1974 (ERISA) interferes with state options through 
its regulation of employee benefit plans, both pension plans and welfare 
benefit plans. ^^^ 

^^'*See Bartlett, State Level Policies and Programs, in Academy, supra note 136, at 
54, 60-61. 

^^^See supra note 56. 

^^The Ohio task force dubbed this the "care or share" approach. Governor's 
Commission on Ohio Health Care Costs: Final Report (July 1984) (summarized in J. 
LuEHRS & R. Desonla, supra note 61, at 37-38). Hospital taxes could also be based on 
net revenues, number of licensed or occupied beds, or other measures. Pooling similar 
to that described in the text already occurs within hospital rate-setting states and in Florida, 
where it helps fund an expanded Medicaid program. E.g., Perkins, Dallek, Do well & 
Waxman, State-Based Financing of Indigent Health Care: Promise and Problems 20 
Clearinghouse Rev. 372, 372-75 (Special Issue, Summer 1986). 

^*^Such charity pooling seems impractical to extend to providers other than hospitals 
because there are so many of them. 

2^«29 U.S.C. §§ 1001 et seq. (1982). Welfare benefit plans covered under ERISA 
include those that provide for medical, sickness, accident, and other non-pension fringe 
benefits. 29 U.S.C. § 1002(1) (1982). It should be noted that nothing in ERISA regulates 
the contents of welfare benefit plans; only reporting and disclosure requirements were 
enacted, according to conventional wisdom because Congress expected national health 
insurance soon to supercede all existing health plans. 



1986] CARE FOR MEDICALLY INDIGENT 907 

Intending to make regulation of employee benefit plans exclusively 
a federal concern, ERISA expressly preempts state regulation of employee 
benefit plans. ^^^ One exception to this ERISA preemption of state law 
is that states may continue to tax and regulate insurance, that is, insurance 
companies and insurance contracts. ^^"^ The Supreme Court has upheld 
such state regulation that mandates benefits to be covered in health 
insurance contracts, for example. ^^^ However, the Court noted that ERISA 
prohibits state regulation of an employer's benefit plan that is "self- 
insured" rather than placed with an insurance company, as this would 
not fall under the "insurance law" exception to the federal preemption. ^^^ 
Increasingly, especially in large employment groups, health benefits are 
self-funded.^^^ 

Given that ERISA prohibits state regulation of employee benefit 
plans other than through the avenue of insurance regulation, it would 
seem, a fortiori, that states cannot mandate that such plans exist. ^^"^ 
Thus, the state of Hawaii is able to maintain its program only because 
of specific amendments to ERISA that "grandfather" the Hawaii Prepaid 
Health Care Act.^^^ Of course, ERISA could be further amended to 
grant states the authority to require private insurance coverage. 

It might be possible for states to achieve similar "insurance" goals 
through their power to tax employers. Clearly ERISA would not prohibit 
states from taxing all employers to fund care or coverage for the 
uninsured, for example, through a general payroll tax. Whether an income 
tax, because it is related to ability to pay, or a payroll levy, because 
it is related to the number of employees, is the more equitable method 
is open to debate. A payroll tax would, of course, tax employers already 
providing coverage in order to help those not now providing coverage, 
and could thus considerably hurt incentives to insure, especially in in- 



^^^29 U.S.C. § 1144(a) (1982). 

2™29 U.S.C. § 1144(b) (1982). 

^^'Metropolitan Life Ins. Co. v. Massachusetts, 105 S. Ct. 2380, 2393 (1985). 

^^^ERISA expressly provides that self-insured plans are not to be considered "insurers" 
or "insurance companies" for the purposes of state regulation, 29 U.S.C. § 1144(b)(2)(B) 
(1982). 

^^^See, e.g., Etheredge, The World of Insurance: What Will the Future Bring?, Bus. 
& Health, Jan. /Feb. 1986, at 5 (describes growth of self -insurance); Self Insurers Out- 
number Fully Insured Among Larger U.S. Corporations, Coalition Rep., April 1985, at 
1. 

"^5wr see Director of Bureau of Labor Standards v. Fort Halifax Packing Co., 510 
A. 2d 1054 (Me. 1985), prob. Juris, noted sub. nom Fort Halifax Packing Co. v. Coyne, 
107 S. Ct. 430 (1986). In this case, Maine's Supreme Judicial Court held that because a 
Maine statute requiring severance pay was only operative when a benefit plan was not 
in existence, the statute did not "relate to" an employee benefit plan and thus was not 
preempted by ERISA. 

^^'Pub. L. 97-473, § 302, 96 Stat. 2605 (1982) (codified at 29 U.S.C. § 1144(b)(5) 
(1982)). 



908 INDIANA LA W REVIEW [Vol. 19:857 

dustries where many companies already provide no insurance. To maintain 
insurance incentives, employers could be allowed to deduct from the 
amount of payroll tax due any amounts contributed to health benefit 
plans (insured or self-insured) for their employees. 

Would such provisions be impermissible regulation under ERISA? 
Perhaps so. Some courts have interpreted certain state plans of taxation 
as prohibited regulation and therefore ruled them preempted by ERISA. 
For example, a federal district court in Connecticut found a statute that 
imposed a 2.75^^0 annual tax on employee benefit plans to be void and 
unenforceable because of ERISA preemption of state regulation. ^^^ More- 
over, in protecting Hawaii's Prepaid Health Care Act in 1983, Congress 
specifically provided that Hawaii's ERISA exemption did not affect the 
status of "any state tax law relating to employee benefit plans. "^^^ Courts 
have interpreted this language to indicate that Congress intended to 
preempt all state tax laws insofar as they relate either directly or indirectly 
to employee benefit plans. ^"^^ 

Despite these rulings, a state may still be able to enact a payroll 
tax with deductions for health coverage such as the one outlined above. 
The rationale behind the deduction would be that these employers are 
already doing their part toward financing health care by providing some 
reasonable form of coverage. The legal argument runs as follows: First, 
the tax is analogous to a state corporate income tax that allows deductions 
for an employer's expenses incurred in maintaining employee benefit 
plans. Clearly, such state income taxes with such deductions have not 
yet been found to "relate to" employee benefit plans for purposes of 
ERISA preemption. A payroll tax with similar offsets should be afforded 
similar status. 

Second, such a payroll tax does not "relate to" employee benefit 
plans because the employer is taxed, not the benefit plan itself. Moreover, 
unlike the voided Connecticut statute, the amount of deduction would 
not discriminate between insured and self-insured health benefits — the 
very distinction ERISA has been held to maintain.^^^ For these reasons. 



"^National Carriers' Conference Comm, v. Heffernan, 454 F. Supp. 914 (D. Conn. 
1978). Connecticut's tax on premiums received by insurance companies was 2%, which 
meant that the tax structure operated as an incentive to use traditional insurance rather 
than ERISA-exempted plans. The court found this discrepancy (2% vs. 2.75%) to be 
"illustrative of the potential use of taxation as a means of regulation." Id. at 917-18. 

^^^29 U.S.C. § 1144(b)(5)(B)(i) (1982). 

"^"^See, e.g.. Northwest Airlines, Inc. v. Roemer, 603 F. Supp. 7 (D. Minn. 1984); 
General Motors Corp. v. California State Bd. of Equalization, 600 F. Supp. 76 (CD. 
Cal. 1984). See Shaw v. Delta Airlines, Inc., 463 U.S. 85 (1983); Alessi v. Raybestos- 
Manhattan, Inc., 451 U.S. 504 (1981). 

^^'^See supra notes 271-72 and accompanying text. Taxing self-insurance for the purpose 
of funding the deficits of state high-risk pools has also been invalidated on ERISA grounds. 
See generally Bovbjerg & Koller, supra note 211. 



1986] CARE FOR MEDICALLY INDIGENT 909 

a combination payroll tax and coverage credit may not be considered 
as regulating employee benefit plans. 

Similarly, states are also free to tax the insurance-like alternative 
plans such as HMO's and PPO's; again, they may offset charitable care 
these entities provide. Indeed, to some extent, states already do so through 
the imposition of insurance premium taxes. 

The calculation of such taxes as well as set-offs for indigent coverage 
or care involve complex administrative questions. Nevertheless, such taxes 
could provide a useful basis for funding, and could equalize the burden 
imposed on competing financing and delivery alternatives — insurance 
companies, self-insurers, and alternative plans like HMO's and PPO's. 

Mandates or taxes on insurers, on medical providers, or on employers 
may have more current political appeal than taxes on individual taxpayers. 
Indirect funding through mandates for individuals to insure themselves 
is another '*off-budget" option for states to consider. It would be foolish 
to replace efficient group purchasing of health coverage by employers 
with more expensive individual policies; however, it might be sensible 
to fill in some gaps with individual mandates. One such mechanism is 
auto insurance, with a long tradition of individual requirements. ^^° Au- 
tomobile owners or drivers could be required to provide evidence of 
adequate health insurance as a condition of Hcensure, especially to cover 
the very large bills that often result from accidents and which contribute 
disproportionately to uncompensated care in hospitals. ^^' 

(ii.) Private revenue. — States can also seek to attract voluntary 
funding from individuals themselves (or their employers, if any) by 
mandating, or themselves running, subsidized insurance plans for some 
of the uninsured. The basic idea here is to encourage insurance coverage 
with subsidies while holding down costs with private contributions to 
premiums. This strategy presupposes that potential eligibles (or their 
employers) can afford to make a contribution, so it does not address 
the impoverished "hard core" of the uninsured. The approach would 
nonetheless address two groups who may be considered medically in- 
digent—the uninsured working poor and the medically uninsurable. Public 
assistance could take the form of subsidizing eligibles' purchase of private 
coverage with cash, vouchers, or tax benefits; alternatively, governments 
could create publicly underwritten plans or insurance pools that eligibles 
could "buy into" at below-market rates. ^^ It would be difficult, but 



^^°See, e.g. Widiss, Introduction: Background and Perspective, in No-Fault Auto- 
mobile Insurance in Action: The Experiences in Massachusetts, Florida, Delaware 
AND Michigan (A. Widiss, J. Little, R. Clark & T. Jones eds. 1977). 

^^^See supra note 257 on the contribution of accidents. 

^^^Assistance to the working poor could readily take the form of providing a tax 
credit for workplace purchase of insurance, which would assist low and high income 
workers ahke, rather than today's tax exclusion, which disproportionately assists upper- 



910 INDIANA LAW REVIEW [Vol. 19:857 

perhaps not impossible, to structure such a new subsidy to aid those 
at high risk of faiUng to insure themselves, without having to subsidize 
too many otherwise similar people who already have coverage. This 
approach is experimental but merits close attention. 

A second category of potential eligibles also needs pubhc help to 
obtain coverage but can contribute themselves. These are nonpoor people 
otherwise uninsurable because of pre-existing adverse health conditions. 
In a number of states, state-run comprehensive insurance risk pools help 
these people buy standard policies at a surcharged rate.^^^ The pools 
help a small fraction of even the uninsurable, and still fewer of the 
uninsured generally, and they do so at a high cost because even the 
surcharged premiums must be subsidized to meet high medical bills. 
Moreover, as now run, the pools do not help the indigent, but only 
those with the wherewithal to pay high premiums themselves. Although 
states may move toward targeted subsidies to help the low income 
uninsurable, high risk pools will provide only limited general help to 
the medically indigent. 

4. Administration. — Any of the strategies just discussed can be 
implemented with varying degrees of public involvement. An entire public 
system can be created, using public funds and employees. Alternatively, 
government may specify what model(s) are desired and contract with 
private companies to administer the plan(s). Or government may help 
currently uninsured people "buy into" existing private plans, including 
those run privately for public employees. ^^"^ Beneficiaries may be required 
to choose among multiple alternatives, e.g., HMO, PPO, private fee- 
for-service plan, pubhc fee-for-service plan. Any of these alternatives 
may be funded with a mix of public and private revenues. 



bracket taxpayers. See generally Enthoven, Health Tax Policy Mismatch, Health Aff., 
Winter 1985, at 5. The self employed could also be given tax benefits equivalent to those 
of group employees, as proposed in the Improved Access to Health Care Bill, H.R. 
4742, S.2402-S.2403, 99th Cong., 2d Sess. (1986). Such major federal tax changes seem 
unlikely, given that comprehensive reforms have just been legislated. See supra note 48. 

^"See supra notes 11 & 26 for description of uninsurables; on the operation of state 
pools, see Bovbjerg & KoUer, supra note 211. 

^^"The state of West Virginia, for example, has a unique multi-employer group plan 
for public employees that already covers about 1 state resident in 8. The plan began at 
the state level, then expanded to cover local employees. The state is seeking foundation 
funding to study the feasibility of opening the plan to small, private employers as well. 
Remarks of Robert Chehig, West Virginia Public Employees Insurance Board, at Conference 
on Facilitating Health Care Coverage for the Working Uninsured: Alternative Strategies, 
Center for Policy Research, National Governors' Association, in Rosemont, Illinois (De- 
cember 16, 1986). The two main implementation problems are how to prevent free-riding 
by small employers who would have bought coverage anyway and how to prevent adverse 
selection by high-utilizing new enrollees that would drive up the cost of the plan for all 
participants. Some judgmental underwriting (exclusion of bad risks) appears to be required. 
On the problems of pooling small groups, see generally Bovbjerg, supra note 24. 



1986] CARE FOR MEDICALLY INDIGENT 911 

The State of Arizona, for example, has brought a number of these 
different methods together in the Arizona Health Care Cost Containment 
System. ^^^ AHCCCS, as it is known, is a comprehensive program of 
medical services provided to the medically indigent on a prepaid basis. 
Arizona runs the program with federal financial participation in lieu of 
conventional Medicaid. The program is privately administered under a 
state contract set by competitive bidding. The private contractor in turn 
contracts with local health plans for the provision of care, again on a 
prepaid basis through competitive bidding. HMO's, PPO's, and others 
are eligible to bid if they provide the requisite services in the designated 
areas. All providers are required to use primary care gatekeepers. 

Currently, AHCCCS is being run as a demonstration project with 
federal Medicaid waiver authority, and results are not complete. The 
results on quality and access are not yet in, and there is some concern 
that people are not being well enough served. ^^^ However, the state itself 
is encouraged that it is delivering good quality care to a broad section 
of the medically indigent at a price less than that which prevails for 
Medicaid in somewhat comparable sunbelt states. ^^^ The state plans to 
expand AHCCCS to include non-Medicaid ehgibles, including the working 
poor. This approach would mix public and private roles both in funding 
and in administration. 

Numerous other initiatives incorporating these economizing ideas are 
under way at the state and local level, mainly initiated by public or 
quasi-public entities. The Robert Wood Johnson Foundation has sought 
to stimulate such trials with technical assistance and modest "seed 
money. "^^^ 

As a matter of public administration, the need to implement controls 
over medical spending points toward local control because most medical 
markets are local. It is difficult to relate individually to providers or 
patients from a distance. Moreover, integrating new medical assistance 
with public hospital care might also occur more readily at a local level. 
Public "tastes" in welfare spending also vary considerably from place 
to place, certainly among states, and even within them. Some areas are 
well known for high taxes and high benefits, while other areas are known 
for the opposite. 

Local control would also result in more experimentation than a 
national or even a state approach, assuming that the responsible localities 

^^^E.g., J. Christianson & D, Hillman, supra note 204. 

^*^Kirkman-Liff, Refusal of Care: Evidence from Arizona, Health Aff., Winter 1985, 
at 15. 

^*^D. ScHALLER, Arizona Health Care Cost Containment System: Annual Report, 
July 1984- June 1985, at 91-118 (March 1986). 

^^^RoBERT Wood Johnson Foundation, Health Care for the Uninsured Program 
(1985) (grant solicitation materials). 

^^'^See generally P. Fox, W. Goldbeck & J. Spies, supra note 22. 



912 INDIANA LA W REVIEW [Vol. 19:857 

are large enough to support professional management. It is no accident 
that changes in private-sector health insurance occur market area by 
market area, through new entry by HMO's and PPO's and aggressive 
benefits management by large employers, third-party administrators, and 
business coalitions. ^^^ On the other hand, medical indigence is greatly 
affected by state-level decisions on welfare, Medicaid, hospital Ucensure, 
and insurance regulation, as well as by federal ERISA, Medicaid, and 
Medicare rules. Moreover, the ability of jurisdictions to raise revenues 
varies, so a broader approach also makes sense. 

Given the current administration's attitude, the federal government 
appears to be out of the funding picture, although federal legislation 
continues to seek state and private solutions. For example, bills apparently 
to be reintroduced in the 100th Congress would require subsidized state 
high-risk pools, as well as revenue pooling for essential hospital care 
on behalf of those who cannot pay.^^° In any event, the short-term 
political reality, along with tradition and legal theory, suggest that 
combined state-local programs will be the dominant approach in the 
future as in the past.^^' Such approaches can combine state strengths in 
financing, pooling, regulation, and managerial expertise (available directly 
or through technical assistance to localities) with local virtues of provider 
and patient relations and flexible tailoring of programs to local desires 
and needs. 

V. Affording Decent Coverage for the Medically Indigent 

Conventional medical care is expensive, as is the insurance needed 
to cover it. One reason that it costs so much is the widespread belief 
that only the best will suffice (especially when care is heavily insured). 
Such attitudes seem to be changing, and certain economizing measures 
have become acceptable. ^^^ However, no * 'magic bullets" exist that can 
make the same conventional care or coverage affordable for all without 
considerable pubhc subsidy or coercion. ^^^ Even with new economies, 
additional efforts to help the medically indigent will cost more than the 
current patchwork of assistance through Medicaid, public hospitals, reg- 
ulatory requirements, and private charity, and society seems unwilling 
to contribute enough money, individually or collectively.^^"* 



^^In the 99th Congress, these bills were S.2402, S.2403, and H.R. 4742, The Access 
to Health Care Act; see also supra notes 63 & 282. 

^^'See discussion of existing programs, supra notes 132-213 and accompanying text. 

^'^The "buyers' revolution" in health financing has necessitated the acceptance of 
hmits on insurance coverage and on patients' and medical providers' discretion to order 
ever more and more expensive health care. See, e.g., J. Califano, supra note 22. 

^"^^See Bovbjerg, supra note 24, at 416 (same conclusion, for private coverage, vol- 
untarily purchased). 

^^'The most obvious demonstration of unwillingness to pay for medical indigents is 
states' reluctance to expand Medicaid to cover as many medical indigents as that program 



1986] CARE FOR MEDICALLY INDIGENT 913 

Improvements seem to require one or both of two interrelated de- 
velopments—greater willingness to pay or increased acceptance of new 
health '^products" that offer lower but still decent levels of protection 
that people will be wiUing to finance. One major obstacle impedes both 
developments — professional and political desires (and legal expectations) 
for high quality medicine within a so-called single-tier system of health 
care for all, even the medically indigent. 

With regard to willingness to pay, several trends offer some en- 
couragement: 

(1) More information about the plight of uninsured indigents 
should increase willingness to help them. 

(2) Ordinary, middle-class people are increasingly at risk of 
medical indigency — because many have lost well-insured jobs, because 
many are beginning to work in small, less-insured workplaces, because 
high medical spending can exceed what was once a reasonable extent of 
coverage, and because more people are developing adverse medical histories 
that hamper obtaining insurance. Funding an adequate social safety net 
should appeal to those concerned about these risks. 

(3) Finally, new mechanisms are being found to control medical 
spending, ^^^ offering the eventual prospect that a politically attractive, 
streamlined '^product" will indeed emerge. 

New products, the second needed development, must be able to 
implement sensible restrictions on the amount of care available and the 
prices paid in order to maximize the number of people who can be 
covered, even if this means somewhat more restricted access to less 
elaborate care. For those who now have no protection at all, some care 
is better than none. Indeed, existing medically indigent programs are 
experimenting with restricting access to providers, as are many middle- 
class plans. 

Likewise, strong utilization control over the services delivered seems 
reasonable, and it may prove appropriate to insist on less expensive, 
nontraditional providers to cover certain services. It definitely makes 
sense to keep people out of the hospital wherever possible. Something 
Hke the Arizona AHCCCS program, perhaps with even a lesser package 
of benefits, may be appropriate depending on the local situation. Of 
course, any restrictions on providers or coverage can prove difficult to 
implement. Further experimentation is needed here. 

This ongoing search for a decent, even if bare-bones, level of coverage 
is significantly hampered by ethical, professional, and legal reluctance 
to allow lower levels. Anything less than equal care for all is often 
castigated as '^rationing" or unethical * 'second class" care. It faces legal 
impediments as well. 

will reach, even though the federal government pays half or more of the cost. See supra 
notes 236-39 and accompanying text. 

^'^^See supra notes 240-54 and accompanying text. 



914 INDIANA LAW REVIEW [Vol. 19:857 

All the permutations of ethical-professional concern cannot be suc- 
cessfully addressed here. In brief, insisting on single-tier medicine for 
all in practice means eliminating any assistance for many of the least 
fortunate, because currently society demonstrably will not provide un- 
limited funds. Perfection is the enemy of the good here, even in the 
opponents' own ethical frame of reference. ^^^ Society accepts dual stan- 
dards for other charity, whether pubhc or private charity, even with 
regard to fundamental needs like food, housing, and clothing; why not 
in medical care?^^^ Moreover, although today many politicians and prov- 
iders pay lip service to the notion of * 'nothing but the best" for all, 
the reality differs. There are different delivery systems for the insured 
middle class, for veterans, for Indians, and for people using public 
hospitals. Accepting different programs for the medically indigent does 
not seem unthinkable. ^^^ Certainly, Medicaid pays less for physicians 
than do private insurance programs and thus buys much lower access 
for Medicaid patients. Yet, even with Medicaid, those within the eligible 
categories are clearly better off than non-eligibles in otherwise similar 
economic circumstances. 

On a more philosophical level, it is notable that opponents seem to 
like to invoke the spectre of " rationing "^^^ because it connotes denying 
people something to which they are entitled and could get, absent a 
meddling government. ^^^ However, labeling lower but decent care or 
coverage "rationing" is conceptually misleading and politically unhelpful. 
In the case of indigent medical care or coverage, the real argument 
concerns the nature and level of any entitlement; the "rationing" no- 



^^^As argued by one respected academic and advocate of public health programs: 
"[F]inally, the argument is advanced that special programs for poor people are fated to 
become poor programs — always the first for recissions. That argument has served too 
long as the refuge for neglecting poor people altogether." Miller, The Role of Health 
Planning in the Provision of Complex and Not-So-Complex Services, in The Role of 
Health Planning in the Competitive Era 43 (F. Sloan, J. Blumstein & J. Perrin eds. 
forthcoming 1987). 

2'Tor example, although it needs to be safe and fit for habitation, public housing 
need not supply middle class space or amenities. Food stamps cover a minimal diet at 
best, and no specific allowance at all is made for clothing. With regard to private charity, 
people seem to donate used clothing rather than new, and soup kitchens hardly offer 
cuisine competitive with many restaurants. It is true that some health care more immediately 
involves hfe and death than do food or housing, but access to true emergency care is 
not what needs to be Hmited. See also supra note 67. 

^^^Compare, e.g., Rosenblatt, Rationing 'Normal' Health Care: The Hidden Legal 
Issues, 59 Texas L. Rev. 1401 (1981) with Blumstein, Rationing Medical Resources: A 
Constitutional, Legal, and Policy Analysis, 59 Texas L. Rev. 1345 (1981). 

^^hus, for instance, gasoline rationing means queues for all, not merely for the 
poor. Cf Bovbjerg & Held, supra note 233 (prefer "resource allocation" to "rationing" 
as descriptive term). "Rationing" as a term makes more sense if read in its older meaning 
of "offering limited quantities" (as in sailors' "rations" of rum), but the usual connotation 
of the expression is wholly different. 



1986] CARE FOR MEDICALLY INDIGENT 915 

menclature merely assumes entitlement to full equality without dem- 
onstrating it or convincing taxpayers or others to fund it. 

Hence, there are both practical and theoretical reasons for accepting 
separate programs for the poor. Beyond the ethical-political arguments 
He practical legal problems. The law also contemplates equality of care 
for all, at least in that where care is provided, the same malpractice 
^'standard of care" applies regardless of the patient's ability to pay.^^° 
Thus, where care is limited and a bad outcome occurs, providers (and 
insurers, as well) face possible liabihty.^^* In practice, legal exposure 
may reduce coverage because providers and funding jurisdictions may 
prefer to offer no nonemergency service rather than limited service or 
coverage with a liability risk. 

How might liability rules protect the medically indigent without 
threatening willingness to help serve them at an affordable price? Prec- 
edents are not encouraging. Under malpractice law, a ''reasonable mi- 
nority" of practitioners may practice differently from the mainstream, ^^^ 
but the rule is grounded mainly in medical uncertainty, not differences 
in patients' ability to pay. The traditional locality rule, although now 
much eroded, is a second possibility. ^^^ The rule recognized local variation 
in the extent of medical talent and resources available. Some cases 
similarly hold it unnecessary for outlying hospitals to have the latest 
equipment available. ^^"^ Such cases, however, focus on geographic rather 
than economic differences. More to the point is the distinction between 
specialists and general practitioners; specialists have a higher standard 
because they hold themselves out to patients as being more qualified 
(and, presumably, charge more as a result). ^°^ Public coverage that held 
itself out as only a decent minimum might seem analogous, but indigent 
patients have no real alternative, so the rationale is not really comparable. 

Another relevant line of legal thinking — now quite academic and 
somewhat heretical — holds that malpractice law should govern only in 
the absence of contractual agreements specifying desired care (and dispute 
resolution procedures). ^'^^ This approach suggests that different people 



^°°See supra notes 97-98, 107-08 and accompanying text. Cf. Atiyah, Medical Mal- 
practice and the Contract /Tort Boundary, 49 Law & Contemp. Probs. 287, 292-98 (Spring 
1986) (desire for egalitarianism a reason for tort, not contract, to govern malpractice). 

'°'See, e.g., Wickline v. State, 183 Cai. App. 3d 1175, 228 Cal. Rptr. 661, rev. 
granted, 231 Cal. Rptr. 560, 727 P.2d 753 (1986) (issue of liability for bad outcome after 
hospital stay cut short under third-party coverage rules). 

^°'^E.g. A. Holder, supra note 97, at 55-57. 

^°^E.g., Comment, Standard of Care for Medical Practitioners — Abandonment of the 
Locality Rule, 60 Ky. L.J. 209 (1971). 

"^E.g., Pederson v. Dumouchel, 72 Wash. 2d 73, 431 P.2d 973 (1967). 

^"^Naccarato v. Grob, 384 Mich. 248, 180 N.W.2d 788 (1970). 

^°^E.g., Havighurst, Private Reform of Tort Law Dogma: Market Opportunities and 
Legal Obstacles, 49 Law & Contemp. Probs. 143 (Spring 1986). 



916 INDIANA LAW REVIEW [Vol. 19:857 

can choose different levels of care for themselves. It could be argued 
that public beneficiaries had voluntarily accepted the restrictions in the 
program, so long as those restrictions were fully disclosed. However, 
this approach is not fully developed as a conceptual matter, much less 
as an accepted rule of law, and its relevance to poor people with few 
real choices is questionable. ^°^ 

Perhaps the very notion that malpractice law should set the standard 
of care, in the sense of what care should be given, is over-broad. Partly 
through an unfortunate linguistic coincidence, the legal standard of 
"care," which originally meant the degree of carefulness required to be 
non-negligent, has come to mean also what services themselves are 
appropriate. Some rethinking seems called for here. The fact that a 
given insurance program or a given provider simply does not cover long- 
term care, mental health, or transplants — or for that matter, certain 
hospitalizations or hospitals — does not seem to be a failure of "care." 
It seems rather a personal or social judgment about the appropriate use 
of limited resources. 

Malpractice rules and judicial process seem better suited to deter- 
mining whether a technical mistake or oversight occurred than to deciding 
broader coverage issues. Thus, one solution to the problem might be 
to establish a program that defines and is limited to specific medical 
services and gives malpractice immunity to those who carefully provide 
those services. Whether the jurisdiction(s) establishing such a program 
can immunize themselves is another question. 

VI. Conclusion 

The main problem for the medically indigent is that they do not 
have enough money. And the main problem with health coverage for 
the indigent is that neither they themselves, their employers, nor their 
government(s) have bought them adequate protection. Medical providers 
have limited ability to provide charity care. Consequently, the medically 
indigent are disadvantaged in their access to medical care. 

This Article has discussed various ways of organizing and financing 
coverage or care for the medically indigent. More public and private 
resources must be raised through some combination of taxation, regu- 
lation, and increased voluntary payment. The effort needed for even 
medium-level assistance is significant, perhaps $15-20 billion in the first 
year, or as much as states already spend on Medicaid. 

If society in its various components is not wiUing to fund universal 
coverage of a conventional kind — and it currently is not — then society 
must settle for less, but in a constructive fashion. It must define a lesser 
but decent health "product," preferably in a subsidized, insurance-hke 

^°'Atiyah, supra note 300. 



1986] CARE FOR MEDICALLY INDIGENT 917 

form that offers beneficiaries choice among competing providers. Prov- 
iders who participate in improving care for the indigent deserve praise, 
not malpractice suits for dehvering only the care that is covered. They 
should receive protection from tort claims of misfeasance when they 
have in fact carefully complied with social norms of adequacy as reflected 
in coverage rules. 

The need is urgent and the time to begin is now. It is better to 
start with a reasonable minimum, with the hope of later expansion, than 
to hold out for optimal plans that may never come to pass. Further 
arguing about "rationing" of care to the poor or the ethics of "two- 
tier" medicine merely postpones difficult coverage decisions, to the clear 
disadvantage of the medically indigent. 



state Hospital Cost Containment: An Analysis of 
Legislative Initiatives 

Carl J. Schramm* 

As a result of the success of various state efforts at containing 
hospital cost inflation and the encouragement such efforts have received 
in recent federal legislation directed at reducing Medicare costs, ^ a second 
wave of state initiatives directed at regulating hospital revenues appears 
to be breaking out in legislatures across the land. In 1983, three states 
enacted mandatory hospital rate-setting legislation.^ In 1984, at least ten 
legislatures considered similar proposals. It has been suggested that in 
the next few years over half of the states will have adopted such 
measures.^ 

Observation of several recent legislative campaigns suggests an in- 
teresting similarity of parties, interests, tactics, arguments, and outcomes 
common to such efforts. Unlike many areas of public action where a 
small number of interests are contesting for resource control, any change 
involving hospitals has an immediate impact on a large number of groups. 
This Article attempts to identify the parties interested in state efforts 
to reform hospital financing mechanisms. It also describes the likely 
arguments and positions of each party, the dynamics of the various 
legislative tactics, and the probable outcomes. 

This analysis is based on the author's experience and observations 
from 1980 to 1985 in eighteen states where hospital rate setting has been 
either: 1) successfully established by legislation, 2) enacted but not given 
hfe as an operating program, 3) considered by the legislature but not 
enacted, or 4) the focus of formal study by a gubernatorial or legislative 
task force or work group. '^ Because hospital rate setting has been the 



*Director, John Hopkins Center for Hospital Finance and Management; Lecturer, 
University of Maryland School of Law; Former Vice Chairman, Maryland Health Services 
Cost Review Commission. Ph.D., University of Wisconsin, 1973; J.D., Georgetown Univer- 
sity Law Center, 1978. 

'Social Security Amendments of 1983, Pub. L. No. 98-21, tit. VI, §§ 601 et seq., 
97 Stat. 65 (codified as amended at 42 U.S.C. §§ 1395ww(b), (d) (1982 & Supp. 1985)). 

The three states were: Maine, Me. Rev. Stat. Ann. tit. 22, § 381 (West Supp. 
1986); Maryland, Md. Health Gen. Code Ann. § 19-209 (Supp. 1986); and Wisconsin, 
Wis. Stat. Ann. §§ 54.01 et seq. (West Supp. 1986). 

^See generally Intergovernmental Health Policy Project, State Health Notes (D. 
Merritt ed. March 1985). 

*See Am. Hosp. Ass'n, State Rate-Setting Legislation: Legal Issues in the 
negotla.tion and implementation of a statute (1984); intergovernmental health 
Policy Project, The Status of Major State Policies Affecting Hospital Capital 
Investment (1984); Nat'l Conference of State Legislatures, Health Care Cost Con- 
tainment Legislation: 1983 Legislative Update Fifty States (1983); Nat'l Conference 
of State Legislatures, 1984 State Health Care Cost Containment Legislation (1984); 

919 



920 INDIANA LAW REVIEW [Vol. 19:919 

object of legislative action or governmental study in approximately twenty- 
three states,^ the experience reported here, while representative, is not 
comprehensive. 

I. Background on State Legislation 

A. Forces for Reform 

It is clear that the nation is struggling with the problem of unac- 
ceptable hospital costs. Evidence suggests that the health care delivery 
system is operating inefficiently.^ Since the passage of the Medicare 
diagnostic-payment system in 1983,^ falling hospital occupancy through- 
out the nation suggests that hospitals have in fact been overutilized.^ 
Moreover, the large increase in the number of physicians entering the 
system^ and the increasing age of the population'^ add a sense of urgency 
to the search for some means of reducing, or at least holding in check, 
the growth of the health care enterprise. Largely because hospitals are 
the most visible entity in the delivery system and have had the fastest 
relative increase in unit prices and absolute budgets, '^ they have been 
singled out as the object of public and private policy aimed at reducing 
overall health expenditures. 

Partly as a response to the entry of government as a significant 



Schramm, Wren & Biles, Controlling Hospital Cost Inflation: New Perspectives on State 
Rate Setting, 5 Health Aff. 22, 23 (1986). 

^See supra note 4 and accompanying text. Previous model state hospital legislation 
has been the basis for several legislative proposals and underlies the recently enacted West 
Virginia legislation. Schramm, A State-Based Approach to Hospital Cost Containment, 
18 Harv. J. ON Legis. 603, 658-78 (1981). 

^See, e.g., Dep't of Health & Human Services, Hospital Prospective Payment 
FOR Medicare: Report to Congress Required by the Tax Equity and Fiscal Re- 
sponsibility Act of 1982 i-iii (1982); Dep't of Health & Human Services, Office of 
Ass't Secretary for Planning & Evaluation, Hospital Capital Expenses, A Medicare 
Payment Strategy for the Future: Report to Congress 1-33 (1986); Prospective 
Payment Assessment Comm'n, Medicare Prospective Payment and the American 
Health Care System: Report to the Congress 9-11 (1986) [hereinafter ProPAC Report 
ON the American Health Care System]. 

'Social Security Amendments of 1983, Pub. L. No. 98-21, tit. VI, §§ 601 et seq., 
97 Stat. 65 (codified as amended at 42 U.S.C. § 1395ww(d) (1982 & Supp. 1985)). 

*ProPAC Report on the American Health Care System, supra note 6, at 19- 
20. 

^See generally The Coming Physician Surplus (E. Ginzberg & M. Ostow eds. 
1984). 

^°See generally Fuchs, "Though Much is Taken": Reflections on Aging, Health, and 
Medical Care, 62 Milbank Mem. Fund Q. 143 (1984). 

"Gornik, Greenberg, Eggers & Dobson, Twenty Years of Medicare and Medicaid: 
Covered Populations, Use of Benefits, and Program Expenditures, Health Care Fin. 
Rev. 13, 43 (Supp. 1985) [hereinafter Twenty Years of Medicare and Medicaid]. 



1986] COST CONTAINMENT 921 

payer of health care costs through Medicare and Medicaid, hospital 
prices have grown at a rate outstripping that of all other goods and 
services in the economy.'^ Consequently, it is not surprising that gov- 
ernment has been the most active party attempting to reduce overall 
hospital cost inflation. Government interest is founded on two bases: 
government is attempting to react to the complaints of citizens about 
a poHtically sensitive issue, and government, as a payer itself through 
Medicare and Medicaid, is directly affected in its own budgets by cost 
inflation in hospital services. 

Governmental approaches to the problem of inflation in certain 
markets can generally be characterized as regulatory in nature, i.e., a 
public agency typically becomes the mechanism by which prices are 
determined.'^ However, in the case of hospital costs, government has 
actively sought non-regulatory answers as well, including the establishment 
of alternative providers of care such as health maintenance organizations 
(HMO's) and the encouragement of financing mechanisms that result in 
more rational economic choices by consumers. The latter approach stim- 
ulates insurers to increase the presence of coinsurance and deductibles 
and to pay for second opinions in order to reduce the incidence of 
unnecessary surgery. •'* 

Recently, however, concern with reducing costs in health and hospital 
care has grown so widespread that a larger number of private parties 
have taken an active role in influencing hospital prices. These include 
employers, unions, and health insurance companies. In response, prov- 
iders, including hospitals and physicians, have unsuccessfully attempted 
voluntary price restraint as one possible solution.'^ 

While there is widespread concern that hospital prices are rising too 
rapidly, few agree on how the problem should be attacked. However, 
several goals seem to be uniform objectives. The first is reducing the 
rate of increase in hospital cost inflation.'^ This has been the most 
widely accepted policy objective, largely because hospital prices have 
been rising faster than prices for other goods and services.'^ 

In more recent years a second goal has become important, namely, 
reducing absolute levels of spending on health care. This objective began 



^^See, e.g., Levits, Lazenby, Waldo & Davidoff, National Health Expenditures, 1984, 
Health Care Fin. Rev., Fall 1984, at 1, 8 [hereinafter National Health Expenditures, 
1984]; Prospective Payment Assessment Comm'n, Report and Recommendations to 
THE Secretary 12-13 (1985) [hereinafter ProPAC Report to the Secretary, 1985]. 

^^See generally S. Breyer, Regulation and Its Reform 15-35 (1982). 

^*See ProPAC Report to the Secretary, 1985, supra note 12, at 13. 

^^See, e.g.. Am. Hosp. Ass'n, 1978-79 Goals of the Voluntary Effort (1979). 

'^Biles, Schramm & Atkinson, Hospital Cost Inflation Under State Rate-Setting 
Programs, 303 N. Eng. J. Med. 663 (1980). 

"Twenty Years of Medicare and Medicaid, supra note 11, at 16-17. 



922 INDIANA LAW REVIEW [Vol. 19:919 

to emerge with the recession of the early 1980's and with the immense 
growth of the federal deficit.'^ Related to reducing absolute levels of 
spending is the goal of reducing per capita spending on health care.*^ 
The emergence of these goals suggests that merely to reduce the rate 
of change in hospital prices, or to cut back levels of spending, is to 
avoid the issue of the drift of real wealth into the health care sector 
from other areas of social enterprise. The twofold growth of GNP shares 
consumed by the health sector in the post-Medicare era is evidence that 
wealth drift is the operative issue of concern. ^° 

Therefore, the objective of those concerned over rising health care 
costs is some effective solution to the problem. While many have argued 
that competitive or market-based solutions offer the best hope of reducing 
the health care cost problem^' — and, to be sure, increased competition 
in health care markets in the next few years will be observed — others 
believe it is inevitable that government will be the prime mover in 
restructuring the reimbursement system. ^^ Government may act to reduce 
its own budget exposure and it may act for broader motives such as 
ensuring an orderly and politically acceptable allocation system. 

B. The Road to Legislation — Four Premises of State 

Regulation 

The first premise of government efforts to reduce costs is that 
legislative intervention and guidance are necessary if any system-wide 
change is to come about. For over a decade, hospital costs have been 
termed a serious, even critical, problem by many private interests. How- 
ever, until very recently, there has been no evidence of any consensus, 
let alone action, among private sector actors. While there are increasing 
signs that some employers have taken an active interest in reducing 
health care costs, ^^ it seems hkely that government action will be necessary 



'^The deficit in the federal budget increased from $59.6 billion in fiscal year 1980 
to an estimated $207.7 billion in fiscal year 1983. Office of Management & Budget, 
Fiscal Year 1982, Budget Revisions, March 1981, at 11; Office of Management & 
Budget, Budget of the United States Government, Fiscal Year 1984 Mil (1983). 

^'^See National Health Expenditures, 1984, supra note 12, at 15-19; see also M. 

ZUBKOFF, I. RUSKIN «fe R. HaNFT, HOSPITAL CoST CONTAINMENT 579-85 (1977). 

^"Schramm, Can We Solve the Hospital-Cost Problem in Our Democracy? , 311 New 
Eng. J. Med. 729 (1984). 

^'See generally A. Enthoven, Health Plan: The Only Practical Solution to the 
Soaring Costs of Health Care 70-92 (1980). 

^^See generally Davis & Rowland, Medicare Reform Options, in Reshaping Health 
Care for the Elderly: Recommendations for National Policy (C. Eisdorfer ed., 
forthcoming). 

^^See, e.g.. The Corporate Rx for Medical Costs: A Push for Revolutionary Changes 
in the Health Care Industry, Business Week, Oct. 15, 1984, at 138-41. 



1986] COST CONTAINMENT 923 

to Stimulate and channel change and to ensure that whatever change 
occurs serves the public interest. 

The second premise is that the forum of policy change will be the 
legislature. Over the last ten years, the executive branch has not developed 
a solution acceptable to a sufficiently large coalition of interests; con- 
sequently, the executive branch has forfeited control of the health care 
cost issue to the legislature. Issues that do not yield to consensual solution 
within the executive branch must be solved, if at all, in the legislative 
branch. Moreover, the legislature, because it effectively controls the 
spending power and is responsible for taxing, has been required to act 
on health care costs from a budget perspective. Clearly, at the federal 
level, it was Congress that created the Omnibus Reconciliation Act in 
1981, changing Medicaid programs substantially,^"^ that fashioned the 
overall hospital spending limits in the Tax Equity and Fiscal Responsibility 
Act of 1982,^^ and that radically reformed the payment system by 
instituting diagnosis-related payment for Medicare in the Social Security 
Amendments of 1983.^^ 

The third premise is that state legislatures have become equal to the 
Congress in developing new legislative approaches to the health care cost 
problem. As the federal ability to control rising health care costs seems 
less apparent, states have moved independently to control inflation. ^^ Of 
course, the states retain regulatory jurisdiction over the hospital industry 
and can co-regulate with the federal government. But more important 
than constitutional authority is the rationale on which state action rests. 
Fundamentally, state authority is based on the economic dependence of 
hospitals on revenues generated in the state and on the nature of the 
hospital as a firm. Once Medicare and the federal share of the Medicaid 
program are removed, sixty percent of hospital revenues come from 
local sources. ^^ In addition, because of the typical non-profit, charitable 
nature of the hospital, the state's interest in regulation is heightened. 
Thus, the economic rationale for state intervention seems well-established. 

The final premise is that state legislatures may be the preferred 
policy locus. Because the nature of the cost problem varies substantially 
from state to state, both in terms of its magnitude and its causes, and 
because the constellation of actors and the strength of the various interest 



"^See Omnibus Reconciliation Act of 1981, Pub. L. No. 97-35, tit. XXIII, §§ 2161- 
2184, 95 Stat. 357 (codified as amended at 42 U.S.C. § 1396n (1982 & Supp. 1985)). 
^Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, § 101(a)(1), 

96 Stat. 331-36 (codified as amended at 42 U.S.C. §§ 1395ww(a), (b) (1982 & Supp. 
1985)). 

^^Social Security Amendments of 1983, Pub. L. No. 98-21, tit. VI, § 601 et seq., 

97 Stat. 65 (codified as amended at 42 U.S.C. § 1395ww(d) (1982 & Supp. 1985)). 

^^See Schramm, supra note 5, at 632-41. 

^^Gibson, Waldo & Levit, National Health Expenditures, 1982, 5 Health Care Fin. 
Rev. 1, 19 (1983). 



924 INDIANA LAW REVIEW [Vol. 19:919 

groups are different in each state, state legislatures are presumably more 
likely to craft acceptable solutions to meet local demands. Moreover, 
in our federal system, experience with a wide variety of state initiatives 
has the potential of increasing the development of more effective ap- 
proaches to the problem of health care costs. ^^ 

Overarching each of the foregoing, however, is a fundamental concept 
of what role regulation plays in society. While many arguments have 
been advanced as to why regulation exists, it seems clear that in the 
case of economic regulation, the state is engaged in balancing interests 
that are not satisfactorily arbitrated in the market. ^° In response to actual 
or perceived market malfunction, the state enters to establish a distri- 
butional scheme (mainly by controlling entry and setting acceptable prices) 
that more adequately reflects an articulated social interest in the outcome 
of the economic exchange under scrutiny. In return for accepting a state 
presence, which necessarily reduces the discretion of the regulated en- 
terprise, the state ensures some degree of security to the regulated entities. 
This quid pro quo reflects the fundamental nature of regulation: a 
formalized bargain where society exacts more acceptable behavior from 
the regulated firm in return for a promise of protection from some 
features of the unregulated marketplace.^^ Contemporary theory in state 
legislatures appears grounded on this exchange theory as opposed to the 
prevailing federal theory of unilateral delegation. 

C. Primer on State Hospital Regulation 

Modern state efforts at regulating the hospital industry began in the 
late 1960's.^^ In several states, controlling hospital cost inflation emerged 
as a matter for public concern and eventual legislation because of the 
public cost of care for the poor. In New York, where publicly supported 
care of the poor imposes a higher tax-related burden than in any other 
jurisdiction, inflation in hospital costs became a major issue in budget 
debates of the late sixties when it was apparent that New York City 
was close to financial collapse." As part of the solution imposed by 
financiers, major reductions in spending, including for health care, were 
necessitated. Thus, the state established a program to supervise the 



^'^See Biles, Schramm & Atkinson, supra note 16. 

^°Breyer, Analyzing Regulatory Failure: Mismatches, Less Restrictive Alternatives, 
and Reform, 92 Harv. L. Rev. 549, 553 n.l7 (1979). 

^'See Stigler, Theory of Economic Regulation, in Perspectives on the Administrative 
Process 81 (R. Rabin ed. 1979); Wilson, The Politics of Regulation, in Perspectives on 
THE Administrative Process 90 (R. Rabin ed. 1979). 

^^See generally Schramm, Wren & Biles, supra note 4, at 22. 

"Health Care Financing Admin., U.S. Dep't of Health & Human Services, 
National Hospital Rate Setting Study, Vol. VII: Case Study of Prospective Reim- 
bursement IN New York 2-8 (1980). 



1986] COST CONTAINMENT 925 

budgets of all hospitals, attempting to reduce spending for all payers, 
including Medicaid. ^^ 

The second state to establish a hospital cost containment program 
was Maryland, where hospital trustees were concerned that inner-city 
hospitals dealing with a higher-than-average caseload of indigent patients 
were in a state of fiscal stress and might be forced to close. As a result, 
trustees of the state's hospitals petitioned the legislature for an agency 
that would reduce hospital spending for all payers and distribute the 
expense of deUvering care to the poor among all patients by estabhshing 
a uniform rate.^^ 

In these two programs the seeds of the hospital regulation movement 
were planted. In both, the state stepped in to protect both the citizens 
who ultimately pay for care and the hospital system from financial 
insolvency related to uncompensated care. In each instance, the system 
of budget discipline imposed on the hospital was prospective payment 
for all care provided over a given period. Also, in both states all payers 
for care were made to pay the same price, thus allowing the costs of 
care provided to the poor to be redistributed over the entire patient 
population. 

Shortly after the New York and Maryland legislatures established 
their programs, four other states initiated prospective hospital cost- 
containment programs. ^^ Three of these states, Connecticut, Massachu- 
setts, and New Jersey were in the northeast, where state legislatures had 
created substantial Medicaid programs in the mid-sixties. Because of the 
balanced budget requirements of state constitutions and recession-con- 
nected declines in tax revenues, these states were interested in reducing 
hospital cost inflation from a budgetary perspective. Another goal of 
the legislation was that both consumers and hospitals would benefit from 
a system that rationalized payment schemes among payers such that all 
citizens profited from reduced spending on hospital care. 

Because of varying delays in collecting necessary financial infor- 
mation, all six states began regulating hospital rates at virtually the same 
time. Examination of the regulatory period from 1976 to the present 



^''1965 N.Y. Laws 795 (codified as amended at N.Y. Pub. Health Laws § 2807 
(McKinney 1985 & Supp. 1986)). 

"See 1971 Md. Laws 627 (codified as amended at Md. Health-Gen. Code §§19- 
201 to 19-220 (Supp. 1985)). 

'*The states were Connecticut, 1973 Conn. Acts 117 (codified as amended at Conn. 
Gen. Stat. Ann. §§ 19a-145 to 19a-166 (West 1986)); Massachusetts, 1973 Mass. Acts 
1229 (codified as amended at Mass. Gen. Laws Ann. ch. 6A, §§ 31-77 (West 1986)); 
New Jersey, 1971 N.J. Laws 136; 1978 N.J. Laws 83 (codified as amended at N.J. Stat. 
Ann. § 26:2H-4.1 (West Supp. 1986)); and Washington, 1973 Wash. Laws ch. 5 (codified 
as amended at Wash. Rev. Code Ann. §§ 70.39.030 to 70.39.910 (West 1975 & Supp. 
1986)). 



926 INDIANA LAW REVIEW [Vol. 19:919 

has consistently shown statistically significant reductions in the rate of 
hospital cost inflation in the regulated states. ^^ It is these data that in 
part account for the growing interest in hospital regulation at the state 
level. 

D. State Activity to Date and its Classification 

After nearly fifteen years, there are now several types of formal 
state-level initiatives to control hospital costs. The most extensive, typified 
by the first six states, is the regulation of total hospital revenues and 
the rates that all payers in the state are charged for care. In 1983, 
Maine, West Virginia, and Wisconsin enacted statutes similar to those 
in effect in the original six states. ^^ 

A second group of states are those that supervise hospital rates but 
do not have authority to set them. For example, in Florida, a public 
body exists to collect hospital price information and to disclose it publicly. ^^ 
A third type of statute merely requires reporting of information on 
hospital prices to a state agency, which in turn may publish the infor- 
mation. "^^ While it is still too early to judge the latter two types of 
efforts, ample evidence suggests that cost-containment programs are 
effective in direct proportion to the amount of government power vested 
in the regulating agency. Mere disclosure, for example, cannot be expected 
to be effective where consumers are fully insured against the costs of 
care. 

II. The Parties and Their Interests 

A. The Identities and Interests of the Twelve Groups 

Most matters considered by legislatures evoke the attention of only 
two or three groups affected by a proposal. The groups include pro- 
ponents (often private citizen/consumers, businesses, social reformers, 
and the executive departments of government) who seek legislative action 
on their behalf or on behalf of their cause; unqualified opponents of 
the proposal; and those who will be marginally disadvantaged by the 
measure and oppose its passage until the offending features have been 
discarded. When proposals that would limit hospital revenues are under 
consideration, however, at least twelve parties with distinguishable in- 
terests have been observed to take active roles. The presence of many 
interest groups makes the consensus necessary for the passage of leg- 

"Biles, Schramm & Atkinson, supra note 16. 

''See Me. Rev. Stat. Ann. tit. 22, § 381 (West Supp. 1986); W. Va. Code §§ 16-5F-1 
to 16-5F-6 (1985); Wis. Stat. Ann. §§ 54.01 et seq. (West Supp. 1986). See Appendix for 
a summary of a variety of state efforts. 

""See Fla. Stat. Ann. §§ 395.501-395.514 (West 1986). 

"^See 1971 Cal. Stat. 1242. 



1986] COST CONTAINMENT 927 

islation problematic for two reasons: the process of multilateral nego- 
tiations is cumbersome and expensive, and the number of issues in 
dispute is extremely large. 

As a result of the large number of interested parties, hospital rate- 
setting proposals present a curious legislative phenomenon; namely, un- 
predictable coalition behavior among the interest groups depending on 
the positions they adopt from state to state. Indeed, several of these 
groups have taken diametrically opposing positions in different juris- 
dictions. Compounding matters is the unpredictable identity of the "in- 
itiator" party from state to state. 

What follows is a description of the interest groups and their re- 
spective positions on the question of regulating hospital revenue. The 
order in which they are presented does not reflect their importance to 
the legislative process. Once the groups and their causes are identified, 
the possible initiators of legislation are examined. Finally, the coalition 
behavior of the parties is explored and likely legislative outcomes — which 
ultimately depend on the nature and number of parties forming the most 
forceful coalition — are discussed. 

1. Community Hospitals. — This group is composed of non-profit or 
voluntary, acute care community hospitals. More specifically, the interest 
group represents the position of professional administrators working in 
these hospitals. Their interests can often be distinguished from those 
who have a stake or interest in the hospital and its continued existence; 
for example, hospital trustees. As will be discussed in more detail below, 
community hospital trustees have traditionally represented what might 
be thought of as a long term local interest in the hospital. 

The American Hospital Association (AHA), the national interest 
group whose membership is overwhelmingly composed of hospital chief 
executives, has vigorously resisted the adoption of rate setting. Reduced 
to its essence, the position of the AHA is based on the criticism that 
regulation reduces the managerial discretion of the professional admin- 
istrator.'^^ Professional administrators recognize that their interests might 
diverge from those of trustees, and the AHA has attempted to influence 
hospital trustees to its way of thinking. For example, the Association 
has established a separate trustee educational effort and has founded a 
magazine designed to influence trustees' perspectives.'*^ 

2. Hospital Trustees.— TiVi^iQQS are more closely connected to the 



""See Hearings Before the Subcomm. on Health of the Senate Comm. on Finance 
on State Hospital Payment Systems, 97th Cong., 2d Sess. 236 (1982) (statement of the 
American Hospital Association); Knieser, Free Market System Is Still the Best Answer, 
56 Hospitals 31 (1982); see also Am. Hosp. Ass'n, supra note 4; Am. Hosp. Ass'n, How 
States Can Opt Out of the Federal Medicare DRG System: A Summary of Legal 
Issues (1983). 

"•^This magazine is Trustee, published monthly by the American Hospital Publishing 
Co. 



928 INDIANA LAW REVIEW [Vol. 19:919 

hospital's role in the community than many of the individuals who work 
in the hospital every day. To the extent that the hospital is viewed as 
a community-owned resource, often based literally on a financial trust 
dedicated to community welfare, trustees may view themselves as the 
custodians of a very special community asset. 

In contrast to the essential '^localness" of the trustee's interests, 
professional administrators participate in national labor markets, and 
their allegiance to a given institution often appears minimal. Whereas 
administrators, qua professionals, view themselves as important to the 
orderly functioning of the nation's hospitals, trustees represent community 
concerns and continuity of interest in the fortunes and successes of a 
local institution. Thus, from time to time, one can observe a clear 
divergence of interest between trustees and professional hospital lead- 
ership. 

In the case of rate setting, a state presence may be desirable or at 
least less threatening to trustees who are members of the community 
elite and can informally make their voices heard in government circles. 
In Maryland, trustees initiated the movement that ultimately resulted in 
the creation of a state agency with authority to set hospital revenue 
limits; they saw government as the only means to distribute equitably 
the burden of uncompensated care and thus preserve the hospital system 
in a time of significant economic stress. Administrators, who as outsiders 
do not enjoy comparable government access, tend to view rate setting 
as an affront to their professional competence in making decisions related 
to hospital resource use."*^ 

3. For-Profit Hospitals. — For-profit hospitals, whose political im- 
portance varies enormously from state to state depending on the share 
of hospital services provided by investor-owned hospitals, have always 
opposed rate-setting legislation. The basis of their opposition seems 
obvious; in regulated markets, firms have their profit level determined 
by a regulatory agency which customarily ties approved rates to actual 
costs of production plus a rate~of-return on investment. In such systems, 
investor-owned hospital executives believe that the freedom to seek max- 
imum profit is removed. It appears that the resistance for-profit hospitals 
offer to state-level proposals to hmit hospital revenue has little to do 
with the number of for-profit hospitals within a jurisdiction. Rather, 
the behavior of for-profit hospitals toward new rate-setting proposals 
suggests that the for-profit industry operates with the domino theory in 
mind — each additional state adopting hospital regulation, even if there 
is no significant investor-owned market share, increases the Hkelihood 
of regulation in other states. ^^ 



*^See Jolly, Election Post-Mortem: Arizona Hospital, Business Health Cost Fight 
Fizzles, Bus. «fe Health, March 1985. 

**See Statement by Cyndee Eyster, Director of State Legislation, Federation of 
American Hospitals, to the Special Committee on Health Care Cost Containment and the 



1986] COST CONTAINMENT 929 

4. Blue Cross. — Blue Cross plans were founded by hospitals as non- 
profit insurance schemes by which patients would fund hospital care 
through premiums/^ As such, most state Blue Cross plans operate as 
specially chartered, non-profit, tax-exempt entities. Over the years, be- 
cause of the close link between hospitals and Blue Cross (until the last 
decade overlapping boards of directors were common), ^^ Blue Cross plans 
with larger market shares have enjoyed significant discounts from hospital 
charges in paying for their subscribers' care/^ To the extent that rate- 
setting legislation would set hospital prices evenly among all payers, in 
an attempt to shift bad debt equitably among all hospitals and patients. 
Blue Cross will find the proposal objectionable because it will result in 
a major inhibition to maintaining what Blue Cross considers competitive 
rates /^ 

5. Commercial Insurers. — Because commercial insurance companies 
do not have direct contracts with providers as do Blue Cross plans 
(where the subscriber/patient stands legally as a third party beneficiary), 
but rather indemnify the insured/patient, they have not been able to 
extract discounts from hospitals. Commercial health carriers argue that 
as a result, virtually every other payer— because they contract directly 
with hospitals on behalf of a pool of patients, albeit an uncertain and 
unpredictable pool from the perspective of any one hospital — is able to 
extract some discount from hospital charges. Thus, commercial carriers 
argue that hospital administrators, in order to meet the demands for 
discounts made by direct payers (Blue Cross, Medicare, Medicaid, and 
workers' compensation), pass on the costs of this practice to those 
patients who pay full charges and seek indemnification from their in- 
surers. ^^ The practice of imposing higher charges on commercially insured 
patients, commonly referred to as cost-shifting, operates to disadvantage 
the indemnification carriers by raising their claims expenses. As a result, 
commercial insurers generally endorse cost-containment proposals which 
promise the equitable treatment of all payers. 

6. Medicaid. — Every state except Arizona established a Medicaid 
program shortly after Congress passed the federal act in 1965.^^ Under 
the statute. Congress provided that roughly half of all costs of state 
programs would be met from the federal treasury provided that state 
programs included certain minimum benefits. ^^ During the 1970's, Med- 

Human Resources Committee of the National Conference of State Legislatures (September 
1984). 

''^S. Law, Blue Cross: What Went Wrong? 6-25 (2d ed. 1976). 

"^See, e.g., Weller, "Free Choice'' as a Restraint of Trade in American Health Care 
Delivery and Insurance, 69 Iowa L. Rev. 1351, 1370-71 (1984). 

"''S. Law, supra note 45, at 1-5. 

^«Ginzburg, Hospital Cost Shifting, 310 N. Eng. J. Med. 893, 895-96 (1984). 

'^Id. at 897. 

^Twenty Years of Medicare and Medicaid, supra note 11, at 16. 

^'Social Security Amendments of 1965, Pub. L. No. 89-97, tit. I, §§ 121-122, 79 
Stat. 343 (codified as amended at 42 U.S.C. §§ 1396 et seq. (1982 & Supp. 1985)). 



930 INDIANA LAW REVIEW [Vol. 19:919 

icaid programs felt the financial strain of hyper-inflation in peculiar 
ways. State revenue is often more sensitive to general economic conditions 
because of sales tax, and the recessionary conditions of the seventies 
reduced state income substantially." In states with relatively generous 
Medicaid programs, inflation in health care costs and a growing number 
of beneficiaries caused Medicaid expenditures to become a major part 
of state budgets by the 1970's.^^ 

State budget officers have long seen Medicaid as particularly im- 
portant to the fiscal condition of the state and have pressured Medicaid 
programs to reduce expenditures. Because federal law requires only 
minimum benefits and state enactments often expand the minimum, 
policy attempts to reduce costs have basically focused on three avenues. 
The first is to reduce the number of beneficiaries by readjusting eligibility 
standards for program coverage. ^"^ The second has been to pressure 
providers into giving Medicaid discounts against either charges or costs. 
These discount approaches have proceeded directly, for example by 
Medicaid unilaterally determining that it will not pay for inpatient care 
after, say, the twentieth day of hospitalization, or indirectly, by not 
increasing the payment for physician visits from amounts established as 
long as a decade ago.^^ The third approach has been to advance plans 
that would reduce the rate of inflation of costs in order to lessen the 
growth of the Medicaid expenditure from year to year.^^ 

While governors may feel obliged to be sympathetic to the interests 
of hospitals and others who might be harmed by regulation, the condition 
of state budgets imposes a certain unavoidable demand on executives' 
allegiance. While cases exist where a state health department has publicly 
assumed a position on rate setting contrary to an executive's, such 
situations are rare and generally change once the governor imposes 
executive discipline. 

7. Medicare. — For the most part, the federal government's role in 
the rate-setting debate at the state level has been minimal. In 1972, 
Congress sanctioned state hospital cost containment initiatives when it 
offered a waiver of Medicare reimbursement principles to those states 
experimenting with rate regulation. ^^ Under this authority, several of the 



"The Reagan Experiment: An Examination of Economic and Social Policies 
Under the Reagan Administration 157-219 (J. Palmer & I. Sawhill eds. 1982). 

"Wing, The Impact of Reagan-Era Politics on the Federal Medicaid Program, 33 
Cath. U. L. Rev. 1 (1983). 

5^R. BOVBJERG & J. HOLAHAN, MEDICAID IN THE ReAGAN Era: FEDERAL POLICY AND 

State Choices 25-32 (1982). 

"Intergovernmental Health Policy Project, Recent and Proposed Changes in 
State Medicaid Programs: A Fifty State Survey (1983). 

^^R. BovBjERG & J. HoLAHAN, supra note 54, at 38-45. 

"Social Security Amendments of 1972, Pub. L. No. 92-603, tit. II, § 222, 86 Stat. 
1390. 



1986] COST CONTAINMENT 931 

rate-setting states were granted Medicare waivers in which the federal 
government agreed to pay its Medicare obHgations according to the rate 
schedule set by the state agency. In 1983, Congress mandated that if 
certain requirements were met by a state rate-setting agency, the Secretary 
of Health and Human Services, acting through the federal Health Care 
Financing Administration (HCFA), must grant a waiver to the applicant. ^^ 
Notwithstanding the nondiscretionary nature of this congressional di- 
rective, the Reagan Administration, acting through the Office of Man- 
agement and Budget, has taken a decidedly hostile approach to Medicare 
waivers. ^^ The Administration seems to perceive rate setting as an ob- 
jectionable advance of regulation in society and to believe that it should 
not be encouraged as a matter of poHcy. 

Medicare's non-participation may influence state legislation regarding 
rate setting in the future. To the extent that rate setting is attractive 
because it imposes the same rate schedule on all payers, thus making 
all payers share equally in uncompensated care, federal participation is 
critical. Apart from its philosophical objection, the Reagan Adminis- 
tration does not support the waiver option because of its perception 
that Medicare expenditures have been higher in waiver states than they 
would have been under normal Medicare reimbursement methods. ^° Not- 
withstanding evidence to the contrary,^* it remains to be seen whether 
the Administration will attempt to revoke federal participation in existing 
waivers or grant waivers to the new rate-setting states. 

8. Business. — In recent years, business leaders have become increas- 
ingly active in the debate over solving hospital costs. Indeed, the interest 
of business has served to refocus the problem away from concern over 
hospital cost inflation to concern over both the absolute level of hospital 
prices and aggregate hospital spending in a given community. ^^ Business 
has joined other interests, most notably organized labor, in an attempt 
to force a discussion of what might be done in the community to reduce 
total hospital budgets. In many cases, employers have acted to reduce 
actual claims expense. ^^ Generally this action has involved pressuring 
hospitals and Blue Cross plans to reduce both utilization by employees 
and the unit prices charged by the hospital to employees. 

This movement is significant because it represents the first time a 



^«Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, tit. I, 
§ 101(a)(1), 96 Stat. 334 (codified at 42 U.S.C. § 1395ww(c) (1982 & Supp. 1986)). 
^"^See, e.g., Washington Report on Medicine and Health, Oct. 29, 1984, at 38. 

•^'S. Renn, The Efficacy of Waivers (1984) (unpublished paper. The Johns Hopkins 
Center for Hospital Finance and Management). 

''See generally The Corporate Rx for Medical Costs: A Push for Revolutionary 
Changes in the Health Care Industry, Business Week, Oct. 15, 1984, at 138-41. 

"See, e.g.. Jolly, supra note 43; Meyerhoff & Crozier, Health Care Coalitions: The 
Evaluation of a Movement, 3 Health Aff. 120 (1984). 



932 INDIANA LAW REVIEW [Vol. 19:919 

major division between a community's employers and a community's 
hospitals has been observed. It probably reflects in part the decision by 
employers over the last decade personally to bear the risk of hospital 
costs by self -insuring. ^"^ Self-insurance has forced many Blue Cross plans 
to play the limited role of claims administration. As a result, if an 
employer is dissatisfied with its claims expense, it may move directly 
against a group of hospitals in an attempt to secure lower costs. 

9. Organized Labor. — Fringe benefits, including health insurance, 
have long been regarded by the leadership of organized labor as one 
of unionism's greatest achievements.^^ Thus, there has been little historic 
concern over the matter of rising hospital costs since higher costs have 
been viewed as resulting in more and better care. Employers paid for 
all or most of the costs of insurance, and union leadership has been 
largely disinterested in the absolute cost of these benefits. However, in 
recent times, the growth of fringe benefit expenses has been so great 
that employers have been more aggressive in bargaining. Unions have 
experienced negotiations in which little or no increase in take-home wages 
was possible because fringe benefit increases had eaten away all that 
the employer was willing to give or all that labor was able to bargain. 
Faced with such a vital challenge to the bargaining process, union 
leadership has increasingly concluded that hospital prices must be con- 
trolled. 

The position of organized labor regarding hospital rate setting has 
been ambivalent in the past and continues to be ill-defined despite an 
increased sense of its importance. In some jurisdictions where hospital 
workers are organized, revenue control of hospitals is perceived as 
inevitably leading to reduced employment. Recently, however, organized 
labor has officially determined that it supports the concept of hospital 
rate regulation and has worked on behalf of regulation in West Virginia." 

10. Consumers.— Consumers have only recently emerged as a force 
in rate-setting legislation. Because they have traditionally been shielded 
from the true costs of health care by comprehensive insurance, consumers 
have been relatively indifferent to inflation in this sector of the economy. 
Insurance carriers have historically paid the costs of health care no 
matter how fast unit prices increased. Consumer apathy has been ex- 
acerbated by the very nature of hospital care finance, a field so complex 



^The Corporate Rx for Medical Costs: A Push for Revolutionary Changes in the 
Health Care Industry, Business Week, Oct. 15, 1984, at 138-41; see also Iglehart, Big 
Business and Health Care in the Heartland: An Interview with Robert Burnett, 3 Health 
Aff. 40 (1984). 

^^See Dunlop, Health Care Coalitions, in Prfvate Sector Coalitions: A Fourth 
Party in Health Care 10-11 (B. Jaeger ed. 1982). 

•^West Virginia Labor Fed'n (AFL-CIO), Committee on Political Education, 
Legislative Report Sixty-Fifth Legislature 16 (1982). 



1986] COST CONTAINMENT 933 

that it would require a substantial investment of time for individuals to 
comprehend the extent of their coverage and their exposure. 

However, recent erosion of the fully protective nature of insurance, 
evidenced by increased copayments and deductibles, coupled with the 
erosion and threatened cutbacks in programs protecting the elderly and 
the poor, have forced more consumer advocates to turn their attention 
to the issue of rising heahh care costs. ^^ Nearly all consumers have faced 
reductions in current coverage. Employer and union approaches have 
primarily involved reductions in the "first dollar" aspects of coverage 
in an attempt to make the consumer more price conscious and thus 
more judicious in the use of care.^^ Similarly, Medicare and Medicaid 
have been attempting to control provider (hospitals and physicians) 
expenditures for several years with little success. As a result, both 
programs have turned their attention to the patient/beneficiary as a 
means of curbing program costs in light of uncontrollable provider 
behavior. 

11. Physicians.— ?\\ys\Q,\dins always resist proposals to control hospital 
revenue. Their objections appear founded on the notion that if hospital 
revenue is constrained, ultimately the freedom of the physician to make 
choices related to the use of the hospital will be reduced. To the extent 
that physicians make a disproportionate share of their income from 
activities related to patient care in hospitals, ^^ rate regulation is seen as 
a potential negative force on physician incomes. Others have suggested 
that physician resistance is based on the domino theory — if hospital 
prices are regulated, physician prices will be next. Recent action by the 
Congress in the 1984 Medicare amendments suggests this fear may not 
be groundless.''^ 

12. Nurses. — Nurses have not played an important role in the rate- 
setting debate as yet. Where they have been visible, in only a handful 
of states, their resistance has been orchestrated by the state hospital 
association. Indeed, the only position taken by spokespersons for nursing 
interests has been that regulation has adverse effects on patient care.^' 
Putting aside the quality issue, however, regulation will have no evident 



^^See Am. Ass'n of Retired Persons, 1985 Federal & State Legislative Policy 
(1985). 

^^See Havighurst, Competition in Health Services: Overview, Issues and Answers, 34 
Vand. L. Rev. 1117 (1981); see also Goldsmith, Death of a Paradigm: The Challenge 
of Competition, 3 Health Aff. 5 (1984). 

^"^See Showstack, Blumberg, Schwartz & Schroeder, Fee-for-Service Physician Pay- 
ment: Analysis of Current Methods and Their Development, 16 Inquiry 230 (1979). 

™5ee Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 2306, div. B, tit. Ill, 
98 Stat. 494, 1070 (amending 42 U.S.C. § 1395u(b) (1982)). 

''^See Schramm, Economic Perspectives on the Nursing Shortage, in Nursing in the 
1980's, at 55 (L. Aiken <& S. Gortner eds. 1982). 



934 INDIANA LAW REVIEW [Vol. 19:919 

economic impact on nurses other than potentially reducing system-wide 
demand for nurses involved in inpatient care.^^ 

Any description of the actors and their interests would be incomplete 
without noting that members of legislatures have their own interests to 
advance on the issue of hospital regulation. Most legislators have hospitals 
in their districts, which have tutored them on the causes of hospital 
inflation and the evils of rate setting. On the other hand, legislators 
inevitably deal with larger social issues and are compelled to behave 
with state-wide interests relative to the state's budget. This tension 
between serving the interests of their constituent hospitals and the needs 
of the state sometimes makes the issue of hospital cost control trou- 
blesome for legislators. The very nature of the hospital cost control 
problem, i.e., its complexity, persistence, and political intractability, 
makes it more amenable to a regulatory solution whereby the legislature 
delegates its authority to a continuing agency. This approach takes 
hospital decisions out of the hands of the legislature and places them 
in the "independent" branch of government where politicians cannot 
be held responsible for the outcome of the regulatory process. ^^ 

B. The Initiator 

One of the most interesting aspects of the legislative process relating 
to hospital cost containment is the changing identity of the initiator of 
regulatory efforts from state to state. As one might suspect, the parties 
involved have somewhat different interests in each state. For example, 
in jurisdictions where Blue Cross market penetration is significant, sizable 
discounts against charges are often encountered. In these states, Blue 
Cross would clearly oppose any action to equalize rates among payers. 
On the other hand, in states where Blue Cross does not enjoy such 
discounts. Blue Cross might look upon rate regulation as a positive 
development designed to keep claims expense under control. 

Based on experience to date, the parties that have first presented 
the idea of regulating hospital rates have included hospital trustees, 
governors, business, commercial insurers, and consumers. In each case, 
the interest in the issue is different. Trustees see rate regulation as a 
means of protecting hospitals from unequal exposure to bad debt expense, 
thus stabilizing the industry as a whole. Governors espouse the notion 
of controlling hospital inflation as a means of dampening the demand 
of state Medicaid programs for general funds. Business leaders have 
advocated regulation out of frustration with hospital inflation. Com- 
mercial insurers see regulation as a means of equity in payment and 



'^Id. at 44-49. 

"Kinney, Coordinating Rate Setting and Planning in States with Mandatory Hospital 
Rate Regulation: What Makes a Difference? (to be published in Journal of Legal Medicine). 



1986] COST CONTAINMENT 935 

protection against cost shifting. Finally, consumers have argued for rate 
controls to address the growing burden of insurance copayments and 
deductibles. 

Obversely, certain parties have never supported rate regulation, much 
less acted as proponents. These include hospital associations and the 
investor-owned hospitals, medical societies, and nurses. The perception 
of each group is that if rate review legislation were to emerge, its 
economic interest might be impaired. 

Several actors have been on each side of the issue in different states, 
and on each side of the issue in the same jurisdiction, but in different 
periods of time. Business has been divided on whether regulations are 
necessary. As mentioned above, many business leaders abhor the notion 
of encouraging the spread of regulation, notwithstanding their perception 
that hospitals will not estabhsh spending restraints on their own. Likewise, 
organized labor has historically resisted hospital regulation as an implicit 
reduction in the benefits available to members and as a potential threat 
to the jobs of the many unionized hospital workers. A final example 
of ambiguous support is the action of Governor James Thompson of 
Illinois, who endorsed legislation designed to estabhsh a hospital reg- 
ulation agency and then failed to appropriate the funds needed to give 
it Hfe.^^ 

In conclusion, one is reminded of the work of Anthony Downs 
regarding the factors that make issues the subject of public, specifically 
legislative, attention. Downs argues that ideas move into pubhc debate 
and are dealt with depending on the parties introducing the idea and 
the amount of pubhc support the idea receives. ^'^ The crux of Downs' 
theory is that issues change through time, and predicting what action 
will emerge depends largely on who initially brings an idea to public 
attention. In the case of rate setting, because of the large number of 
interested parties, the importance of the initiator of the idea is over- 
whelmed by the identity of parties who support the notion. 

C. Coalitions of Parties and Their Behavior 

While the formation of coalitions is key in understanding the process 
that brings hospital revenue regulation about, there is little systematic 
knowledge about the operation of joint interests. There are, however, 
certain groups whose interests seem to coincide and others where certain 
antipathy is observed. The most commonly observed link is between 
commercial insurers and employers, if employers are at all active on the 
issue. Likewise, the bond between hospitals and Blue Cross seems certain. 



'^See Crozier, State Rote-Setting: A Status Report, 1 Health Aff. 74 (1982). 
"Downs, Up and Down with Ecology: The "Issue-Attention Cycle," 28 Pub. Interest 
38 (1972). 



936 INDIANA LA W REVIEW [Vol. 19:919 

In most cases, the similarity of positions between trustees and hospitals 
prompts joint activity to resist rate setting. Increasingly, where business 
has taken a positive stand, it is supported by organized labor, due largely 
to the formal existence of labor-management coalitions. 

Just as certain parties find it in their interest to work together, the 
opposite also holds. Blue Cross and commercial insurers seldom appear 
to work together, just as physicians never join employers or unions in 
their positions. Similarly, for-profit hospitals will never work with or- 
ganized labor, Medicaid, Medicare, and organized nurses generally op- 
erate on their own and seldom become an integral part of any coalition. 

D. Likely Outcomes — Predicting Success or Failure 

In the legislative process, it is always difficult to predict success or 
failure with any certainty. Considering the enormous diversity among 
state legislatures, it is virtually impossible to develop a paradigm that 
would be useful in forecasting the outcome of a drive to bring about 
hospital rate regulation. However, several postulates appear helpful in 
understanding the legislative disposition of hospital revenue control pro- 
posals. The first is that no one group can be successful in a legislative 
campaign. It appears that some majority of the more important actors 
must support legislation in order for it to pass. The second postulate 
is that active opposition by a small number of key interests can prevent 
passage. It appears that hospitals, working with Blue Cross, have generally 
been successful in preventing passage, especially if trustees have been 
active in their resistance. The third postulate is related; namely, no one 
group can prevent passage. Acting alone, hospitals, physicians, organized 
labor, and Blue Cross have been unable to prevent the passage of rate- 
setting legislation. 

The net importance of these observations is that one must watch 
the joint behavior of the parties surrounding a legislative proposal. 
Success or failure lies in the coalitions that effectively work for or against 
the proposal. 

III. Positions of the Parties 

A. The Context of Argument in the Legislative Milieu 

Having observed the legislative and executive process related to 
hospital rate regulation in several jurisdictions, it is possible to inventory 
the major positions advanced by proponents and opponents of regulation. 
Because of the apparent interest in the phenomenon, this Article gives 
limited attention to the arguments in favor of hospital rate regulation. 
Instead, it concentrates in more detail on the arguments offered by 
opponents. This approach should prove more useful in understanding 



1986] COST CONTAINMENT 937 

the legislative process, as legislation typically succeeds more by over- 
coming negatives than by being embraced for its obvious utility to society. 

B. Why Hospital Rate Settingl 

The statistical case that rate-setting achieves the objectives of leg- 
islation establishing a regulatory mechanism for hospital revenues is 
rather easily made and, indeed, is nearly universally confirmed by eval- 
uative research on the effects of the regulatory process. ^^ In the post- 
1976 regulatory era, the rate of increase in the cost of an average hospital 
admission has risen more slowly in the original six rate-setting states 
than in the 45 remaining jurisdictions — a finding of particular interest 
given the contrary inflationary experience of the six states in the pre- 
regulatory period. ^^ Inflation in the cost of a hospital stay is a convenient 
proxy for measuring the effectiveness of the legislation in accomplishing 
its goal of reducing overall inflation. 

C. Arguments on Behalf of Rate Setting 

Given the success of the original state efforts to control hospital 
spending, it is interesting to examine the arguments advanced on behalf 
of hospital revenue regulation more carefully. It is important, however, 
to appreciate that for the most part, the success of rate setting has been 
Hnked to its ability to impose the same rate on all payers for hospital 
care. In most states, hospitals charge a variety of prices for the same 
services depending on the source of payment. Thus, cash paying patients 
and those insured by indemnity policies (commercial insurance) are re- 
ferred to as charge-based payers because they pay for the actual cost 
of their care plus a markup to the charged price. Medicare and many 
state Medicaid plans have traditionally paid * 'reasonable costs," with 
no markup over the actual cost of providing care for the beneficiaries. 
In four of the original rate-setting states, the federal government, using 
its authority to waive Medicare regulations, agreed to reimburse hospitals 
at the rates set by the state agencies. In several states, Medicaid programs 
pay less than actual costs by setting lower-than-cost fee schedules for 
hospital care. In between are payers such as workers' compensation 
carriers that pay according to a fee schedule. Blue Cross plans which 
generally pay charges minus a contractually-agreed discount, and other 



'^See, e.g.. Biles, Schramm & Atkinson, supra note 16; Sloan, Rate Regulation as 
a Strategy for Hospital Cost Control: Evidence from the Last Decade, 61 Milbank Mem. 
Fund Q. 195 (1983). But see Mitchell, Issues, Evidence, and the Policymaker's Dilemma, 
1 Health Aff. 84 (1982); Morrisey, Sloan & Mitchell, State Rate-Setting: An Analysis 
of Some Unresolved Issues, 2 Health Aff. 36 (1983). 

"See Appendix, Fig. 1 for the rate of cost increases in the original six states and 
Figs. 2-7 for the experience in each of the six. 



938 INDIANA LA W REVIEW [Vol. 19:919 

payers who have entered into agreements for discounts with the hospital. 
Clearly, the existence of multiple price schedules in hospitals suggests 
the existence of cross-subsidization of costs among patients depending 
on payment source. ^^ In this respect, the average hospital operates as an 
implicit social taxing scheme on its patients. 

The most important argument advanced for the initiation of rate- 
setting is that it clearly establishes strong incentives to reduce price 
inflation and ultimately to reduce the underlying costs of hospital care. 
To the extent that certain price levels are disallowed by the agency, the 
hospital must act to reduce costs. 

The second most persuasive argument relates to the uniform price 
imposed in "all-payer" states; namely, that hospitals find all patients 
equally attractive. In states where different rates of reimbursement attach 
to different patients, equal access to hospital care is jeopardized. Hospitals 
clearly find certain patients more attractive than others. Likewise, where 
the state agency adjusts the uniform price in each hospital to reflect 
the cost of caring for poor patients, the hospital can be immunized 
against the risk of uncompensated care to those patients who have no 
form of insurance protection. Thus, discounts are awarded only to payers 
who offer demonstrated cost savings to hospitals, and no payer bears 
an unequal obligation to subsidize the care of uncovered patients. Related 
to inter-payer equity is the removal of any cause for hospitals to tax 
certain payers by "cost-shifting" unmet expenses from some patients to 
others. 

Finally, in a package of attributes that might be characterized as 
management reforms, hospitals in regulated jurisdictions operate within 
a more predictable revenue environment, with a consistent set of incentives 
and payment methods from carrier to carrier. Further, due to the public 
collection of information, hospitals in regulated jurisdictions find eval- 
uation of comparative performance easier. 

D. Arguments Against Hospital Revenue Regulation 

Opponents of hospital revenue regulation fall into two types: those 
who oppose regulation in general and those who object specifically to 
hospital rate control. The former adapt general economic arguments 
against regulation to the hospital setting. The latter argue from experience 
and use the record of hospital regulation in other jurisdictions as evidence 
of why regulation should not be adopted in the instant case. In the 
legislative milieu, these theoretical and experiential arguments are both 
used simultaneously and are often confused with each other. 

1. Adverse Effects of Hospital Regulation in General.— The general 



^^See generally B. Kinkead, Pricing Policy in the Hospital Industry (1984) (unpublished 
thesis, Johns Hopkins University). 



1986] COST CONTAINMENT 939 

arguments against hospital regulation are variants of well-known anti- 
regulatory reasoning that has developed over the hundred-year span of 
regulation in America. The most important generic argument relates to 
the effect of regulation on competition and the operation of market 
forces. Quite clearly the most commonly shared value in the American 
economy is the importance of freely functioning markets. Our commercial 
creed is based on the notion that markets act to distribute goods im- 
partially in a manner that maximizes efficient production and equitable 
distribution. Notwithstanding the importance of this economic tenet, our 
history since the advent of industrialism has been rife with tension between 
parties attempting to control markets and maximize profits. In the early 
phases of industrialism, private interests appeared to consolidate capital, 
manufacturing, and distribution networks in order to reap "monopoly" 
profits. As government responded to perceived abuses in the market by 
enacting antitrust laws, it appeared as if government was seeking to 
regulate markets in the interest of the consumer. Most economists believe, 
however, that government regulation of markets merely reflects a trans- 
formation of the mechanism by which large commercial interests operate 
to protect their market shares and, consequently, their prof its. ^^ Thus, 
economists argue that while business interests vociferously oppose reg- 
ulation in general as destructive of the working of the free market, 
many businesses enjoy and seek government intervention in ordering the 
market in which they operate. 

The foregoing demonstrates that regulation has been ubiquitous in 
our economic order for nearly one hundred years. That regulation is 
antithetical to the operation of free markets is not clear from history, 
nor is it clear that consumers would tolerate an exclusively competitive 
market.^^ Indeed, as suggested above, the existence of regulation in an 
industry cannot be interpreted as the triumph of government over private 
interests. Rather, it suggests that a public presence has been introduced 
as an implicit bargain which occurs through our pohtical process. Con- 
sumer/voters acting through their government have extracted price conces- 
sions in exchange for a government promise to protect the regulated 
industry from potential competitors and sagging profits. From this per- 
spective, it is difficult to view the position that regulation is antithetical 
to competition and our free market tradition as anything but a historic 
and simple perspective on a tremendously complex issue. ^^ 

Closely linked to the argument that regulation is anticompetitive is 
the position that it inhibits innovation and experimentation. Much of 
what we value in the free enterprise system are the dynamics of the 
constant vying for market share. As a result, competitive firms are forced 



^"^See Stigler, supra note 31. 

^^See generally S. Breyer, supra note 13, at 1-35. 

^'See generally H. Commager, The American Mind (1950). 



940 INDIANA LAW REVIEW [Vol. 19:919 

to innovate and experiment with new products. In a regulated market, 
it is feared that formal entry rules will inhibit new competitors, and 
that existing firms will no longer feel pressured to innovate and seek 
improved efficiencies. As a result, consumers will not benefit from lower 
prices over time. 

A third general argument against regulation is that the transaction 
costs of regulation are excessive. For example, regulated firms must bear 
the additional legal and administrative costs of complying with rules 
that are not imposed by the marketplace as well as the process-related 
costs of seeking government approval for decisions. The burden of these 
process costs is passed on to consumers. Surveys by hospital associations 
suggest that the costs of complying with regulatory requirements add 
substantially to hospital costs. ^^ Moreover, some argue that the costs of 
regulation are borne disproportionately by regulated firms and that larger 
firms bear relatively heavier costs than smaller firms. In any event, the 
distillate of these claims is that regulation is costly and that the burden 
of these costs does not fall neutrally on all firms. ^^ 

The final contention against regulation is that it intrudes into the 
decision-making authority of management. In the case of hospitals, it 
is further argued that regulation eventually invades the clinical decision 
making of physicians. ^"^ Regardless of the motive for regulation, the very 
nature of the process circumscribes the authority of managers and ad- 
ministrators. The existence of a public agency charged with setting 
operating rules for the industry and monitoring the behavior of regulated 
firms is the mechanism whereby the public's interest in the firm's decision 
making is presumably established. 

The arguments against regulation in general meet peculiar difficulty 
when applied to hospitals. Regarding the theory of imposing a public 
interest in the decision making of the hospital, it must be remembered 
that the typical hospital was estabhshed as a public service entity, in 
nearly all instances as a non-profit, charitable institution.^^ It is therefore 
curious that hospitals would resist the imposition of a regulatory scheme 
whose rationale is to protect the public from the unbridled discretion 
of the regulated entities. Likewise, regarding regulatory costs in the 
hospital industry, many of the regulatory strictures already in place were 
developed by hospitals themselves in an attempt to develop uniform 



^^See, e.g., Hosp. Ass'n of New York State, Cost of Regulation, Report of 
THE Task Force on Regulation (1978); Lewin, Sommers & Sommers, State Health Cost 
Regulation and Administration, 6 Toledo L. Rev, 647 (1975). 

''See Cutler & Johnson, Regulation and the Political Process, 84 Yale L.J. 1395 
(1975). 

^See Zuckerman, Becker & Adams, Physician Practice Patterns Under Hospital Rate- 
Setting Programs, 252 J. A.M.A. 2589 (1984). 

''See Am. Hosp. Ass'n, Hospital Statistics, 1986 ed. 18-19, Table 5A (1987). 



1986] COST CONTAINMENT 941 

Standards for their industry. Indeed, few if any industries in our economy 
have been so persistent in estabUshing self-policing bodies such as the 
Joint Commission on Accreditation of Hospitals (JCAH) or in seeking 
legislative delegation to these private regulatory efforts.^^ For example, 
a hospital can become a certified Medicare provider and qualify for 
federal payment simply by receiving JCAH accreditation.^^ 

2. Specific Adverse Effects of Hospital Regulation. — The specific 
adverse effects of hospital regulation are generally associated with a 
particular interest which might be offended. For this reason, the problems 
with regulation will be examined from five perspectives. 

a. Financial effects on hospitals. — Because revenue is affected, hos- 
pitals argue that regulation seriously erodes their short and long term 
financial strength. In the short term, it is argued that regulation affects 
the liquidity of the hospital, threatening its ability to meet current 
liabilities from current revenues. Through time, the additive nature of 
this revenue shortfall is said to threaten the hospital's solvency. As a 
result, accumulated capital resources, particularly endowment funds, are 
used to the long-term detriment of the hospital's fiscal stability. 

On the basis of Stigler's theory of regulation, one would not expect 
this outcome. ^^ Indeed, one would suspect that the presence of regulation 
would lead to a strengthened fiscal position for the hospital. Some 
evidence suggests that this is so. While hospital operating margins in 
the first six regulated states were lower than in other jurisdictions, through 
time hospitals in regulated states have experienced constant improvement 
in their margins relative to their past and to the non-regulated juris- 
dictions.^^ 

Related to the argument that their fiscal status is jeopardized by 
revenue regulation is the hospitals' contention that the presence of a 
regulatory scheme operates as a liability in hospital capital markets. This 
contention is important because public capital markets have become 
increasingly important to hospitals in recent years. ^'^ Roughly a decade 
ago, most new capital investment in hospitals was funded through phil- 
anthropic gifts and accrued surpluses; now, however, most new con- 
struction is funded through revenue supported debt obligations sold by 
hospitals on the pubUc bond market.^' Should a hospital operating in 



**II A Hospital Law Manual, Licensure I (1980). 

^'See 42 U.S.C. § 1395bb (1982 & Supp. 1985). See generally Jost, The Joint 
Commission on Accreditation of Hospitals: Private Regulation of Health Care in the Public 
Interest, 24 B.C.L. Rev. 835 (1983). 

^^See Stigler, supra note 31. 

*'5ee Appendix, Fig. 8. 

^See generally D. Cohodes & B. Kinkead, Hospital Capital Formation in the 
1980's (1984). 

'•M at 51-53. 



942 INDIANA LAW REVIEW [Vol. 19:919 

a regulated environment find its ability to place revenue bonds impaired, 
it could greatly increase the cost of debt service through the life of the 
obligation. While investors may have previously viewed the hospital rate- 
setting agency as an impediment to the hospital's ability to set rates at 
levels sufficient to support its debt service, hospital capital markets are 
now taking comfort in the presence of an agency which, among other 
goals, seeks to insure the hospital from bad debt (traditionally the greatest 
threat to an institution's long-term solvency), and which has had a 
demonstrable positive effect on operating margins. ^^ 

b. Adverse effects on medical practice and the organization of the 
market for care. — Perhaps the most important argument relating to the 
advent of regulation is that is has unintended and counterproductive 
consequences. Most of these * 'secondary" effects relate to changes in 
medical practice and a reorganization of the medical care delivery system 
in response to the establishment of a regulatory system. 

These observations generally rest on the early utilization experience 
of hospitals during the first years of hospital rate regulation. Initially, 
rate-setting methods focused on controlling the rate of change in unit 
prices within the hospital for all services delivered to patients. ^^ In 
response, quite naturally, hospitals began to increase the volume of units 
delivered in order to protect overall revenues. Likewise, there is some 
evidence that hospitals encouraged increased admissions, again to protect 
the level of revenues.^ Soon after this response was observed, regulatory 
agencies developed new rate-setting methods which established positive 
incentives for hospitals to reduce overall costs. Thus, regardless of the 
change in the regulated price per unit of service, the hospital would 
attempt to reduce the overall budget. One such approach developed in 
Maryland is referred to as the Guaranteed Inpatient Revenue System. ^^ 
Here, as in the recently adopted federal Medicare payment system, a 
hospital is paid a set amount per admitting diagnosis. Under the Maryland 
system, at the beginning of the fiscal year, the agency promises a 
prospectively agreed upon budget to a hospital producing care for a 
given number of cases of a certain complexity (based on its historic 
experience) as measured by diagnostic groups. Should a hospital deliver 



^^See, e.g., Effects of New Jersey's DRG Hospital Reimbursement System on 
Hospitals' Access to Capital Markets, Report of the Health Research and Edu- 
cational Trust of New Jersey (1983). 

"Health Care Financing Admin., U.S. Dep't of Health & Human Services, 
First Annual Report of the National Hospital Rate-Setting Study: A Comparative 
Review of Nine Prospective Rate-Setting Programs (1980). 

^"Worthington & Piro, The Effects of Hospital Rate-Setting on Volumes of Hospital 
Services: A Preliminary Analysis, 4 Health Care Fin. Rev. 47 (1982). 

'^For a description of the Guaranteed Inpatient Revenue System, see Esposito, Hupfer, 
Mason & Rogler, Abstracts of State Legislated Hospital Cost-Containment Programs, 4 
Health Care Fin. Rev. 129, 143-44 (1982). 



1986] COST CONTAINMENT 943 

care under budget, it keeps fifty percent of all savings. Thus, the hospital 
has a strong incentive to improve internal efficiency and not to increase 
volumes. 

A second undesired effect of regulation is the reordering of the 
market resulting from efforts to avoid the reach of the rate-setting 
agency. Increasingly, hospitals have been attempting to diversify into a 
large number of out-of-hospital ventures, including off-campus ambu- 
latory surgical facilities, nursing homes, and diagnostic centers that are 
not traditionally within the contemplation of the enabhng statutes. As 
a result, hospital rates may be held constant but overall spending on 
health care may accelerate as hospitals "unbundle" their services, in- 
tending to maximize revenue by developing whole new markets. This 
phenomenon points out one area for improvement needed in regulation, 
namely, control of capital decisions related to the situs of health care. 
Most communities are burdened with excess hospital capacity. Increas- 
ingly, it appears, more efficient and cheaper treatment sites such as 
ambulatory care facilities and HMO's are being developed. As this trend 
continues, the overinvestment in unnecessary hospital capacity becomes 
more acute. Therefore, states should consider removing inefficient ca- 
pacity by closing or encouraging the merger and consolidation of existing 
facilities. ^^ 

c. Adverse effects on payers. — Obviously, if regulation operates well, 
payers should benefit by having their claims expense reduced. However, 
all payers will not be equally affected, just as all payers will not have 
an equal interest in hospital cost containment. Hospital revenue regulation 
may have beneficial results for some and harmful effects for others, 
before examining the impact of regulation on various payers, it is 
important to remember that in non-regulated jurisdictions, real hospital 
costs differ substantially from one payer to the next.^^ To the extent 
that rate setting sets a uniform price for all payers, those presently 
enjoying price concessions (in many states, everyone except cash-paying 
patients and indemnity or commercial insurance carriers) will resist reg- 
ulation. It is also important to note that from the perspective of some 
carriers, the fundamental premise of controUing hospital price inflation 
may not be in their interest. For those carriers who have their rates 
established by state insurance commissions (all carriers except Medicare 
and Medicaid), premiums are often set on the basis of claims expenses 
plus some allowance — usually a percentage of expenses for administrative 
costs. Thus, these carriers have actually benefited from rising a hospital 
costs! 



^^See, e.g.. Final Report of the Governor's Commission on Ohio Health Care 
Costs (July 9, 1984); Final Report of the Governor's Task Force on Health Care 
Cost Containment (State of Maryland, Dec. 14, 1984). 

^^See generally Ginzburg, supra note 48. 



944 INDIANA LAW REVIEW [Vol. 19:919 

In regulatory systems where hospital costs will be controlled for a 
subset of payers (e.g., Medicaid and Blue Cross — a system once in effect 
in Massachusetts), costs will unavoidably be shifted to the unregulated 
payers. If the regulated cost of a stay is set lower than the average 
prevaihng in the hospital, and the institution cannot shift its cost curve 
in the short run, it will attempt to shift the shortfalls incurred in serving 
patients covered by regulated payers to patients to whom the hospital 
is free to charge any price. As hospitals shift unmet expenditures, the 
unregulated carriers may experience a relatively higher rate of claims 
cost than prevailed in the pre-regulatory period. This cost-shifting burden 
has been felt most heavily by commercial carriers who, because of their 
indemnity relationship with their insureds, are among the last payers 
whose rates are included in regulation. ^^ 

Closely related to the issue of cost-shifting among payers treated 
unequally by rate setting is the burden an all-payer approach might place 
on the state treasury should Medicaid be required to pay at the same 
rate as other payers. Especially in jurisdictions where the state Medicaid 
program has unilaterally established payment schedules substantially be- 
low the rates charged to other payers, the legislature will find it difficult 
to deal with the initial costs of reestablishing Medicaid payment at equal 
levels. In 1982, for example, Governor Thompson of Illinois decided 
that even though he had endorsed a hospital regulatory program enacted 
by the legislature, the cost of bringing the state's Medicaid payments 
up to those required by the all-payer nature of the program was too 
high, and the legislation was never implemented.^^ 

In addition to the adverse effects that concern both the commercial 
insurers and Medicaid programs, there is concern that Medicare obli- 
gations increase in states where the federal program reimburses at rates 
established by state agencies. The federal government may choose in 
certain jurisdictions to pay at rates other than its nationwide payment 
method.'^ As noted previously, in an attempt to stimulate state exper- 
imentation with all-payer rate setting, Congress recently enacted statutory 
language providing that any state enacting comprehensive regulatory 
programs that set hospital rates for all payers would qualify for a waiver 
of the Medicare payment method. The Reagan Administration has viewed 
the proHferation of hospital rate setting as an undesirable expansion of 
government regulation. ^^^ It has argued that where Medicare pays rates 
in accordance with all-payer systems, the total cost to the Medicare 
program exceeds what would have been paid under prevailing payment 
principles. However, recent studies have established that Medicare pay- 



''Id. 

^See Crozier, supra note 74, at 74. 
^°°See S. Renn, supra note 61, at 1. 
'"'See Washington Report on Medicine and Health, Oct. 29, 1984, at 38. 



1986] COST CONTAINMENT 945 

ments in the regulated states where the federal government has waived 
its payment principles have in fact been substantially lower than they 
would have been absent the waiver. '°^ 

The final payer adversely affected by rate-setting legislation is Blue 
Cross. As noted above, many Blue Cross plans enjoy discounts against 
charges because of their close connection with hospitals, their policy of 
not contesting claims, and their assurance to hospitals regarding method 
of payment. To the extent that an all-payer system would reduce these 
discounts or limit them to their economic value to the hospital, Blue 
Cross will be adversely affected since it will have to compensate for the 
resulting increase in claims expense by increasing premiums in the short 
run. 

d. Adverse effects on patient /consumers. — Two arguments are ad- 
vanced relating to the adverse effects of regulation on patients. The first 
suggests that one of the inevitable outcomes of regulation is the rationing 
of care. This argument holds that when hospital budgets are constrained, 
less care will be delivered and some hospital needs of the population 
will go unmet. The argument assumes that productivity within the hospital 
cannot be improved and that the level of hospital care currently delivered 
is medically necessary. Indeed, the weight of all the evidence related to 
this question indicates that we are oversupplied with hospitals. 

The second adverse consequence of regulation from the patient's 
perspective is its potential impact on the quality of care. In reasoning 
similar to that underlying the rationing argument, opponents of hospital 
revenue limits suggest that with fewer resources at the physician's com- 
mand, the patient will be deprived of necessary services and supplies 
for maximum quality care. Because there are virtually no scientific 
measures of quality available, any statement about quality can be nothing 
more than expert opinion. It could, in fact, be argued that by setting 
resource constraints on hospitals, one of the benefits to emerge will be 
strong incentives to examine treatment outcomes more carefully so as 
to optimize resource use. 

e. Adverse effects on hospital employees. — The final category of 
arguments against rate setting is that it will have adverse effects on 
those who are economically Hnked to the continued well-being of in- 
dividual hospitals. While the number of individuals potentially affected 
by a reduction in spending on hospital care is extremely large, hospital 
employees are likely to be the most immediately affected by any potential 
reduction of hospital revenue. One reason why this group receives such 
attention is that if a hospital is to keep its operating expenses in line 
with permitted revenues, it must focus attention on labor costs. Labor 
costs alone account for over sixty percent of hospital expenses. '^^ 



^^See S. Renn, supra note 61. 

'"^Am. Hosp. Ass'n, Hospital Statistics 23 (1984). 



946 INDIANA LAW REVIEW [Vol. 19:919 

Concern over the impact of hospital regulation on employment is 
most commonly articulated in two arguments. First, hospitals will move 
to reduce labor expenses before any other cost-cutting approaches are 
taken. Obviously, because labor expenses account for such a high share 
of total costs, attention will be focused on reducing labor costs by layoffs 
and/or reductions in pay levels. In the case of layoffs, enormous political 
pressure builds on local officials to seek ways of expanding the hospital's 
budget in order to protect jobs. In the case of wage reductions, employees 
generally find such steps enormously unnerving to their sense of security, 
and the hospital adopting such a strategy may jeopardize organization 
morale. 

The second labor-related argument is akin to the first but reflects 
a more subtle approach to reducing labor costs. It involves the substitution 
of higher-skilled with lower-skilled and lower-paid workers. For example, 
faced with new budget constraints, a hospital might attempt to substitute 
registered nurses with lower-paid practical nurses, or it might attempt 
to use nurse anesthetists in conjunction with physician anesthesiologists. 
There is some evidence, however, that in regulated situations some 
hospitals attempt to improve efficiency by replacing lower-skilled per- 
sons with fewer, more highly paid personnel. ^^"^ 

IV. Discussion 

The issue of regulating hospital rates will grow in importance in the 
future. Indeed, state legislative activity in this area will increase, as will 
other avenues to establish a formal role for state government in the 
regulation of hospital finances. One of the most interesting lessons from 
observing legislative proceedings in eighteen states is the unpredictabihty 
of the outcome. As mentioned at the outset, the multiphcity of parties 
and the inconsistency of their coalition behavior from state to state 
make the legislative process very difficult to control, and often it appears 
a risky investment for those seeking to enact rate-setting laws. 

Examining the legislative outcome in several states suggests the dif- 
ficulty of working through legislation relating to hospitals. Of the eighteen 
states where legislation has been proposed or introduced during the last 
three years, laws have emerged in only three. While it is difficult to 
draw comparisons with other types of legislation, this success rate seems 
particularly low. On the other hand, previous observations suggest that 
there is a long gestation period for statutory proposals to limit hospital 
revenues. Moreover, the hospital industry nearly always ranks among 
the largest in terms of aggregate budgets in any state. 

In response to the unpredictability and difficulty of pursuing a 
legislative program, recently it appears as if those seeking cost contain- 



"^Schramm, supra note 71, at 45. 



1986] COST CONTAINMENT 947 

merit through the regulation of hospitals have taken new non-legislative 
approaches. By far the most dramatic has been the referendum attempt 
conducted in Arizona in the fall of 1984. Here, a coalition of major 
businesses interested in the establishment of a regulatory system for 
hospital budgets was urging a rate-setting bill upon the state legislature. '°^ 
The hospitals' opposition was extremely strong and the legislature was 
apparently deadlocked. As an avenue for circumventing the legislature, 
the employer coalition ran a successful drive for a state-wide referendum 
in November of 1984. The legislature similarly developed several proposals 
related to hospital costs and placed them on the November ballot. 
Likewise, the hospitals developed a referendum proposal calling for 
limited regulation. In all, five regulatory proposals went before the voters. 
None passed despite what appeared in exit polling as a strong commitment 
to the idea by a majority of the voters. Explanations of the results vary, 
but the important observation here is that while the legislative route 
may prove difficult, the shortcut of referenda seems equally if not more 
unpredictable. Similar referendum campaigns have been discussed in other 
states, but since the Arizona experience, interest in the idea appears to 
have declined. 

An emerging alternative to hospital revenue legislation seems to be 
attempts to change the underlying causes of the problem of high absolute 
hospital cost. In general, these approaches appear to focus on two 
separate issues — one institutional and the other more market-oriented. 
The first relates to the oversupply of hospital beds. For over twenty 
years, the connection between excess hospital beds and high costs has 
been recognized and has motivated policy at both the federal and state 
levels. In the last few years, however, with admission rates, length of 
stay, and overall occupancy falling in the nation's hospitals, the issue 
of excess capacity has taken on added importance from the perspective 
of reducing hospital costs. This results from the now widely observed 
phenomenon of hospitals attempting to compete with each other to fill 
beds — often at the risk of unnecessary hospitalizations — and from the 
costs of carrying overhead expenses on unfilled beds. Several states have 
recently published studies showing that as much as one third of their 
bed supply is unneeded.'^^ As a result, the states are taking action to 
remove hospital beds through a series of legislative proposals that involve 
redeveloping hospital capital into other uses, pubhc ''buy-outs" of ex- 
isting hospital debt, and exemptions to antitrust laws in order to en- 
courage mergers and consolidations between hospitals.' 



107 



^^^See Jolly, supra note 43. 

'°^See generally Ohio and Maryland Commission reports, supra note 95. 

'""See Intergovernmental Health Policy Project, supra note 4. 



948 INDIANA LAW REVIEW [Vol. 19:919 

The market approach involves several states moving to payment 
mechanisms, principally for Medicaid, that revolve around fixed unit 
prices for given diagnoses. Similar to the federal diagnostic related group 
(DRG) system of payment recently imposed by Medicare, state Medicaid 
programs are looking to the unit price system as a means of forcing 
hospitals to cut their costs or suffer financial loss in treating the Medicaid 
population. In a similar vein, some states have promoted health main- 
tenance organizations (HMO's) as a means of reducing hospital utili- 
zation. In Wisconsin, for example, a plan to put state workers into 
HMO's has stimulated rapid development of similar organizations in the 
state. io« 

The final observation related to state hospital rate regulation regards 
the role of the federal government in the development of future state 
initiatives in this area. In the past, the federal government has encouraged 
state efforts at controlling the hospital marketplace principally through 
Medicare waivers. As mentioned, under this authority the federal gov- 
ernment cedes to certain rate-setting states the power to establish the 
rate at which Medicare pays hospitals for treatment of the Title 18 
population. Currently, however, continuation of the waivers in the four 
states that qualified seems tenuous,'"^ and the granting of new waivers, 
although recently encouraged by Congress, seems less and less Hkely 
under the current Administration. Fundamentally, the Reagan Admin- 
istration has opposed Medicare waivers on the basis that they encourage 
regulatory solutions to social problems and represent the inevitable ex- 
pansion of government. 

In response, several new state rate-setting laws, such as that of 
Maine, '''^ ehminate the need for Medicare participation in the regulatory 
scheme. Thus, Medicare is '*carved out" and does not participate in 
the otherwise all-payer nature of the system. As a result, hospitals treating 
Medicare beneficiaries must operate within the DRG payment limits for 
these patients, while all other payers operate at the rates established by 
the state. Under this system. Medicare cannot participate in savings that 
accrue to other payers, and hospitals might make substantial profits 
from the Medicare population, at least in the initial years of the federal 
DRG system. Increasingly states will attempt to avoid bringing the federal 
government into their plans for controlling hospital costs both because 
the federal government is hostile to such state initiatives (something of 
an irony given the interest the current Administration has in state par- 
ticipation in other issues), and because the states are discovering that 
the systems can operate adequately without Medicare participation. 



'°^See generally Andreano, Wisconsin Health Care Reforms Blend Tighter Regulation 
and Competition, Bus. & Health, Jan. /Feb. 1984, at 47. 

'""See Washington Report on Medicine and Health, Oct. 29, 1984, at 38. 
"°Me. Rev. Stat. Ann. tit. 22, § 381 (West Supp. 1986). 



1986] COST CONTAINMENT 949 

V. Afterword 

What makes for success in the legislature has little to do with 
successful administration of its product, namely, a policy initiative em- 
bodied in statute. If the legislative effort is to yield a successful solution 
to the ultimate problem, the statutory scheme and the legislative intent 
must be transformed into a properly functioning agency and program. 
Necessarily, the legislature must enact statutes that embody the best 
contemporary thinking about the problem and its solution. 

However, the best laws do not assure an acceptable solution to the 
problem. A good example of the difference between statute and per- 
formance exists in the comparison of the Maryland and Washington 
statutes and their success in containing hospital costs. The Maryland 
statute was enacted in 1971 and provided for comprehensive control of 
all hospital budgets in the state.'" Shortly after its enactment, the 
Washington legislature passed a bilP'^ modeled on the Maryland law, 
incorporating all of the features of the Maryland drafters. After a decade 
of experience, Maryland's agency was able to point to statistically sig- 
nificant reductions in hospital cost inflation and overall budgets,'*^ while 
no significant effect on costs was discernible in Washington throughout 
the period.""^ 

The absence of effect in the one state and success in the other 
suggest only that the system envisioned in the law itself is not the 
controlling essential. It merely points up the importance of several factors 
which are necessary to make hospital cost control a reality. The first, 
obviously, is continuing commitment on the part of the legislature to 
the importance of the issue. Second, once the delegation by the legislature 
is complete, the more important factor is the support of the state's 
executive. Continuous reinforcement by the governor is necessary if the 
agency is to be protected from the enormously powerful political forces 
concerned with the administration of the regulatory system. Third is the 
independence of the agency; good appointments by the governor and 
insulation from political pressure are requisites for an effective imple- 
mentation of the legislature's intention. Finally, and of overwhelming 
importance, is the presence of a strong and professional staff for the 



'"1971 Md. Laws 627 (codified as amended at Md. Health-Gen. Code Ann. 
§§ 19-201 to 19-220 (Supp. 1985)). 

"'1973 Wash. Laws ch. 5 (codified as amended at Wash. Rev. Code Ann. §§ 70.39.030- 
70.39.910 (West 1975 & Supp. 1986)). 

"'Coelen & Sullivan, An Analysis of the Effects of Prospective Reimbursement 
Programs on Hospital Expenditures, Health Care Fin. Rev., Winter 1981, at 1; Cohen 
& Colmers, ReViews: A State Rate-Setting Commission, 1 Health Aff. 99 (1982). But 
see Mitchell, Issues, Evidence, and the Policymaker's Dilemma, 1 Health Aff. 84 (1982). 

'"'C/'. Coelen & Sullivan, supra note 113. 



950 



INDIANA LA W REVIEW 



[Vol. 19:919 



agency. Without a skilled and politically neutral staff, the rate-setting 
experiment will not succeed. 

The foregoing analysis underscores the observation of one analyst 
that "good people cannot make a bad law work, just as bad people 
cannot make a good law work." Good laws are necessary to give force 
to a strong rate-setting program, and public-spirited people of deter- 
mination must be encouraged to administer the will of the people as 
expressed through the legislature. 



APPENDIX 

FIGURE 1 . 

PERCENTAGE CHANGE SINCE 1972 
N EXPENSE PER ADMISSION (ADJUSTED) 




1974 



LEGEND: MEAN REGULATED 6 MEAN NONREGULATED 45 

JOHNS HOPKINS CENTER FOR HOSPITAL FINANCE AND MANAGEMENT 



1986] 



COST CONTAINMENT 



951 



FIGURE 2. 



ANNUAL PERCENTAGE CHANGE IN 
EXPENSE PER ADMISSION (ADJUSTED) 



25 



20 



15- 



10 



5- 




— I r 

1983 1984 



1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 

YEAR 



LEGEND: CONNECTICUT UNITED STATES 

JOHNS HOPKINS CENTER FOR HOSPITAL FINANCE AND MANAGEMENT 

FIGURE 3. 

ANNUAL PERCENTAGE CHANGE IN 
EXPENSE PER ADMISSION (ADJUSTED) 



25 



20 



15- 



10 




1972 



1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 



YEAR 



LEGEND: MARYLAND UNITED STATES 

JOHNS HOPKINS CENTER FOR HOSPITAL FINANCE AND MANAGEMENT 



952 



INDIANA LA W REVIEW 



[Vol. 19:919 



FIGURE 4. 



ANNUAL PERCENTAGE CHANGE IN 
EXPENSE PER ADMISSION (ADJUSTED) 



25 



20 



15 



10 



0- 




1 — 

1974 



1972 



1973 



1975 



1976 



1977 



1978 



YEAR 



1979 



1980 



I 
1981 



1982 1983 



1984 



LEGEND: MASSACHUSETTS UNITED STATES 

JOHNS HOPKINS CENTER FOR HOSPITAL FINANCE AND MANAGEMENT 

FIGURE 5. 

ANNUAL PERCENTAGE CHANGE IN 
EXPENSE PER ADMISSION (ADJUSTED) 




1972 



1973 



1974 



1975 



1976 



1977 



1978 



YEAR 



1979 



1980 



1981 



1982 



1983 



1984 



LEGEND: NEW JERSEY UNITED STATES 

JOHNS HOPKINS CENTER FOR HOSPITAL FINANCE AND MANAGEMENT 



1986] 



COST CONTAINMENT 



953 



FIGURE 6. 



ANNUAL PERCENTAGE CHANGE IN 
EXPENSE PER ADMISSION (ADJUSTED) 



25- 



20- 



15- 



10 



5- 



0- 




T 1 — 

1972 1973 



1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 

YEAR 



1984 



LEGEND: NEW YORK UNITED STATES 

JOHNS HOPKINS CENTER FOR HOSPITAL FINANCE AND MANAGEMENT 

FIGURE 7. 

ANNUAL PERCENTAGE CHANGE IN 
EXPENSE PER ADMISSION (ADJUSTED) 



25 



20 



15 



10- 



5- 



0- 




T — 1 — ! 1 i 1 \ 1 1 1 1 1 r 

1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 

YEAR 



LEGEND: WASHINGTON ■ UNITED STATES 

JOHNS HOPKINS CENTER FOR HOSPITAL FINANCE AND MANAGEMENT 



954 



INDIANA LAW REVIEW 



[Vol. 19:919 



FIGURE 8. 



TOTAL OPERATING MARGIN 




YEAR 



LEGEND: MEAN REGULATED 6 MEAN NONREGULATED 45 

JOHNS HOPKINS CENTER FOR HOSPITAL FINANCE AND MANAGEMENT 



Liver Transplantation in Massachusetts: 
Public Policymaking as Morality Play* 

Clark C. Havighurst** 
Nancy M. P. King*** 

In 1982, Jamie Fiske, the infant daughter of Mr. and Mrs. Charles 
Fiske of Massachusetts, was dying of congenital liver disease. Her death 
was imminent, except for the possibility that a liver transplant — a dif- 
ficult, risky, and extremely costly surgical procedure considered by many 
authorities still to be experimental — could prolong her hfe, for months 
or years, under a Ufetime regimen of drugs to prevent her body's 
natural rejection of the foreign tissue. No surgeons or hospitals in 
Massachusetts performed liver transplants at the time. Moreover, the 
Massachusetts Blue Cross and Blue Shield plans (MBCBS), the family's 
health insurers, advised the Fiskes that such an experimental procedure 
would not be covered under their policy. • Thus begins the complex 
morality play, * 'Liver Transplantation in Massachusetts." 

In addition to the Fiskes, the players in this drama include: two 
state-appointed commissions, composed of prominent citizen-experts; the 
state Department of Public Health; the state Medicaid program; MBCBS 
and Blue Shield's president, John Larkin Thompson; and, as a kind of 
Greek chorus, the omnipresent media. The role of ''identified life"^ is 



♦Support for the research reflected in this article was provided under Grant No. HS 
05326 from the National Center for Health Services Research and Health Care Technology 
Assessment, U.S. Department of HeaUh and Human Services. The authors are indebted 
to personnel of the Massachusetts Department of Public Health and Blue Cross of 
Massachusetts and to members of the Task Force on Organ Transplantation for their 
generous help in facilitating access to information and documents and for submitting to 
interviews. Conversations with numerous individuals, most of which are cited herein, 
greatly assisted the authors in forming their impressions of liver transplantation in Mas- 
sachusetts. The interpretations offered here are of course not necessarily shared by those 
who assisted the authors or participated so conscientiously in the policymaking effort. 
** William Neal Reynolds Professor of Law, Duke University. A.B., Princeton University, 
1955; J.D., Northwestern University, 1958. 

***Instructor, Department of Social and Administrative Medicine, University of North 
Carolina at Chapel Hill. B.A., St. John's College, 1975; J.D., University of North CaroHna 
at Chapel Hill, 1980. 

'Because the Fiskes had initially been guaranteed coverage for the transplant by an 
MBCBS employee, the Blues eventually agreed to pay for Jamie's treatment even though 
the procedure was technically excluded from plan coverage. 

The special function of characters Uke Jamie— endangered individuals whose jeop- 
ardy could be relieved by heroic or extraordinary governmental action— in dramas of this 
kind has been observed by numerous critics. Interestingly, many if not most of these 
critics have been Harvard professors and citizens of Massachusetts. See, e.g.. Fried, The 
Value of Life, 88 Harv. L. Rev. 1415 (1969); Fuller, The Case of the Speluncean Explorers, 
62 Harv. L. Rev. 616, 623 (1949); Schelling, The Life You Save May Be Your Own, 

955 



956 INDIANA LA W REVIEW [Vol. 19:955 

played by Jamie Fiske, whose plight precipitated a dramatic medical 
rescue and who has so far lived as happily ever after as her circumstances 
permit. Absent from the play, even as off-stage voices like the unborn 
children in Die Frau ohne Schatten,^ are the "statistical lives" that 
policymakers reputedly find easier to ignore than identified hves in 
allocating public resources. "^ 

The action takes place under the full glare of publicity. The setting, 
the Commonwealth of Massachusetts between 1982 and 1985, features 
a highly regulated health care system built on assumptions that were 
common in the 1960's and 1970's but that are not universally embraced 
in the United States today. To understand the plot of this drama, it is 
helpful to recognize that the political ethos of Massachusetts envisions 
a true health care ''system" governed centrally in accordance with exphcit 
public choices. Thus, although Jamie Fiske' s fate was not directly in 
the hands of the Commonwealth, the state government seemed to view 
itself as responsible for seeing that nothing so pubUcly heart-rending 
could happen again. 

This review of the Massachusetts experience with liver transplantation 
treats it as a case study of how a centrally controlled health care system 
faces difficult choices concerning health care and health care technology. 
Despite its many special features, the problem of liver transplantation 
is not sui generis. Health care abounds with similar questions concerning 
marginal trade-offs between benefits and costs. Although few of them 
are as visible or as fraught with the characteristics of "tragic choices"^ 
as organ transplantation, the basic dilemma of whether to spend scarce 
resources to achieve a particular health benefit of possibly less than 
commensurate value is always the same. The choice of decisionmaking 
mechanisms, pubhc or private, through which to address these inescapable 
trade-offs has been the fundamental problem of health poHcy in the 
United States.^ 

in Problems in Public Expenditure Analysis 127 (S. Chase ed. 1968); Zeckhauser, 
Procedures for Valuing Lives, 23 Pub. Pol'y 419, 447, 458-59 (1975); see also Evans, 
Health Care Technology and the Inevitability of Resource Allocation and Rationing 
Decisions, pts. 1 & 2, 249 J. A.M. A. 2047, 2208 (1983); Friedman, Rationing and the 
Identified Life, Hosps., May 16, 1984, at 65; infra text accompanying notes 37-43. 

^A well-known operatic fantasy by Richard Strauss and Hugo von Hofmannsthal. 

*See generally Havighurst, Blumstein, & Bovbjerg, Strategies in Underwriting the 
Costs of Catastrophic Disease, Law &. Contemp. Probs., Autumn 1976, at 122, 140-45; 
see also supra references cited note 2 and infra text accompanying notes 37-43. 

The term is Guido Calabresi's. See generally G. Calabresi & P. Bobbitt, Tragic 
Choices (1978). Tragic choices arise in situations where no decision can be satisfying 
because any choice necessarily sacrifices one or more irreconcilable fundamental values. 
Scarcity is the fundamental condition that necessitates such choices. Not all choices are 
tragic, of course, and markets are usually tolerated to allocate mundane goods and services. 
Where the opportunity cost of a particular choice includes a highly visible possibility of 
a lost life or other personal tragedy, however, its potentially tragic character appears. 

^See generally Havighurst & Blumstein, Coping with Quality /Cost Trade-offs in 
Medical Care: The Role of PSROs, 70 Nw. U.L. Rev. 6, 9-45 (1975). 



1986] LIVER TRANSPLANTATION 957 

American society as a whole is somewhat less committed than Mas- 
sachusetts to centralized decisionmaking on questions of what health 
services should be provided. Indeed, although the enactment of Medicare 
and Medicaid in 1965 started a seemingly inexorable movement toward 
such centralization of authority in government hands, recent years have 
seen a distinct movement in the opposite direction, particularly in federal 
policy.^ Despite the promise of this new poHcy and some signs that 
hopes for it are being rewarded, it is still not clear that private choices 
can effectively ration expensive, potentially hfesaving therapies or that 
such rationing, if effective, would be acceptable politically. Many believe 
that effective and acceptable rationing can be achieved only by having 
government assume direct or indirect control of technology and health 
care spending. Although the Massachusetts experience with liver trans- 
plants provides no answers to these policy questions, it yields some 
insights into the relative merits of both approaches.^ 

I. Act One 

Jamie Fiske's father successfully pleaded her need for a transplantable 
organ (and financial assistance) before the entire country, leading to a 
successful transplant at the University of Minnesota in November 1982. 
As a direct result of Jamie's case and the publicity it attracted, several 
things happened back home in Massachusetts. Several hospitals in Boston, 
all of them nationally prominent research and tertiary care centers, began 
expressing an interest in undertaking liver transplants. Other candidates 
for transplant surgery began appearing and pressing for financial support 
for the expensive lifesaving therapy. Such developments immediately 
focused attention and pressure on state government, because Massachu- 
setts hospitals were not free to offer the service without a "determination 
of need" (DON) by state health planners^ and because the state Medicaid 
program was one of the payers being asked to cover the cost. In addition, 
although MBCBS were private entities, they were finding it difficult both 
on medical grounds and as a public relations matter to insist that liver 
transplantation was still "experimental" and therefore not covered by 
their insurance contracts. MBCBS were hopeful that the state would 



''See generally Market Reforms in Health Care (J. Meyer ed. 1983); Havighurst, 
The Changing Locus of Decisionmaking in the Health Care Sector, 11 J. Health Pol, 
Pol'y & h. 691 (1986). 

Tor other studies providing insight on technology assessment, rationing, and tragic 
choices in different health care settings, see generally H. Aaron & W. Schwartz, The 
Painful Prescription (1984) (describing the rationing of health care in the United Kingdom); 
Institute of Medicine, National Academy of Sciences, Assessing Medical Technol- 
ogies (1985); Minnesota Coalition on Health Care Costs, The Price of Life: Ethics 
and Economics (Dec. 1984) [hereinafter Minnesota Coalition Report]; Office of Tech- 
nology Assessment, Medical Technology Under Proposals to Increase Competition 
IN Health Care (1982). 

^Mass. Gen. Laws Ann. ch. Ill, § 25B (West 1977). 



958 INDIANA LAW REVIEW [Vol. 19:955 

take the heat either for denying the service or for authorizing it and 
the higher insurance premiums needed to pay for it. Under these cir- 
cumstances, the Commonwealth government did the predictable thing — it 
appointed a commission.'" 

A. The Fineberg Task Force and Report 

The Liver Transplantation Task Force (LTTF), which was created 
in December 1982, was charged by the Commissioner of Public Health 
with the task of discussing several issues, including the question, "Should 
this type of program and procedures be encouraged or permitted?"" 
Notably, this charge directly raised the fundamental question of whether 
the state should allow livers to be transplanted at all. It envisioned a 
range of possible postures for the state, from prohibition to neutrality 
to active encouragement. Although outright suppression of either research 
on a new technology or use of a technology once developed would, in 
practice, raise serious political and legal questions, the LTTF was never- 
theless asked to recommend what state policy ought to be. 

The LTTF's report, known as the Fineberg Report, ^^ was issued in 
May 1983. It described liver transplantation as 

a technically feasible, extreme and expensive procedure, de- 
monstrably capable of extending the lives of some patients near 
death, and with substantial uncertainties about optimal selection 
of patients, appropriate criteria for excluding other patients, 
optimal matching of donor organs and recipients, effectiveness 
under conditions of more widespread use, and the extent of 
benefits and costs. '^ 

The report recommended that liver transplants in Massachusetts be Hmited 
to one adult and one pediatric program with extensive data to be gathered 
from these programs in order to clarify the numerous "uncertainties" 
it had identified.'"^ The LTTF viewed both this data gathering and 
systematic evaluation of the procedure as vitally important. 



'"This commission was the Liver Transplantation Task Force (LTTF), which was 
created in December 1982. 

"Letter from Alfred L. Frechette, Commissioner of Public Health, Commonwealth 
of Massachusetts, to Harvey Fineberg, Harvard School of Public Health (Dec. 27, 1982) 
reprinted in Final Report of the Task Force on Liver Transplantation in Massa- 
chusetts B1-B2 (May 1983). 

'TiNAL Report of the Task Force on Liver Transplantation in Massachusetts 
(May 1983) [hereinafter Fineberg ReportI (known as the Fineberg Report after the chairman 
of the LTTF, Harvey Fineberg of the Harvard School of Public Health). 

'Ud. at 34. 

'"Id. at 36, 40-41. The report also recommended that liver transplantation be initiated 
under a special one-year DON exemption, so that the data gathered by the new programs 
could be evaluated before a final DON determination was made. Id. at 39-40. In a 



1986] LIVER TRANSPLANTATION 959 

In addition, the Fineberg Report provided extensive cost estimates 
on liver transplantation, derived largely from data supplied by MBCBS.*^ 
It identified eleven cost components, ranging from preoperative expenses, 
surgery, and follow-up to the costs of complications, including 
rehospitalization and additional transplants.^^ It concluded by estimating 
that the average cost per Massachusetts patient surviving one year after 
the transplant would be $238,800. '^ The report candidly acknowledged 
that some of its assumptions may have reduced the reliability of this 
estimate, noting that it took hospital charges to reflect true resource costs 
and ignored both indirect economic effects and "potential savings at- 
tributable to averted medical expenses" incurred in caring for a dying 
patient.'* The report's completeness and candor on these points were un- 
precedented; they serve to highlight the shortcomings of other prominent 
studies and the great need for better data gathering.'^ 

The LTTF's average total cost figure obscures the possibility that 
the marginal or incremental cost of a transplant may be considerably 
less. Based on the observation that transplantation could be undertaken 
in Massachusetts hospitals without adding equipment or personnel, the 
LTTF concluded that hospitals undertaking transplantation should be 
required to do so within their respective current cost ceilings under 
Massachusetts' system for regulating hospital revenues. ^^ Under this rec- 
ommendation, a hospital could receive no additional funds by virtue of 
adding a liver transplantation program and would thus have to finance 
its involvement from any surpluses it might earn or by economizing on 
(or terminating) the provision of other services. It appears that the LTTF 
judged liver transplantation to have so little proven value to date that 
new public or private outlays for it were not warranted. A payment 
restriction was one of several methods by which the LTTF hoped to 
achieve a "controlled dissemination of liver transplantation in Massa- 
chusetts" until more data on its efficacy, cost, and desirability were 
collected. ^' 

Although this decisive call for caution seemed to stem from strong 
reservations about the value of the new technology, the Fineberg Report 
stopped short of addressing the most fundamental question raised in its 
charge. Admitting great discomfort in addressing the question of whether 
liver transplantation should take place at all, the LTTF passed the buck. 

thoughtful discussion estabUshing the need for this data gathering, the report described 
liver transplantation as being somewhere "on the continuum between 'experimental' and 
'established.' " Id. at 8. 

''Id. at 25. 

'"•Id. at 27. 

''Id. 

''Id. at 29. 

''Id. at 30. 

^°Id. at 39-40. 

^'Id. at 35. 



960 INDIANA LA W REVIEW [Vol. 19:955 

Declaring itself "not legitimately constituted to render these views on 
behalf of society, "^^ the LTTF asked the Commissioner of Public Health 
to "appoint a broadly representative advisory body to consider the 
difficult value judgments about whether society can and should support 
liver transplantation and to what degree. "^^ Hidden in this response, it 
should be noted, is an affirmation of the assumption that a single choice 
for "society" as a whole is necessary and appropriate and that this 
choice should be made by a committee in the first instance and ultimately 
by political processes. By recasting the question to focus on whether 
society should "support" transplantation, the LTTF seemed to eliminate 
the possibility that transplantation would be expressly forbidden. It is 
also possible, however, that the LTTF simply recognized that the reg- 
ulatory blanket covering Massachusetts hospitals was so stifling that a 
decision not to "support" transplantation was tantamount to prohibiting 
it. 

B. The Regulatory Setting 

The specific occasion for creating the LTTF was an application by 
New England Deaconness Hospital to the Department of Public Health 
for an exemption from state DON requirements that would allow a small 
number of liver transplants in 1983.^^ On further inquiry, the Department 
found that the Massachusetts General Hospital, Children's Hospital, and 
the New England Medical Center were also prepared to perform liver 
transplants.^^ It was hardly surprising that Boston's internationally prom- 
inent research hospitals were eager to perform liver transplants after the 
publicity given to Jamie Fiske's ordeal. 

Like those of other states, Massachusetts' certificate-of-need program 
(known as DON) makes capital expenditures and substantial changes of 
service subject to approval by state authorities.^^ Such regulatory pro- 
grams, the adoption of which was at one time required by federal law,^^ 
were established in an effort to curb the proliferation and expansion of 
health care facilities so that growth would correspond to officially pro- 



^^Id. at 31. The LTTF's reservations about its competency were based on the fact 
that it was composed predominantly of scientists. 

^^Id. at 42. 

^See Letter, supra note 11. Several interviews confirmed the identity of the institution 
in question. 

^'These four hospitals supplied the LTTF with much of its information about the 
feasibility of liver transplantation in Massachusetts. See Fineberg Report, supra note 12, 
at app. D. 

^^Mass. Gen, Laws Ann. ch. Ill, § 25B (West 1977). 

^The Health Planning and Resources Development Act of 1974, Pub. L. No. 93- 
641, 93 Stat. 606 (1974) (codified in scattered sections of 42 U.S.C), made the availability 
of certain federal funds conditional on the enactment of a certificate-of-need program 



1986] LIVER TRANSPLANTATION 961 

jected needs. ^^ The Massachusetts DON statute and regulations give 
especially broad authority to the Department of Public Health to de- 
termine whether a '^substantial change in services" is needed,^^ and it 
was apparently conceded that a hver transplantation program needed 
state approval under this provision. The immediate reason for commis- 
sioning the Fineberg Report was to assist the Department in the DON 
process. ^^ Without affirmative action by the Commonwealth, Boston's 
research hospitals would be barred from performing liver transplantation. 

For interested hospitals, getting a DON was only the first regulatory 
hurdle. Massachusetts places a ceiling on hospital expenditures through 
its "all-payer" Maximum Allowable Cost (MAC) system.^' Under this 
system of revenue limits, each acute care hospital's annual operating 
budget ceiling is determined in advance by the state, and the hospital 
is then permitted to collect revenues necessary to cover its anticipated 
needs from Medicare, Blue Cross, and private insurers, roughly in pro- 
portion to the number of beneficiaries treat ed.^^ Instituted in 1982, the 
MAC program assures each hospital prospectively that it will receive 
payments reflecting its actual 1981 costs plus adjustments for inflation, 
exceptions, and certain other factors." The provision for exceptions 
permits a hospital to seek additional revenues to cover the anticipated 
costs of approved new services, such as liver transplants, and capital 
and operating expenses associated with other DON's.^'* 

Naturally, any hospital receiving a DON to begin performing hver 
transplants would also wish to receive payment for them under a MAC 
exception. Under the Fineberg Report's recommendation, however, the 



meeting certain standards. The federal compulsion has recently been relaxed. See Dere- 
gulation Is Growing Trend for State CON Programs, Alpha Centerpiece, Feb. 1986, at 
1. Pending legislation would make state participation voluntary. See Health Planning Bill 
Passed, 44 Cong. Q. Weekly Rep. 268 (1986). 

^«On the policy underlying certificate-of-need laws, see generally C. Havighurst, 
Deregulating the Health Care Industry: Planning for Competition 26-30, 54-63 
(1982); Bovbjerg, Problems and Prospects for Health Planning: The Importance of In- 
centives, Standards, and Procedures in Certificate of Need, 1978 Utah L. Rev. 83, 84- 
97; Havighurst, Regulation of Health Facilities and Services by "Certificate of Need,'' 
59 Va. L. Rev. 1143, 1148-69 (1973). 

^^Mass. Gen. Laws Ann. ch. Ill, § 25B (West 1977); Mass. Regs. Code 105, § 
100.020 (1977). 

^"Fineberg Report, supra note 12, at app. B. 

"The MAC system was put into place by chapter 372 of the Massachusetts Acts of 
1982. See Mass. Gen. Laws Ann. ch. 6A (West Supp. 1985). It established a prospective 
payment system for Medicaid and private insurers, modeling the approach after a Blue 
Cross hospital payment contract already in use. A federal waiver made the state's payment 
system binding on the Medicare program. Id. 

'^See Mass. Gen. Laws Ann. ch. 6A, §§ 50-56 (West Supp. 1985). 

''Id. 



962 INDIANA LA W REVIEW [Vol. 19:955 

exception would not be granted and the hospital would have to finance 
the service out of savings elsewhere. Under these circumstances, a trans- 
plant candidate with an insurer willing to pay for the procedure might 
not find a Massachusetts hospital willing to provide it, because any 
hospital revenue from treating that patient would have to be offset 
by reduced revenue from treating other s.^^ On the other hand, a MAC 
exception would allow the hospital to cover the costs of transplants by 
cost shifting, increasing its charges to the various payers in order to 
pay for transplants needed by patients lacking adequate insurance. ^^ 

Under these regulatory circumstances, the willingness or unwillingness 
of payers to pay for, or of patients to buy coverage for, such procedures 
would have little or no effect on whether transplants would be undertaken. 
This decision was essentially the state's, and if the state decided to 
authorize the service, the public would pay for it one way or another. 
But this payment would not necessarily be through the usual method 
of openly levying taxes and explicitly appropriating funds for worthy 
pubhc projects. The Massachusetts philosophy, with which no one seems 
to have quarreled throughout this episode, is apparently that the state 
alone, through the DON-MAC process, should finally dictate such mat- 
ters. The state's potential role in frustrating transactions between a willing 
buyer and a willing seller was not commented upon. As will be seen, 
the state was comfortable with — though perhaps not entirely comfortable 
in — its role as giver or withholder of lifesaving medical treatment. 

C The Political Scene 

It is a widely noted fact of our political life that when an individual 
human life is placed in visible, media-covered jeopardy, a tug on the 
public heart strings loosens governmental purse strings, causing expend- 
itures to save that "identified life" which far exceed what government 
is wilhng to spend to save an otherwise comparable "statistical life."^^ 
This phenomenon of our media-driven democracy can be viewed in 
contrasting ways. It is either, on the one hand, an inexcusable pandering 
to public passions by public officials freely using pubhc funds to establish 
that they are compassionate and deserve re-election or, on the other 



"Freezing the resources available to an institution places responsibility for allocating 
those resources on the institution and its physicians. Decisions may not reflect the public's 
priorities because internal institutional politics allow economic interests and professional 
values to enter the picture. See Harris, Regulation and Internal Controls in Hospitals, 55 
Bull. N.Y. Acad. Med. 88 (1979). 

^^The MAC system effectively breaks most of the links between the private insurance 
coverage that individuals buy and the care they receive. Hospitals are free to provide any 
of the myriad of services authorized by their DON and to tax the cost proportionately 
to all payers, up to the MAC limit. See supra note 35. 

"See supra notes 2, 4. 



1986] LIVER TRANSPLANTATION 963 

hand, a healthy and reassuring affirmation that the community prizes 
each individual and is not coldly calculating when human life is at stake. 
Although such seemingly inefficient expenditures may be defensible be- 
cause they give the community a chance to feel good about itself, it is 
also possible that they cultivate false impressions and divert attention 
and resources away from unfulfilled obligations. 

Jamie Fiske's story had poignant consequences nationwide and il- 
lustrated the dilemmas that government faces in allocating public re- 
sources to health care in a political environment that demands concern 
for a handful of identified lives. Following Jamie's transplant, public 
and private financing mechanisms across the country faced strong public 
pressure to cover the costs of the procedure for other individual victims, 
frequently children. ^^ The pressure was particularly acute for state Med- 
icaid programs; a number of governors and legislatures responded by 
issuing ad hoc directives to finance highly pubHcized cases with state 
funds. In Missouri, for example, the legislature specifically authorized 
an exceptional payment on behalf of a 16-year-old girl, only 'to reverse 
itself the following week when two things happened: additional candidates 
appeared, demonstrating that one costly symboHc act would not be 
enough to satisfy the media, and perhaps consequentially, such private 
legislation was found to violate the state constitution.^^ 

Nowhere was the political pressure on a Medicaid program greater 
than in Massachusetts — the home of Jamie Fiske, as well as a major center 
for biomedical research and a state that had gone very far in accept- 
ing pohtical responsibility for the operation of the health care enterprise. 
Massachusetts Medicaid declared liver transplants reimburseable for eligi- 
ble persons in the summer of 1983. From then until January 
1984, Massachusetts was in the anomalous position of guaranteeing to 
the very poor an extremely costly medical procedure that was not available 
to middle-class MBCBS subscribers. Thus, taxpayers were forced to buy 
for others transplants which they had not yet chosen to purchase for 
themselves through insurance. Although MBCBS was also under pressure, 
it was able as a private entity to hold out longer. This experience seems 
to confirm that elected officials and programs accountable to them — even 
more than private nonprofit organizations that strive to be perceived as 
benign dispensers of good things — do indeed seize opportunities to 
demonstrate their compassion by spending scarce public funds irra- 
tionally.^o 

^^See, e.g., Friedman & Richards, Life and Death in a Policy Vacuum, Hosps., May 
16, 1984, at 79; Wessell, Medical Quandary: Transplants Increase, and So Do Disputes 
Over Who Pays Bills, Wall St. J., Apr. 12, 1984, at 1, col. 1; Rust, Transplant Successes 
Stir Debate on Coverage, Am. Med. News, Oct. 21, 1983, at 1. 

^^Friedman & Richards, supra note 38, at 80. 

''°One report asserts that this pattern is not universal, and suggests that public insurers 
are on the whole reluctant to cover expensive new technologies. Evans, Transplant Coverage: 



964 INDIANA LA W REVIEW [Vol. 19:955 

Undoubtedly, Medicaid dollars allocated to transplants could have 
been put to better use in saving statistical lives or purchasing *' quality- 
adjusted Hfe years. "^^ In Cahfornia, the point was illustrated most 
tellingly: the legislative decision to pay for liver transplantation came 
at the same time that the legislature decided to terminate state support 
for its medically indigent population, those who cannot afford insurance 
for their own health care but are not deemed poor enough to warrant 
public assistance/^ The eagerness of public officials to gain credit for 
their humanitarianism, especially when someone else's money was at 
stake, was revealed even in the White House, which made a number 
of dramatic appeals to state governments and private payers on behalf 
of particular individuals.^^ These scenes of elected representatives crowd- 
ing onto the stage of this morality play left to the audience's imagination 
the effects of government policies on those who lacked the limehght.'^'^ 

D. The Private Sector: MBCBS 

Just as the public sector felt pressure to finance transplants for 
identified patients, private insurers all over the country, particularly Blue 
Cross plans, found themselves making difficult case-by-case decisions in 
full view of the media. MBCBS's particular problem in this regard was 



A Public Policy Dilemma, Bus. & Health, Apr. 1986, at 5. As the Missouri experience 
{see supra text accompanying note 39) suggests, government's largess will stop when the 
costs to policymakers exceed the political benefits of being associated with a lifesaving 
effort. 

"'Expanding Medicaid ehgibility and coverage of preventive services would be obvious 
strategies. See, e.g.. President's- Commission for the Study of Ethical Problems in 
Medicine and Biomedical and Behavioral Research, Securing Access to Health 
Care: The Ethical Implications of Differences in the Availability of Heath Services, 
19-20, 59-65, 79-90 (1983) thereinafter President's Commission Report] (discussing what 
ought to be encompassed by "an adequate level of health care" available to all citizens 
and highlighting current problems in health services delivery). On the use of "quality- 
adjusted life years" as a way of assigning priorities to public investments in health and 
safety, see, e.g., Zeckhauser & Shepard, Where Now for Saving Lives?, Law & Contemp. 
Probs., Autumn 1976, at 5, 11-15. 

■'^Wessell, supra note 38. 

"^M; see also Iglehart, Transplantation: The Problem of Limited Resources, 309 N. 
Eng. J. Med. 123, 126-27 (1983); Meyer, Transplant Eunding: A Controversial New Area, 
Washington Post, Sept. 12, 1984, at C3, col. 1. 

'^In yet another demonstration of elected officials' felt need to "do something" to 
respond to media attention to the transplantation issue and to get media attention for 
themselves, the Massachusetts legislature, in late 1983, added a check-off box to the state's 
income tax returns so that taxpayers could direct that a portion of any tax refund go 
into an organ transplantation fund. In 1985, when the checkoff first appeared on tax 
forms, some 37,000 taxpayers contributed approximately $187,000 to the fund, which will 
probably be used primarily to help pay for cyclosporin and other follow-up care for 
transplant recipients. Interview with Joan Gorga, Dept. of Pubhc Health, Boston (July 
1985). 



1986] LIVER TRANSPLANTATION 965 

not solved by the continued failure of Massachusetts regulators to au- 
thorize transplants, because insureds could still request treatment out of 
state. For this reason, MBCBS did not oppose the effort by local hospitals 
to get DON approval for transplantation. Indeed, MBCBS took the view 
that if they were going to have to pay for transplants eventually, it 
would be better to pay for in-state procedures. "^^ They anticipated that 
the MAC system would control the incremental cost and that the DON 
system would limit the number of facilities. "^^ Together these regulatory 
programs might restrict the capacity and the incentives of the system 
to perform more than a few procedures. 

For the time being, however, MBCBS were reluctant to accept 
responsibility for paying for liver transplants anywhere. According to 
MBCBS officials, public pressure to pay for liver transplants in 1982 
and 1983 was enormous. Although they did not wish to be perceived 
as denying potentially beneficial care, however costly, to any insured,'*^ 
the plans were also hesitant to waive the contractual limitation under 
which they were obUgated to pay only for generally accepted medical 
procedures. One reason for this attitude was recognition of the financial 
cost which transplants would impose on them immediately and which 
would have to be built into future premiums charged to customers already 
grumbling about high insurance costs. "^^ 

Another explanation, however, had to do with MBCBS's view of 
their precise role in the Massachusetts system. MBCBS complained that 
they were not getting clear signals from their usual sources. On the one 
hand, there were the pressures from the media and the example set by 
the Medicaid program. On the other hand, the health care system's 
central decisionmakers were not speaking with one authoritative voice. "^^ 
For example, in 1982 and 1983, although liver transplants were gaining 
favor, MBCBS's medical advisors could not reasonably declare liver 
transplantation to be accepted therapy covered by their policies because 
any reasonable chance of a procedure's success depended upon use of 
a drug, cyclosporin A, which the U.S. Food and Drug Administration 
(FDA) considered experimental until September 1983.^° 

Apparently wedded to a vision of themselves as mere financing 
intermediaries bound to give effect to any doctor's prescription made 



"•'Interviews with Douglas Dickson, Ombudsman, and James Young, M.D., Medical 
Director, Massachusetts Blue Cross (July 15, 1985); see also Rust, supra note 38, at 16. 

"•^Dickson and Young interviews, supra note 45. 

''Id. 

"•^Wessell, supra note 38. 

"^Rust, supra note 38. The termination of the National Center for Health Care 
Technology in a 1981 funding cut left MBCBS and other third-party payers without the 
prospect of an authoritative governmental opinion on which to base their payment decisions. 

'"Food & Drug Administration, U.S. Dep't of Health & Human Services, HHS 
News, Pub. No. 83-19 (Sept. 2, 1983). 



966 INDIANA LAW REVIEW [Vol. 19:955 

according to policies centrally determined by professional or governmental 
decisionmakers,^^ MBCBS preferred to rest coverage decisions on the 
actions of public regulatory agencies such as the FDA. They thus resisted 
any suggestion that they should embark on independent assessments of 
medical treatments, either paying for something officially deemed ex- 
perimental or refusing on benefit/cost grounds to pay for something 
that enjoyed professional and governmental approval. As nonprofit cor- 
porations together constituting the dominant health insurer in Massa- 
chusetts, MBCBS were dependent on the pubhc's perception of them as 
a benign source of financial assistance in meeting officially recognized 
medical needs. The Blues were beginning, however, to see the high cost 
and difficulties of marketing themselves in this way. 

In mid- 1983, MBCBS's arguments for not paying for liver transplants 
began to collapse. In May, the Fineberg Report called liver transplantation 
"cHnically justifiable,"" and in June, a National Institutes of Health 
consensus conference stated that "liver transplantation offers an alter- 
native therapeutic approach which may prolong Ufe in some patients."" 
When these lukewarm semi-official endorsements of liver transplantation 
were combined with media attention to the plight of transplant candidates 
and the relative willingness of other insurers and Medicaid to pay for 
liver transplants, they seemed to leave MBCBS with no choice. MBCBS 
had to discover some way around their own guidelines or be perceived 
as denying treatment solely because of the procedure's high cost. The 
solution that MBCBS hit upon was to offer their subscribers a Transplant 
Insurance Program, called 'TIP."^"* By this means, they hoped to bridge 
the gap until the FDA would approve cyclosporin A, which would allow 
MBCBS, consistent with their principles, to build transplants into their 
basic coverage and rates. 

TIP was a separate, optional rider offered to all employment groups 
or ''accounts" at a cost of 55 cents per individual or $2 per family per 
month. TIP offered full coverage for heart, heart-lung, and Hver trans- 
plants, beginning five days before the procedure and continuing for 
twelve months thereafter. ^^ If an account chose to purchase TIP, it would 
be mandatory rather than optional for the account's insureds or "mem- 



'•For complex reasons, private health insurers have long denied responsibility for 
influencing providers' treatment decisions, relying instead on professional or governmental 
decisionmakers to establish what services should be paid for. See Havighurst, Explaining 
the Questionable Cost-Containment Record of Commercial Health Insurers, in The Po- 
litical Economy of Health Care (H. Freeh ed. to be published). 

"Fineberg Report, supra note 12, at 2. 

"National Institutes of Health, Consensus Development Conference Summary, 
Liver Transplantation (1983). 

'^See Rust, supra note 38, at 16-17. 

"Blue Cross & Blue Shield of Mass., "Special Announcement: New Transplant 
Insurance Plan" (Sept. 1983) [hereinafter Special Announcement] (mailing to accounts). 



1986] LIVER TRANSPLANTATION 967 

bers." Before offering TIP, Blue Cross conducted several opinion surveys 
to determine whether the public pressure they were feeling would actually 
translate into individual choices to purchase transplant insurance. These 
surveys indicated considerable desire for such insurance on the part of 
surveyed individuals and families. ^^ However, the response to TIP itself 
differed significantly from the response to the surveys. 

TIP was offered to MBCBS accounts in September 1983. Although 
John Larkin Thompson, president of Blue Shield, called TIP "the 
ultimate referendum on whether or not the public wants to pay for 
these operations, "^^ TIP was not offered directly to individual members 
because MBCBS feared the effects of adverse selection. ^^ It was left to 
employers to act for their insured employees. Conceivably, publicity 
given to the transplant issue placed employers in a political position vis- 
a-vis their workers that was not dissimilar to that of MBCBS and 
Medicaid vis-a-vis the larger public. Not wanting to appear to economize 
at the expense of employees who might need a transplant, employers 
may have been more wiUing to buy TIP than the employees themselves 
would have been. On the other hand, employers might be reluctant to 
buy transplant coverage because its cost might be perceived as difficult 
to pass on to employees. 

Each account was sent a special announcement explaining TIP, which 
stated, "The public has indicated its desire to have coverage for organ 
transplants."^^ The announcement was clear and complete, but gave 
accounts only about a month to make a decision whether to begin TIP 
coverage on November 1. It left them, however, the alternative of picking 
it up at their regular renewal period during the next calendar year. 

The TIP "referendum" was never completed because MBCBS dis- 
continued it as of February 1, 1984. Cyclosporin A had actually received 
FDA approval in September 1983,6« and in January 1984, MBCBS's 
medical advisory committee finally recommended that liver, heart, and 
heart-lung transplants be considered medically accepted procedures. These 
developments allowed transplantation coverage to be extended to all 
accounts, with a premium increase roughly equal to the TIP premium. 

In contrast to the results from MBCBS's preHminary surveys, TIP 
did not prove especially popular during its brief marketing. By the time 
it was discontinued, only 7400 of the 24,348 accounts to which it was 
offered had purchased the coverage, 7100 had refused it, and the rest 



^^Dickson interview, supra note 47. 

"Rust, supra note 38. 

^^Dickson interview, supra note 47; Interview with Dorris C. Commander, Under- 
writing Manager, Blue Cross of Massachusetts (July 1985). 

^^Special Announcement, supra note 55. 

^FooD & Drug Administration, U.S. Dep't of Health & Human Services, HHS 
News, Pub. No. 83-19 (Sept. 2, 1983). 



968 INDIANA LAW REVIEW [Vol. 19:955 

— over 9800 — had not responded/* Even the Massachusetts Commissioner 
of Insurance, who had statutory responsibility to act as the account 
decisionmaker for MBCBS's 120,000 nongroup subscribers (includ- 
ing a special group of low-income individually insured), had failed to 
make a decision regarding TIP before it was mooted." There are many 
possible explanations for the modest response rate. Some accounts may 
have intended to pick up TIP when they next renewed their coverage. 
According to MBCBS, however, financial considerations probably loomed 
largest in accounts' decisionmaking. In addition, some accounts, par- 
ticularly large ones based in more than one state, may have preferred 
to pay for transplantation in different ways so as to be able to offer 
uniform coverage to employees in all states. One employer, Honeywell, 
wanted the opportunity to approve the transplanting facility. ^^ MBCBS 
were much more interested in seeing that someone other than themselves, 
preferably the state through DON, would be responsible for approving 
facilities and quality control. ^"^ 

At MBCBS, there was little surprise at TIP's poor showing, and 
the perceived reason for it was TIP's cost. Yet no thought was ever 
given to making a point of the public's apparent indifference to transplant 
insurance once an actuarially fair price tag was attached. Perhaps MBCBS 
saw no difference from a public relations standpoint between denying 
transplants on the ground that the procedure was experimental and telling 
an individual that because his employer had rejected the TIP offer, he 
could not have a lifesaving procedure that the plan was providing for 
others. 

In any case, MBCBS made no real effort to examine and ponder 
the significance of the TIP experiment. Indeed, they were quite happy 
to extend their regular coverage to handle transplants. TIP had been 
complicated and cumbersom.e. Because it constituted a separate insurance 
program with a separate pool of funds, TIP required a lot of tracking 
to separate costs attributable to the transplant from ordinary medical 
costs. This tracking difficulty led, in part, to the *'five-days-before, 
twelve-months-after" policy under which all medical costs incurred within 
that period were deemed attributable to the transplant. Both this policy 
and, later, the demise of TIP sacrificed Blue Cross's ability to extract 
easily any data on transplants. All transplant data now go into the files 
with every other medical procedure and, as such, are entered per hos- 
pitalization rather than per individual insured; cumulative information 



^'Friedman & Richards, supra note 38, at 79. 

*^Dickson interview, supra note 47, 

"On Honeywell's transplant coverage, see Minnesota Coalition Report, supra note 
9, at 48; Utah Health Cost Management Foundation, Honeywell's Transplant Coverage 
Stresses Cost Containment, Health Cost Management Nev^s, May 1985, at 3. 

**Young interview, supra note 47. 



1986] LIVER TRANSPLANTATION 969 

on rehospitalization, outpatient care costs, and related other costs are 
difficult to retrieve. ^^ 

Although apparently efficient, blending transplant coverage into a 
system geared only to paying claims and not to evaluating the costs and 
benefits of particular procedures may be a false economy. It is, however, 
a predictable feature of a health care system in which private insurers 
such as MBCBS perceive themselves merely as executing orders from 
the top. MBCBS throughout this episode seemed troubled only that they 
were unable to interpret the conflicting signals they received. Once 
transplants crossed the threshold of acceptability at the FDA, the NIH, 
the LTTF, and the DON agency, the Blues could go happily back to 
their usual business of forcing consumers to buy things that they have 
had no real opportunity to refuse. 

E. Enter the Task Force on Organ Transplantation 

The foregoing events left Massachusetts about to plunge into trans- 
plantation. Yet a number of problems still existed; these resulted primarily 
from the way in which the DON and MAC programs articulated. Simply 
granting a DON without increasing the MAC allowance, as recommended 
by the Fineberg Report, would give rise to the danger that hospitals, 
instead of cutting back on indisputable waste to finance transplants, 
would terminate other, more essential services, creating problems through- 
out the system. For example, a hospital closing a maternity service and 
using its MAC allowance to start transplants would leave its obstetrical 
patients to burden other hospitals, which could not be assured of increased 
MAC allowances to provide for these patients. In this way, the threat 
of sudden introduction of a costly new therapy revealed major flaws in 
the state's basic faith that hospitals' revenue needs could be predicted 
by a formula without creating major anomalies, windfalls, and unfair- 
nesses. 

The liver transplant challenge also revealed faults in the regulatory 
system. Simply granting a MAC exception on the theory that transplants 
had now become just another accepted therapy would mean losing the 
opportunity to ensure that the procedure was being used appropriately 
and that information on its safety, efficacy, and cost would be available 
for subsequent appraisal. The six-figure price tag for each procedure 
made it clear to everyone that letting the system treat liver transplants 
as it treats virtually everything else had significant fiscal impUcations. 
It of course occurred to no one to question publicly whether letting the 
system freely prescribe high volumes of other treatments with five-, four-, 
three-, and even two-figure price tags might also be socially inappropriate 
or wasteful. Thus, the basic belief that doctors and hopsital employ 

"Commander interview, supra note 58. 



970 INDIANA LAW REVIEW [Vol. 19:955 

their limited resources rationally and in accordance with public objectives, 
a faith on which the entire regulatory system was built, was not chal- 
lenged.^ Instead, it was concluded only that the transplant issue, because 
it had met the public eye and could not politically be ignored, had to 
be addressed with greater particularity. Why the system could not be 
trusted here, when it was trusted to make virtually all other choices, 
was never made clear. 

The need to control transplants specially loomed so large that another 
commission, the Task Force on Organ Transplantation (OTTF), was 
appointed. This new task force had a broader scope than the earlier 
one. It was charged with making policy for heart and heart-lung trans- 
plants as well as hvers.^^ It was also asked to provide a social evaluation, 
not just a technical report. As the next act of our morality play will 
show, the OTTF was equal to the challenge to pronounce on the largest 
questions of public policy in health care. 

II. Act Two 

The OTTF was convened in October 1983, by the Commissioner of 
Public Health under the chairmanship of George Annas of the Boston 
University School of Public Health. It was charged "with the development 
of standards and processes for evaluating the use of organ transplan- 
tation."^^ The question expressly left unanswered by the Fineberg Report 
— whether transplantation should "be encouraged or [even] permitted" — 
was not even raised: "The work of the Task Force can be categorized 
in terms of the when, who, what and how of organ transplants."^^ 
Although the OTTF did hear testimony on the issue during its meetings, ^^ 
the objections raised concerning whether to proceed with transplantation 
at all did not detain OTTF members long.^^ The political climate obviously 
precluded a firm stance against the new technology. 



^See supra notes 35 & 36. 

^The OTTF's report was unclear why transplantation of bone marrow, kidneys, and 
other organs was not treated as well, but in stating that liver and heart transplants were 
"the [only] ones currently clamoring for wider introduction," the OTTF confirmed that 
its inquiry was shaped by politics, not by a desire to rationalize the provision of all 
expensive medical care. Report of the Massachusetts Task Force on Organ Trans- 
plantation (1984) [hereinafter OTTF Report]. 

''Id. at 3, 119 (app. A). 

'''Id. at 119 (app. A). 

™Dr. Alan Sager of the Boston University School of Public Health argued before 
the OTTF that "all citizens of the CommonweaUh should have equal access to all effective 
care now routinely available before the range of therapies is expanded." Testimony of 
Alan Sager (Oct. 31, 1983). 

^'Interview with George Annas, OTTF chairman (July 1985). The recent report of 
the National Task Force on Organ Transplantation, created by the National Organ Transplan- 
tation Act, Pub. L. No. 98-507, 98 Stat. 2339 (Oct. 19, 1984), does not address this issue, 
simply assuming that transplantation of all kinds should be covered by public and private 



1986] LIVER TRANSPLANTATION 971 

The OTTF's report, the recommendations of which were unanimous, 
was released in October 1984, although preliminary recommendations 
were released in January. 

A. The OTTF's Recommendations 

The OTTF's first recommendation advocates the introduction of liver 
and heart transplantation "in a controlled, phased manner that provides 
the opportunity for effective evaluation and review of its clinical, social, 
and economic aspects by a publicly-accountable body after an initial 
phase of 2-3 years of limited transplantation. "^^ This position, which 
sounds and may well have been, under the circumstances, eminently 
reasonable, was almost certainly inevitable, given the political impossi- 
bility of saying "no" to transplants. The OTTF, hke the LTTF before 
it,^^ was clearly seeking a middle ground that would accommodate the 
pressure to allow transplants but not open the door to unlimited spending 
on the new technology. The recommendation of a later evaluation was 
necessary to preserve the appearance that the procedure was still in an 
investigatory or probationary stage. As the Fineberg Report had noted, 
however, it is hard to stop a program once it has begun. ^"^ 

The OTTF conveyed the impression that its unanimous conclusions 
were reached by rational planning, deep thinking by academic experts, 
and a collective social conscience. There is also the possibility, however, 
that it was simply compromising conflicting views, accommodating po- 
litical pressures, and rationalizing the result. Although the charge that 
the OTTF's actions were in fact "political" might be taken as a criticism, 
many in Massachusetts would no doubt say that because the conclusions 
flowed from an open process and a representative body, the legitimacy 
and soundness of the result and of the values promoted are unchal- 
lengeable. Whether such faith in the politics of interest-group liberalism 
is warranted should be regarded as an open question, however, ^^ and 
indeed it is one of the central questions inspiring this appraisal. 

The OTTF's second recommendation elaborates on the first by em- 
phasizing that transplantation should not be made "generally available" 
until after the recommended review by a "publicly-accountable body," 



financing programs. U.S. Dep't of Health & Human Services, Public Health Service, 
Health Resources & Services Admin., Organ Transplantation: Issues and Recommen- 
dations (April 1986). The Minnesota Coalition Report, noting the trend to coverage, recom- 
mended that it "should remain optional for group accounts;" no opinion was expressed 
on public plans' policies. Minnesota Coalition Report, supra note 8, at 47-48. 

720TXF Report, supra note 67, at 10. 

^^See supra text accompanying notes 14 & 21. 

^'*Fineberg Report supra note 12, at 36. 

^'C/. Havighurst, More on Regulation: A Reply to Stephen Weiner, 4 Am. J.L. & 
Med. 243, 247-49 (1980) (disputing claims by a Massachusetts advocate of regulation that 
politicized regulation is legitimized by the democratic process and should be immune to 
general criticism). 



972 INDIANA LAW REVIEW [Vol. 19:955 

which should not be limited to assessing the technology's status as 
"experimental" or otherwise 7^ The Report also makes clear that in the 
task force's view, availability is synonymous with general reimbursea- 
bility.^^ It opines, too, that general availability should not result only 
through the state Medicaid program's becoming "the de facto insurer 
for all such procedures,"''^ by virtue of inadequate private financing and 
the impoverishment of transplant candidates. To prevent this result and 
to "ensure fairness in the distribution of burdens regarding reimburse- 
ment," the Report suggests that coverage be prescribed by a "joint 
committee" of government representatives and private insurers.''^ Such 
a body might violate the federal antitrust laws, however, unless its 
decisions were embodied in official government action. ^° 

Recommendations (3) and (4) by the OTTF introduce the issue of 
costs. During the evaluation period, authority to do transplants would 
be granted only to those hospitals that agree to perform them within 
the MAC, with an exception for each procedure that amounts to the 
costs of organ procurement and cyclosporin.^' This attempt to force 
hospitals to finance a portion of the cost of transplant programs by 
economizing was apparently the only way, even in this heavily regulated 
state, in which the volume and hence the overall cost of transplants 
could be kept down. To protect against the concomitant risk that trans- 
plantation would displace other vital services, recommendation (3) sug- 
gests that need determinations in the DON program be made only upon 
a showing that the cost of adding transplantation can be borne without 
sacrificing more desirable services. "As a principle, the Task Force 
believes that if it turns out that liver and heart transplantations take 
resources away from higher priority health care services, and decrease 
their accessibility to the public, then transplantation procedures should 
not be performed. "^^ 

In a section antecedent to its specific recommendations, the OTTF 
gives its final word on how to prevent a modest amount of costly 
transplantation from diverting resources from essential services: 



760TTF Report, supra note 67, at 11. 
''Id. at 11-12. 

""Id. 

«°In general, the Sherman Act, 15 U.S.C. § 1 (1983), prohibits collective actions of 
the kind that are taken for granted in centrally governed health care systems as a useful 
adjunct or alternative to direct government control. Although the McCarran-Ferguson Act, 
15 U.S.C. § 1001 (1983), provides a partial exemption from the Sherman Act for "the 
business of insurance," an agreement not to sell a certain type of coverage has been held 
to fall within an exception to this exemption. St. Paul Fire & Marine Ins. Co. v. Barry, 
438 U.S. 531 (1978). 

siQTTF Report, supra note 67, at 14. Such costs would amount to about $9000 
per heart transplant and $44,000 per liver. Id. 

'Ud. at 13. 



1986] LIVER TRANSPLANTATION 973 

[T]he Task Force believes that these procedures should be per- 
formed on [all] those who are likely to benefit from them, so 
long as the total cost is controlled, and resources are not diverted 
from higher priority medical procedures to liver and heart trans- 
plantation. The question of what a "higher priority" procedure 
is will be based on the total number of individuals affected, 
and the importance to their lives of the intervention. For example, 
it may be appropriate to shut down an underutilized maternity 
program to do organ transplants. The burden of demonstrating 
that such a tradeoff is appropriate, however, should be on the 
hospital proposing it. Accordingly, in the [DON] process, all 
currently available health care services should be presumed to 
be higher priority than transplantation. The applicant should 
have the burden of demonstrating that transplantation has a 
higher priority than any other currently available health care 
service from which organ transplantation diverts funds and/or 
support systems. ^^ 

Such an allocation of the burden of proof would apparently require a 
hospital to prove its own past inefficiency and waste of public resources 
in order to quahfy for the establishment of a transplant program; a 
well-run hospital doing only things highly beneficial to patients need not 
apply. Such paradoxes are common under regulation. Perhaps the crown- 
ing irony, which the task force itself notes in its chapter on costs, ^'^ is 
that transplantation can be contemplated in Massachusetts only because 
much of its high cost can be paid out of waste in the system — the very 
thing that regulation was supposed to prevent. The presumption that the 
OTTF created against the displacement of existing services by transplants 
can hardly be taken, in context, as an expression of faith that regulation 
has in fact achieved true efficiency. 

Recommendation (5) addresses patient selection criteria and would 
require them to be "public, fair, and equitable" and based initially on 
medical suitability criteria and secondarily on the principle of first-come, 
first-served, in the event demand exceeds the supply of organs. ^^ For 
Massachusetts residents, the ability to pay should not be a factor, nor 
should social class or family support. ^^ The report suggests an "appeal 
mechanism" to ensure fairness, thereby conjuring up a vision of two law- 
yers advocating their dying cUents' competing claims to a single liver before 
a neutral decisionmaker. This is a particularly striking example of how 
far the OTTF would go to ensure that the state appear legalistically fair 



"M at 9, 10. 

^'Id. at 60. 

^'Id. at 16-17. 
'^Id. 



974 INDIANA LAW REVIEW [Vol. 19:955 

in dispensing life and death. ^^ With almost equal plausibility, the report 
could have required that patient selection reflect *' affirmative action" 
aimed at redressing past societal injustices toward certain groups. 

Finally, recommendation (6) introduces the idea that heart and liver 
transplants in the Commonwealth should be undertaken by hospitals 
belonging to a consortium organized to share data, experience, and 
resources. ^^ This idea apparently did not originate with the OTTF because 
it stated that there is no economic justification for beginning organ 
transplantation at more than one hospital, but that if more than one 
hospital is to do the procedure, there must be a truly integrated and 
cooperative effort — a "worthwhile consortium."*^ The consortium con- 
cept had appeared earlier in a staff recommendation by the Depart- 
ment of Public Health in connection with the pending DON apph- 
cation.^ In addition, the consortium idea was dictated in part by the 
state's refusal to grant a MAC exception, thereby drastically limiting 
the number of procedures that any one institution could afford to 
perform. 

Use of several institutions put the regulators on very shaky ground, 
however, in light of another prime goal of regulation — ensuring the quality 
of care. Because it is widely accepted that experience improves out- 
comes, the Department of PubHc Health could have been criticized 
if it authorized several hospitals each to perform less than the optimal 
number of procedures per year. The consortium concept, if it allows 
experience truly to be shared, overcomes this objection.'' Its adoption 
in Massachusetts, however, appears to have been only a face-saving com- 
promise, necessitated by the pohtical unpopularity of giving all the business 
to one institution.'^ 



«Tor warnings of the consequences of excessive "due process" in dealing with 
sensitive issues of this kind, see Blumstein, Constitutional Perspectives on Governmental 
Decisions Affecting Human Life and Health, Law & Contemp. Probs., Autumn 1976, 
at 231; Havighurst, Blumstein & Bovbjerg, supra note 4, at 155-57. For scholarship 
approving the legalistic approach, see J. Katz & A. Capron, Catastrophic Diseases: 
Who Decides What? 239-40, 246-48 (1975); Note, Due Process in the Allocation of Scarce 
Life Saving Medical Resources, 84 Yale L.J. 1734 (1975). 

880TTF Report, supra note 67, at 18-20. 

''Id. 

^Id. at app. B. 

^'A factitious consortium, however, could result in significantly poorer patient out- 
comes. This reasoning was the substance of an ultimately unsuccessful challenge mounted 
by the OTTF's chairman to the later-proposed Boston heart consortium. See Brief for 
Appellant at 10-13, George J. Annas Ten Taxpayer Group v. Department of Public Health 
(Health Facilities Appeals Board argued July 9, 1985) (Project No. 4-3306). 

^^George Annas has described the consortium concept as "primarily a political issue 
. . . grafted onto the original draft of the Report at the request of the Commissioner of 
Public Health." Annas, Regulating Heart and Liver Transplants in Massachusetts: An 
Overview of the Report of the Task Force on Organ Transplantation, 13 Law, Med. & 
Health Care 4, 5 (1985). 



1986] LIVER TRANSPLANTATION 975 

The consortium approach solved problems for a number of the par- 
ticipants in the drama. The consortium idea was initially attractive to the 
Department of Public Health because it would reheve it of the politically 
difficult task of choosing among powerful institutions. MBCBS, which 
took credit for planting the seed of the consortium concept, were pro- 
bably hoping to avoid having to select among or oversee competing 
hospitals or to adopt their own patient selection criteria.'^ The four 
hospitals seeking authority for liver transplants had figured out for 
themselves the advantages of a united front both in seeking a DON^"* and 
in avoiding possible future competition. 

B. The Egalitarian Motif 

Perhaps the most notable feature of the OTTF report is its strong 
emphasis on equahty in the distribution of transplanted organs. Perceiving 
this as the central question in the morality play, the task force declaimed: 

On the issues of equity and fairness, we concur with the 
conclusions of the President's Commission for the Study of 
Ethical Problems in Medicine: society has an ethical obligation 
to ensure equitable access to health care for all; and the cost 
of achieving equitable access to health care ought to be shared 
fairly. Transplantation of livers and hearts should therefore only 
be permitted if access to this technology can be made independent 
of the individual's ability to pay for it, and if transplantation 
itself does not adversely affect the provision of other higher 
priority health care services to the public. ^^ 

A literal reading of the italicized lines indicates that the OTTF not 
only endorsed the provision of transplants to those who cannot afford 
them, but also took the startling position that paying patients should 
be denied transplants in Massachusetts until such time as every equally 
needful patient could get one. As noted earlier, it is easily within the 
power of Massachusetts regulators — without actually making the perfor- 
mance of this therapeutic procedure a criminal act^^ — to prevent a dying 
patient from purchasing a transplant with his own money from will- 

^^ Young interview, supra note 47. 

^"Some members of the OTTF viewed the consortium concept with suspicion, con- 
sidering it an end run around the DON process that permits four programs rather than 
just one to perform transplants and makes it easier for the hospitals to demonstrate that 
other services are not being displaced. Cf. Brief for Appellant, supra note 91, at 9-10 
(makes this argument with regard to the proposed heart transplantation consortium). 

^'OTTF Report, supra note 67, at 9-10 (emphasis added). 

^^Outright state prohibitions of therapeutic procedures can raise a constitutional issue. 
E.g., Roe V. Wade, 410 U.S. 113 (1973) (abortion); Rogers v. State Board of Medical 
Examiners, 371 So. 2d 1037 (Fla. Dist. Ct. App. 1979) (chelation therapy). Regulatory 
programs having comparable effects are more difficult to challenge legally but should 
raise similar concerns. 



976 INDIANA LA W REVIEW [Vol. 19:955 

ing providers. The OTTF apparently approved the use of the state's 
prohibitory powers in this way in order to coerce a pubhc desirous of 
transplants for themselves into providing them for everyone. Probably, 
however, the task force never expected that such extortionate use of the 
state's regulatory power would actually be necessary to effectuate its poHcy 
objective of equity in transplantation.^'' 

Although the OTTF may not have meant what it said about with- 
holding transplants from paying patients as an inducement to the pro- 
cedure's equitable provision, the OTTF was clearly unresponsive to the 
interests of those citizens who would not require the state's assistance 
to finance a transplant. Under the report's recommendations, transplants 
will occur only on the state's own terms, and only a limited number 
of transplants will be performed, regardless of the availability of organs. 
Because recipients of these few procedures must be selected, some patients 
who could and would pay their own way will not get treated.^* Yet, if 
they were allowed to purchase their own treatment outside the MAC 
system, there would be no diversion of resources from * 'higher priority" 
health care. The OTTF appears content with a state policy that could 
deny a transplant to a dying person who had made expHcit financial 
provision for it. The best explanation for this complacency in the face 
of a denial of lifesaving medical care may be simply that the OTTF 
members had lost the capacity to conceive of the purchase of health 
services as a private matter. If so, their attitude reveals a great deal 
about the political culture of Massachusetts and its approach to health 
care. 



^^The DON for the liver transplantation consortium had already been granted in 
January, and a heart transplantation DON was issued in May. Letter from Department 
of Public Health to Dr. Richard Nesson, Brigham and Women's Hospital, May 16, 1984, 
reprinted in OTTF Report, supra note 67, at 129. 

^^The OTTF may have viewed this as only a theoretical danger. It may have expected, 
for example, that all medically defensible transplants would in fact be provided. Disa- 
greement is likely, however, over whether a particular procedure is desirable or "indicated," 
and it is well-documented that as a technology improves, the medical indications for its 
use broaden. See Caplan, Organ Transplants: The Costs of Success, Hastings Center 
Rep., Dec. 1983, at 23, 31. The OTTF also might have thought that anyone who could 
afford the procedure could also afford to travel out of state to get it. This proposition 
holds true, however, only if other states reject a Massachusetts-type hostility to trans- 
plantation and also permit outsiders to obtain organs and if the patient's ability to pay 
does not stem from the purchase of health insurance, which typically does not cover the 
many additional expenses associated with out-of-state treatments. Although the OTTF may 
have had reason to discount the risk that some self-supporting patients would be denied 
desired transplants, its report expressly recognizes that the number of people waiting for 
transplants might exceed the number of procedures that could be done. It is possible that 
it is simply not fashionable in Massachusetts publicly to express concern about the "right 
to health care" of anyone except the poor. 



1986] LIVER TRANSPLANTATION 977 



C. Denouement 

The OTTF Report was received by the Pubhc Health Council of 
the Department of Public Health and was the subject of a public hearing 
on November 5, 1984. The council unanimously adopted the report's 
recommendations as official policy and instructed the Department to use 
the text of the report for guidance in DON proceedings. The current 
state of organ transplantation in Massachusetts appears to have followed 
the outlines of the OTTF's script. There are questions, however, whether 
the spirit of its recommendations has been observed in practice. For 
example, it is doubtful that hospitals seeking DONs for transplantation 
have given any real guarantee that "higher priority" services will not 
be affected. Also, it has been questioned whether the consortium is 
really functioning as an integrated research program dedicated to col- 
lecting useful data for later evaluation by a "publicly-accountable body."^^ 
It would appear that the drama is not yet over.*^° 



"^See infra note 117. Both the OTTF and the Department of Public Health con- 
templated a later evaluation of the liver transplantation program to see whether higher 
priority services were being displaced and expected that the data collected would shed 
light on this issue, on which the consortium would have the burden of proof. The first 
annual report of the consortium, covering January 26, 1984, to January 26, 1985, was 
brief, even cursory, and seems not to contain the data required by the DON, let alone 
data that could prove anything about displacement. Boston Center for Liver Trans- 
plantation, 1984 Annual Report (1985). Even the actual costs of transplantation per 
survival year are impossible to calculate from the report. Patients' rehabilitation status is 
only sketchily assessed, and no data are supplied as to the basis for rejection of candidates 
or the current health status of those rejected. Id. Without comparative outcomes, it is 
impossible to judge the procedure's value or the predictive effectiveness of the patient 
selection criteria used. There is also no evidence that transplants have not displaced 
desirable services. 

Some OTTF members, including Chairman George Annas, argue that the coalition 
is violating at least the spirit of its DON. Annas interview, supra note 71. The Department 
of Public Health seems to feel, however, that because the data collection requirements 
for livers were never very well defined, the coahtion's first report is satisfactory, Gorga 
interview, supra note 44. At a recent conference, panelists discussing the Massachusetts 
system — including Pubhc Health Commissioner Walker, transplant surgeon Roger Jenkins, 
OTTF chairman Annas, and economist Marc Roberts — disagreed in almost every particular 
regarding whether the Department and the consortium were doing what they were expected 
to do. Conference on Transplantation and Artificla.l Organs: Issues Along the 
Experiment-to-Therapy Spectrum (Nov. 1985). The lack of agreement on a variety of 
issues suggests that the apparent consensus surrounding the OTTF Report resulted from 
a failure to address practical issues and a papering over of potential problems. Indeed, 
at the conference just cited, OTTF chairman Annas labeled the OTTF "a quasi-Quixotic 
noble failure." Id. 

'°^At present, however, the even more complicated debate over heart transplantation 
in Massachusetts is apparently diverting much attention from the liver issue. Gorga interview, 
supra note 44; see supra note 91. The parties to this debate are more experienced and 
sophisticated than they were at the time of the liver debate. In particular, Massachusetts 
expects to employ many of the recommendations developed by the Battelle Human Affairs 



978 INDIANA LAW REVIEW [Vol. 19:955 

III. Reviewing the Performance 

Viewers of the morality play "Liver Transplantation in Massachu- 
setts" must come away unsatisfied but instructed in the difficulties of 
putting life-and-death choices on the poHtical stage. Perhaps more than 
any other state, Massachusetts, aided and abetted by a powerful intel- 
lectual community, has assumed the role of dominant decisionmaker in 
health care matters. The case of liver transplantation provides a unique 
test of the abihty of at least one model of a monolithic, highly regulated, 
and politicized health care system to address difficult choices involving 
expensive medical technology. *°^ 

In the Massachusetts system, it was necessary for the state to decide 
publicly whether to allow liver transplantation at all, and the action of 
the drama was ostensibly about the making of this choice. Politically, 
however, the state probably never really had the option of rejecting 
transplants once major research institutions resolved to perform them 
and the media concluded that access to them was the right of every 
Commonwealth citizen. As in a Greek tragedy, the outcome was fore- 
ordained, and the characters were never truly free to alter the inevitable 
result. It is in the nature of "tragic choices" that once they become 
political, they are driven mainly by forces beyond the power of individuals 
to control or escape.'^ To accept the decisions emerging from the black 
box of Massachusetts state government as appropriate societal choices 
is to ignore not only the previously-noted questionable features of the 
political process, but also the shortcomings of regulation, some trou- 
blesome ethical issues, and the possible availability of alternative deci- 
sionmaking mechanisms. 

A. Regulatory Inadequacies 

Having approved transplants in principle, the Commonwealth of 
Massachusetts and its respective task forces then had the problem of 



Research Center. See R. Evans* National Heart Transplantation Study; Final Report 
(1984) (prepared by the Battelle Human Affairs Research Center for Health Care Financing 
Administration, DHHS, Washington, D.C.) 

^°^See supra note 8. A particularly interesting point of comparison is provided by 
the Minnesota Coalition Report which, as the product of a private organization, is much 
less a political document than the OTTF report. Minnesota Coalition Report, supra 
note 8. 

'"^Keeping such issues out of the political arena is itself difficult. As a societal attempt 
to resolve the tragic choice by finessing it, this strategy, like others, is apt to be unstable 
precisely because it sacrifices important values, such as openness and explicitness. Professor 
Calabresi predicts an inevitable and continuing oscillation among imperfect solutions as 
society continually reasserts those values (equity, efficiency, freedom, etc.) that are being 
neglected by whatever system of choosing is currently in place. See G. Calabresi & P. 
Bobbitt, supra note 5, at 195-99. However, whether a stable system can be designed or 
happened upon without explicit policy choice is an empirical question. In any case, 
depoliticization would appear to be a vital first step toward possible stability. 



1986] LIVER TRANSPLANTATION 979 

rationing the costly procedure. However, the Massachusetts regulatory 
scheme, despite its comprehensiveness and complexity, provided no public 
mechanism for deciding explicitly how often and under what circum- 
stances the procedure would be done. As one protection against high 
costs, the task forces recommended against a complete pass-through of 
expenditures for transplants, thus forcing hospitals to look elsewhere for 
at least some of the necessary funds. Under the state's regulatory control 
of hospital revenues, virtually the only way for a hospital to generate 
such funds would be to cut back its other activities. The OTTF's response 
to the danger that transplants would displace more valuable hospital 
services was to instruct the DON agency to withhold approval of a 
transplantation program that could not prove that only relatively wasteful 
activities would be eliminated in order to accommodate it. As a regulatory 
standard, this requirement was highly impractical and unrealistic, ^^^ but 
it protected the task force against the criticism that it had authorized 
a diversion of resources to lower-priority uses. 

With all their regulatory paraphernalia, Massachusetts officials lack 
the statutory powers they need to control directly the volume and cost 
of transplants. As to these and all other medical procedures, the state 
can only identify institutional providers of needed services and control, 
in a rough way, the total resources at each institution's disposal. Because 
these powers do not add up to effective control of medical technology, 
the level of transplantation activity in Massachusetts remains ultimately 
in the hands of prestigious doctors and hospitals, subject to certain 
resource constraints. Although limiting the resources available to prov- 
iders can control aggregate costs, the Massachusetts MAC controls relate 
in no recognizable or rational way to the potential benefits or costs of 
any particular procedure. Allocational decisions are thus left in providers' 
hands. ^^"^ Once Massachusetts is satisfied that the resources used in organ 
transplantation are not obtained by eliminating "higher priority" health 
services currently being provided, it permits transplants to proceed without 
regard to the additional possibility that those resources might have still 
other, more valuable uses. 

Thus, although Massachusetts has made it appear that it has exercised 
statesmanlike control in this highly publicized area, it may have done 
nothing more than give certain Boston hospitals the green light to 
rearrange institutional priorities to facilitate new adventures on the fron- 
tiers of medicine. The main constraint on these institutions is the risk 



'"See supra note 99. Two critics of the OTTF's burden-of-proof recommendation 
for DON proceedings have said, "[I]t is difficult to imagine a process that is more 
conceptually confining, less amenable to empirical analysis, and more open to subjective 
interpretation." Overcast & Evans, Technology Assessment, Public Policy and Trans- 
plantation: A Restrained Appraisal of the Massachusetts Task Force Approach, 12 Law^, 
Med. & Health Care 106 (1985). 

^^See supra note 36. 



980 INDIANA LAW REVIEW [Vol. 19:955 

that their actions will offend future state officials or the '*publicly- 
accountable body" that the OTTF recommended to evaluate transplan- 
tation later on. The implicit threat that the state might take unspecified 
action in the future puts the participating institutions on notice that 
they had better be able to defend their use of resources or face unpleasant 
consequences. Such is life in a centrally managed health care system, 
where things fortuitously attracting public notice receive minute attention 
while well enough is left alone. Politicization of transplantation achieves 
control for its own sake but provides little assurance that resources will 
be put to their best use. A regulatory system that purported to make 
all the necessary allocational choices would be a more stifling form of 
regulation than even Massachusetts would be Ukely to tolerate. 

B. Questions of Values 

Above all, Massachusetts strove for ethical high ground in establishing 
its position on liver and heart transplants. Yet a careful reading of state 
policy as reflected in the OTTF report reveals a willingness to countenance 
the denial of transplants to paying patients — not out of any paternalistic 
concern, but simply because some other person in comparable condition 
could not afford the same treatment. Perhaps it was the prospect of 
organ shortages and bidding wars that only the well-to-do could hope 
to win that induced the OTTF to approve the denial of transplants to 
paying patients. After all, the question of how to ration scarce medical 
resources has long inspired ethicists to philosophical debate, ^"^^ and the 
OTTF, chaired by a leading participant in that debate, ^^^ may have 
assumed that it had been convened primarily for the purpose of pre- 
scribing an ethically satisfying system for rationing scarce organs. ^^^ The 



'°The relevant literature is voluminous. For general sources, each of which itself 
draws on many others, see N. Daniels, Just Health Care (1985); In Search of Equity: 
Health Needs and the Health Care System (R. Bayer, A. Caplan & N. Daniels eds. 
1983); H. Smith & L. Churchill, Professional Ethics and Primary Care Medicine 
(1986); Childress, Rationing of Medical Treatment, in 4 Encyc. of Bioethics 1414 (W. 
Reich ed. 1978). 

^'^See, e.g., Annas, No Cheers for Temporary Artificial Hearts, 15 Hastings Center 
Rep. 27 (Oct. 1985); The Phoenix Heart: What We Have To Lose, 15 Hastings Center 
Rep. 15 (June 1985); Allocation of Artificial Hearts in the Year 2002: Minerva v. National 
Health Agency, 3 Am. J. Law & Med. 59 (1979). 

'°'The OTTF's apparent eagerness to respond to that charge may be seen in its failure 
to consider seriously the possibility of encouraging the sale of organs by families of 
deceased potential donors to those awaiting transplants. OTTF Report, supra note 67, 
at 37. A market for organs would ehminate shortages and the need for rationing systems 
to allocate a limited supply. However, instead of seeking to break down the current 
cultural taboo against the buying and selling of body parts, see the National Organ 
Transplantation Act, supra note 71 (prohibiting the sale of organs in interstate commerce), 
the OTTF took the easier political path. Indeed, it may have welcomed organ shortages 



1986] LIVER TRANSPLANTATION 981 

OTTF did not, however, expressly restrict its recommendations to sit- 
uations where there were not enough organs to go around. As it appears, 
the OTTF was entirely comfortable with a policy that would force self- 
supporting transplant candidates to join (and perhaps die in) the state- 
mandated queue even if an adequate number of organs was available. 

In support of its willingness to deny transplants to paying patients, 
the OTTF invoked a well-known 1983 report by the President's Com- 
mission for the Study of Ethical Problems in Medicine and Biomedical 
and Behavioral Research. ^°^ Although the President's Commission did 
declare that society has an ethical obligation to guarantee a decent level 
of health care to its neediest citizens, '^^ nowhere did it indicate that it 
would be ethical to hold the wealthy and well-insured sick hostage without 
treatment until society honored this obligation. Moreover, the President's 
Commission clearly stated that it was not ethically necessary for all 
citizens to receive the same health care.^'° Thus, it certainly laid no 
foundation for the Massachusetts policy of forcing all transplant can- 
didates to take their chances in a state-sponsored life-and-death lottery. 

The OTTF again misrepresented the President's Commission in citing 
its report as authority for guaranteeing procedures as costly as liver and 
heart transplants to persons who cannot afford the insurance necessary 
to purchase them.^'^ Although recognizing a public obligation to provide 
a decent minimum level of health services to all, the Commission did 
not fully define that level or specify what services should be included 
in the guaranteed package. Moreover, there are numerous reasons why 
one might conclude that procedures as costly as liver transplants ought 
not to fall under society's guarantee until the nation becomes a great 
deal wealthier and has met a great number of other needs, including 
non-health needs, of its less advantaged citizens.''^ The OTTF seemed 



as a constraint on the number of costly procedures and as an excuse for implementing 
their rationing theories. See, e.g., OTTF Report, supra note 67, at 80, 83. 

The shortage of organs is currently being addressed by donor education efforts, 
ranging from promoting the slogan "Organ Donors Recycle Themselves" to legislation 
requiring hospitals to request donations from families of potential donors. 

'°^5ee supra text accompanying note 95 (citing President's Commission Report, supra 
note 41). 

'°^The President's Commission Report states as its first premise that "society has an 
ethical obhgation to ensure equitable access to health care for all," and continues: 
"Equitable access to health care requires that all citizens be able to secure an adequate 
level of care without excessive burdens." President's Commission Report, supra note 41, 
at 4 (emphasis added). 

''"Id. 

•"OTTF Report, supra note 67, at 74. 

"^As the President's Commission explains: 

[T]he standard of adequacy for a condition must reflect the fact that resources 

used for it will not be available to respond to other conditions. Consequently, 

the level of care should reflect a reasoned judgment not only about the impact 



982 INDIANA LAW REVIEW [Vol. 19:955 

to conclude that the mere fact that transplants may save lives is enough 
to obligate society to pay'^^ — despite the explicit finding that at $230,000 to 
$340,000 per patient surviving one year, liver transplants were several 
times more costly than the most costly of other generally accepted medical 
treatments. ''"^ The OTTF thus backed itself into an ethically debatable 
position. While arbitrarily treating transplantation as being so valuable 
that it should be available to all, it also declared that because of the 
expense, only those transplants that could be financed primarily out of 
system waste should be provided. Thus, the OTTF's desire to demonstrate 
its and Massachusetts' commitment to providing lifesaving treatment for 
all led it to restrict transplants' availability to all patients, including 
those who would not require public financing. Such a policy had spe- 
cifically been denounced by the President's Commission as "an unac- 
ceptable restriction on individual liberty. "^^^ 

Under the circumstances, it seems probable that the OTTF and the 
Commonwealth were more concerned with performing a symboHc act 
than with giving the poor the essentials of a good Ufe. Indeed, although 
the OTTF expUcitly endorsed the equitable distribution of transplantation 
as an available means of "prevent[ing] the gulf between the haves and 
have nots from widening,'"*^ the primary beneficiaries of the transplant 



of the condition on the welfare and opportunity of the individual but also about 
the efficacy and the cost of the care itself in relation to other conditions and 
the efficacy and cost of the care that is available for them. 
President's Commission Report, supra note 41, at 36; see supra notes 41 & 70. 

"^The OTTF's conclusion that organ transplantation should be part of that adequate 
level of care is apparently justified by the stated pubhc perception that transplantation 
is "life-saving." OTTF Report, supra note 67, at 5. The President's Commission Report, 
however, does not contemplate and indeed does not seem geared toward addressing the 
inclusion of extreme and expensive technologies in the guaranteed minimum level of care. 
For example, it states: 

Society will reasonably devote some resources to health care but reserve most 
resources for other goals. This, in turn, will mean that some health services 
(even of a lifesaving sort) will not be developed or employed because they would 
produce too few benefits in relation to their costs and to the other ways the 
resources for them might be used. 
President's Commission Report, supra note 41, at 19. 

"^On cost figures, see OTTF Report, supra note 67, at 43-69. These figures have 
been criticized as excessive. E.g., Overcast & Evans, supra note 102, at 107. See supra 
text accompanying notes 17 & 20. 

"^President's Commission Report, supra note 41, at 20; see also id. at 4, 18; Pauly, 
Equity and Costs, 13 Law, Med. & Health Care 28 (1985). A better reading of the 
President's Commission Report surely would conclude that the state ought to ensure 
equitable access to lower-cost, higher-priority services, leaving expensive technologies outside 
the "decent minimum" but available for purchase by those who choose to devote personal 
resources to that end. 

"^OTTF Report, supra note 67, at 75; see Pauly, supra note 115, at 29. The OTTF 
surely places disproportionate emphasis on catastrophic health care as a way to rectify 
perceived injustices in the social order. It is open to challenge not only by those who 



1986] LIVER TRANSPLANTATION 983 

policies adopted were not the less well-off populations, from which a 
few transplant candidates might come, but those who could take public 
credit for making the humanitarian choice. The OTTF members, the 
pubUc officials involved, and the citizens of Massachusetts as a whole 
avoided appearing cold-hearted and uncaring in the face of imminent 
death by symbolically extending lifesaving assistance to a handful of 
afflicted patients. The troubling question remains, however, whether the 
Commonwealth has so far discharged its other, perhaps greater respon- 
sibilities to its disadvantaged citizens that those basking in the glow of 
this good work are truly entitled to feel good about themselves. 

C. The Alternative of Off -Stage Choices 

Whenever tragic choices are made upon a public stage, it is probably 
inevitable that the actors will play to the audience, sacrificing some 
values, particularly allocative efficiency, in order to be seen as acting 
vigorously in the defense of human life. Before one can criticize the 
performance in Massachusetts, therefore, it is necessary to ask whether 
there is any way in which these difficult issues could have been resolved 
without public posturing and with a greater expectation that resources 
would not be used in pursuit of health benefits too modest to justify 
the outlays. Can the role of politics in these difficult matters be limited? 
One discussion of this question frames the challenge as follows: 



would be prevented from purchasing transplants but also by the have-nots in question, 
who might reasonably choose to have the resources applied where they have greater need 
and can expect greater benefit. It appears, however, that the OTTF had a larger political 
agenda. Chairman Annas has acknowledged as much in responding to criticisms such as 
those suggested here: 

The Task Force . . . saw its charge as an opportunity to express our views on 
how the system ought to work. The Task Force believed that fairness and equity 
are critical values that are more important than perpetuating a system where 
only the rich and those with the right insurance or publicity acumen can obtain 
transplants. The fact that we have not tried for equity and fairness elsewhere 
in the system does not make it somehow wrong to take the opportunity we 
have in heart and liver transplantation to try to introduce equity and fairness 
in the real world. We must begin somewhere. Anywhere will entail some ar- 
bitrariness. But the symbolic nature of transplantation, and its ability to capture 
the public's attention and support, commend it as a reasonable place to begin. 
Far from presuming "the vahdity of the status quo," the Task Force believed 
that transplantation provides a unique opportunity to modify some of the the 
health care system's fundamental operating assumptions. 
Annas, The Dog and His Shadow: A Reply to Overcast and Evans, 13 Law, Med. & 
Health Care 112, 113 (1985). Annas's visionary goal is, however, as remote as ever. 
The OTTF Report's passionate concern for equity ironically succeeds only in raising to 
the level of principle the political preference for identified over statistical lives, while 
doing little to clarify the debate over the extent to which government should guarantee 
the provision of health care services. 



984 INDIANA LAW REVIEW [Vol. 19:955 

[A]lthough there are good reasons for our society to seek to 
spare its individual members catastrophic health care costs, in 
doing so it will almost inevitably commit more resources than 
it really wants to commit, or should commit, to such a purpose. 
This result is probable because government will find it difficult 
to impose, or even tolerate, needed limits on very expensive 
medical efforts to save lives and preserve health without seeming 
to deny the sanctity of human life. The challenge is thus to 
design social institutions which neither unduly sacrifice society's 
humanitarian ideals nor overspend on medical services not war- 
ranted by the benefits they yield. . . . [G]overnment cannot 
safely assume too central a role in decisionmaking on life-and- 
death and similar issues and . . . society will be better off if 
institutional arrangements are such that death and suffering from 
catastrophic disease continue to be perceived as "more an act 
of God than of the legislature." Careful attention to program 
details and to the allocation of decisionmaking responsibility is 
necessary if society is to succeed, in the context of expanded 
protection against catastrophic medical expenses, in preserving 
both humanitarian values and democratic government's benign 
— if not its beneficent — image. 



1 17 



The quoted study "identifies a critical need to keep government's profile 
low in order to facilitate saying 'no' when it is appropriate to do so" 
and "seeks to help government limit its moral as well as its financial 
exposure while honoring a substantial commitment to assist victims of 
catastrophic disease. "'^^ 

The Massachusetts performance reviewed here casts only a little light 
on the possibility that government can be removed from center stage 
in these dramas and that there can be introduced instead the deus ex 
machina of an unregulated, demand-driven market for health services. 
The foundation of the Massachusetts system is, after all, the assumption 
that regulation is essential to prevent inefficient growth and wasteful 
spending on health services of all kinds. Although there was a time 
when this assumption seemed unchallengeable, actual reforms in some 
health care financing mechanisms have recently begun to reveal the 
potential of private purchasing decisions in a competitive marketplace 
to curb the excessive flow of resources into the health care sector and 
to confine spending to activities that are relatively cost-effective. ^^^ 

"^Havighurst, Blumstein & Bovbjerg, supra note 4, at XIZ-IA (quoting Artificial 
Heart Assessment Panel, Nat'l Heart & Lung Inst., The Totally Implantable 
Artificial Heart 247 (1973) (separate views of C. Havighurst)). 

"»M at 124. 

"'See, e.g., Arnett, Health Spending Trends in the 1980's: Adjusting to Financial 
Incentives, Health Care Fin. Rev., Spring 1985, at 1; Davis, Is Cost Containment 
Working?, Health Aff., Fall 1985, at 81. 



1986] LIVER TRANSPLANTATION 985 

Certainly what is known about the efficacy and costs of Uver trans- 
plantation does not suggest that only irrational or impoverished persons 
would ever choose to forgo this treatment even in the face of certain 
death. ^^ It thus may be socially desirable and practically feasible to 
leave decisions about whether or to what extent to cover liver trans- 
plantation to private choices of employers, health insurers, and organized 
health plans, all of which are accountable to consumers in a competitive 
market.'^' Even where public financing is necessary, government may 
recede from its current role as dominant decisionmaker by cashing out 
current in-kind benefits and letting beneficiaries shop for private coverage 
with financial help in the form of a government-supplied voucher. '^^ In 
this fashion, government can fulfill its responsibility for providing a 
decent minimum level of health services without having to rule definitively 
on what services beneficiaries must select. 

Whether the performance of a competitive, demand-sensitive market 
for health care will satisfy the full range of public expectations is still 
an open question, but there is at least some evidence that health care 
consumers and providers are now economizing in ways previously resisted. 
Thus, it may be possible 

to eschew trying to solve the [catastrophic disease] problem in 
any definitive fashion and instead to take steps to enhance each 

'2°Available data suggest not only that liver transplantation is uniquely expensive but 
that it can plausibly be viewed as of questionable benefit. Although the OTTF Report's 
survey of liver transplantation morbidity and mortality is brief, OTTF Report, supra note 
67, at 29-32, other sources raise some important questions concerning the toxicity of 
cyclosporin, the effect of long-term administration of immunosuppressive drugs on the 
growth and development of children, and the near-total lack of measures of the quality 
of survivors' lives. See Nat'l Center for Health Services Research, DHHS, Liver 
Transplantation (1983); Starzl, 1 Transplantation Proceedings (1985). The OTTF 
addressed these major concerns only in connection with the prospect that too many 
transplant seekers might die in the state-mandated queue; if this happens, the OTTF 
Report advocates that individuals meeting the medical criteria for inclusion "be persuaded 
not to attempt to join the queue" by telling them the truth about transplantation. OTTF 
Report, supra note 67, at 83. The implication is that if people understood all of the 
risks, consequences, and side effects of transplantation and their implications for the 
duration and quality of life of survivors, a significant number of candidates would 
voluntarily forgo the procedure. One would suppose that potential candidates deserve the 
opportunity to achieve that full understanding regardless of the size of the organ supply. 
The OTTF was even farther, of course, from seeing any connection between doubts about 
the value of the procedure and the procedure's extraordinary costs; it was also opposed 
to letting individuals compare likely benefits and costs before deciding whether to invest 
in the necessary insurance. Id. The Minnesota Coalition Report specifically contemplates 
such choices. Minnesota Coalition Report, supra note 8, at 47-48. 

'^'Allowing individual consumers to exercise free choice creates problems of adverse 
selection and may be questionable policy for other reasons. See infra note 124. 

^^^See Minnesota Coalition Report, supra note 8, at 38-41. This report discusses 
two alternative strategies for "implementing the 'basic level of health care' principle." 
Id. One of these is a voucher-type strategy that would leave the private sector substantial 
decisionmaking freedom. 



986 INDIANA LAW REVIEW [Vol. 19:955 

individual's ability to solve his own personal problem by choosing 
among a variety of available options, with public financial as- 
sistance where necessary. Such a strategy lacks the tidiness and 
specificity which policymakers often desire and would doubtless 
leave many residual problems. . . . But the fundamental values of 
pluralism and freedom . . . suggest an obHgation not only 
to tolerate but also to foster diversity on matters as intensely 
personal and private as the means of coping with life-threatening 
disease and the attendant tragic choices. '^^ 

Such an approach provides a major challenge to society's ability to 
educate consumers and foster rational decisionmaking about low-prob- 
ability events. ^^"^ 

The Massachusetts experience with liver transplantation yielded one 
interesting datum helpful in appraising the market alternative when 
MBCBS offered TIP at an actuarially fair price to their group accounts 
and fewer than one third of them accepted the offer. Unanswered, of 
course, are many questions, including the ultimate one — whether a 
situation in which some citizens are protected against a highly visible 
health care need and others are not is a stable and tenable one or one 
that would disintegrate upon the appearance of a transplant candidate who 



^^^See Havighurst, Blumstein, & Bovbjerg, supra note 5, at 189. 
'^The simple view is that "organ transplantation is the epitome of an insurable event; 
transplants are random, rare, their risk probabilities are measurable, and transplants are 
prohibitively expensive for most individuals." Minnesota Coalition Report, supra note 
8, at vi. But letting individuals choose is not necessarily the optimal policy. For example, 
Calabresi observes: 

I'd Uke to know, for instance, if any individual does value his own hfe in a 

way that can meaningfully be used in choosing between life and death risks. If 

each of us were paid to take a one in a million chance to lose our life, 

reaUstically, how much would we ask? How much more would we ask if the 

chance of death were one in one thousand? Or one in two? I would suggest 

that the value that most of us would give to our lives would not be the same 

value in the three cases, after discounting by mathematical risk. In other words, 

the value we as individuals put on our life is not independent of the gamble 

we are taking. This fact makes it very, very difficult as a practical matter to 

define any value as the appropriate one in creating incentives for safety. 

Calabresi, Commentary, in Ethics in Health Care 48, 52 (1974). For findings from 

psychological research suggesting inconsistencies and incoherence in consumer decisions 

that require the weighing of risks and valuation of alternative outcomes, see Kahneman 

& Tversky, The Psychology of Preferences, 246 Sci. Am. 12 (1982); Tversky & Kahneman, 

The Framing of Decisions and the Psychology of Choice, 211 Sci. 453 (1981). Although 

these difficulties suggest the shortcomings of individual choice, most market choices of 

insurance coverage are not made by uninstructed consumers. Instead, they are most likely 

to emerge from collective processes in employment groups and to reflect the sophistication 

of employers, insurers, and medical care providers. Such collective choices are likely alone 

to reflect both shared values and the existence of alternative uses of the resources at 

stake. 



1986] LIVER TRANSPLANTATION 987 

turned down the available protection. This empirical question deserves 
more thoughtful attention than it has yet received. For example, it would 
not be conclusive evidence against relying upon market choices to ration 
transplantation if an occasional patient should receive, at an employer's 
or insurer's expense, a treatment that was not included in purchased 
coverage. Informal provision of such charity for occasional exceptionally 
appealing cases is not an unthinkable alternative to the Massachusetts 
rationing system. Indeed, it could supply just the buffer against highly 
publicized denials of care that is needed to maintain an effective barrier 
to spending vast resources on marginally beneficial treatments. 

Attention must also be given to the design of coverage that can 
survive the inevitable questioning and legal challenges. One can imagine, 
for example, insurance policies that provide liver transplants for the 
most appealing patients, such as children, but deny them to victims of 
less attractive diseases, such as alcohoHsm. Other mechanisms for con- 
trolling costs and ensuring quality include limiting coverage to transplants 
obtained in centers that have been identified by the insurer as efficient 
and low-cost. Although much remains to be learned about whether and 
how to purchase this costly and still questionable service, privatization 
of catastrophic insurance, perhaps with tax and other incentives to 
encourage coverage broad enough to minimize the demoralizing effects 
of tragic choices, would seem to make possible sensible rationing tech- 
niques that the public sector could not itself sustain. ^^^ 

Perhaps the best way to conclude this reflection on how society 
handles these difficult matters is to ask how these problems will be 
addressed a hundred years from now. Is there any doubt that society 
will somehow reassess its commitment to saving lives without regard to 
cost and will come to accept as a matter of course some deaths that 
could be prevented by the application of high technology? There are 
many different ways in which patients can be selected for treatment, 
not all of which require reliance on government to act directly or indirectly 
as the giver or denier of life itself. Without question, our attitudes 
toward such matters are changing. Ultimately we must give up some 
cherished but so far unexamined collective beliefs. The frightening but 
certain truth is that we are acting out our own morality play — one in 
which some simpUstic values, of the kind that flourish most in a political 
environment, must eventually give way to some hard realities of the human 
condition. As in any great drama, the central question is whether other, 
more vital values will be preserved. 



'"Current proposals to provide catastrophic health insurance protection, see, e.g.. 
Perspectives, Catastrophic Insurance, Washington Rep. on Med. «& Health, Apr. 21, 1986, 
would benefit from being examined in light of the concerns expressed herein about placing 
government in a central decisionmaking role. 



The Lithotripsy Game in North Carolina: 
A New Technology Under Regulation and Deregulation* 

Clark C. Havighurst** 
Robert S. McDonough*** 



I. The Stakes in the Game — Rewards of a New Technology 

Every few years, it seems, an expensive new medical technology tests 
the ability of the health care system to assess its efficacy, safety, and 
cost-effectiveness and to allocate resources so that patients receive optimal 
treatment at reasonable cost. Resembling in this respect earlier diagnostic 
imaging technologies, extracorporeal shock wave lithotripsy (ESWL) is 
a recent technological breakthrough that has captured the attention of 
health planners and policymakers. • This noninvasive procedure, which 
employs equipment costing up to $2.7 million per installed unit, is 
revolutionizing the treatment of urinary stones.^ 

ESWL appears to be a highly desirable technology from every stand- 
point. Not only does it achieve excellent results with lower complication 



*Support for the research reflected in this Article was provided under Grant No. 
HS05326 from the National Center for Health Services Research and Health Care Tech- 
nology Assessment, U.S. Department of Health and Human Services. The authors are 
indebted to the numerous individuals, most of whom are cited herein, who greatly assisted 
the authors in forming their impressions of lithotripsy in North Carolina. The interpretations 
offered here are of course not necessarily shared by those who assisted the authors or 
participated so conscientiously in the policymaking effort. 

**WilUam Neal Reynolds Professor of Law, Duke University. A.B., Princeton Univer- 
sity, 1955; J.D., Northwestern University, 1958. 

***B.A., 1982, B.S., 1982, University of Texas at Austin; J.D. Candidate, Duke 
University School of Law, 1987; M.A.P.P.S. Candidate, Duke Institute of Policy Sciences 
and Public Affairs, 1988; M.D. Candidate, Duke University School of Medicine, 1988. 

'For formal technology assessments of ESWL, see National Center for Health 
Services Research & Health Care Technology Assessment, U.S. Dep't of Health & 
Human Services, Extracorporeal Shock Wave Lithotripsy (ESWL) Procedures for 
the Treatment of Kidney Stones (1985); Office of Technology Assessment, United 
States Congress, Effects of Federal Policies on Extracorporeal Shock Wave Lith- 
otripsy (1986); Farrell, Percutaneous Ultrasound Procedures for the Treatment of Kidney 
Stones, 1986 Int'l J. Tech. Assessment Health Care 152; Health and Public Policy 
Committee, American College of Physicians, Lithotripsy, 103 Annals Internal Med. 626 
(1985). For other recent descriptions and evaluations, see Mueller, Extracorporeal Shock 
Wave Lithotripsy of Ureteral Stones: Clinical Experience and Experimental Findings, 135 
J. Urology 831 (1986); Riehle, Extracorporeal Shock Wave Lithotripsy for Upper Urinary 
Tract Calculi: One Year's Experience at a Single Center, 255 J. A.M.A. 2043 (1986); 
Webb, Extracorporeal Shock Wave Lithotripsy and Percutaneous Renal Surgery, 58 Brit. 
J. Urology 1 (1986). 

^In ESWL, electrohydraulic shock waves shatter kidney stones into small fragments 
so that they can be passed naturally by the patient. Chaussy & Schmiedt, Shock Wave 

989 



990 INDIANA LAW REVIEW [Vol. 19:989 

rates than invasive therapies,^ but even given the high cost of "Hthotrip- 
ters," it may cost less per treatment than the surgical procedures it 
replaces/ Margaret Heckler, Secretary of Health and Human Services, 
called attention to both the medical benefits and the cost savings of ESWL 
when she announced the approval of the first lithotripter by the Food 
and Drug Administration (FDA) in 1984.^ 

Although there is virtually no question that ESWL is highly effi- 
cacious and extremely safe, it has created significant problems for the 
health care system. In particular, early and widespread recognition of the 
potential benefits of ESWL put intense and sudden pressure on those pro- 
cesses that society has installed to evaluate medical technology and to guide 
the health care system's development. State certificate-of-need (CON)^ 
regulators were put in the position of being able to award very big 
prizes to a very few. Entrepreneurial urologists and hospitals, playing 
for large stakes, pushed the regulatory system very hard. In cases where 
the regulators stood firm, they were in the potentially awkward position 



Treatment for Stones in the Upper Urinary Tract, 10 Urologic Clinics N. Am. 743 
(1983). Prior to the procedure, the patient is anesthetized to keep him pain-free and 
immobilized while shocks are administered. Finlayson & Thomas, Extracorporeal Shock- 
Wave Lithotripsy, 101 Annals Internal Med. 387, 388 (1984). The patient is then placed 
into a tub of water over a shock- wave generator. A two-axis x-ray system is used to 
locate the stone and the shock-wave generator is adjusted so that the shock-waves are 
focused on the stone. Approximately 1300 shocks are administered during the average 
one-hour procedure. 

A lithotripter currently costs approximately $1.7 miUion, not including the costs of 
installation, which can add an additional $1 million to the price. American Hosp. Ass'n, 
Lithotripters: Noninvasive Devices for the Treatment of Kidney Stones, 6 Hosp. Tech- 
nology Series: Guideline Report 15, 19 (1985). But see infra note 15 (stating that several 
U.S. companies are exploring the manufacture of lower cost lithotripters). 

^Surgical lithotomy has an associated mortahty rate of 0.8 percent, R. Smith & D. 
Skinner, Complications of Urologic Surgery and Management 102 (1976), whereas 
ESWL has a complication rate of less than one percent with virtually no associated 
mortahty, Finlayson & Thomas, supra note 2, at 388. 

"•The primary cost saving of ESWL comes from a reduction in the length of hospital 
stay. FDA Approves Lithotripter for Kidney Stone Shattering, 253 J. A.M. A. 620 (1985) 
[hereinafter FDA Approves Lithotripter]. An uncomplicated surgical lithotomy requires an 
average stay of one to three weeks. Castaneda-Zuniga, Nephrostolithotomy: Percutaneous 
Techniques for Urinary Calculus Removal, 134 Am. J. Radiology 721, 724 (1982). The 
newer technique of percutaneous nephrolithotomy requires four to eight days of hospi- 
talization. Id. ESWL patients currently remain in the hospital only three days on average, 
and it is anticipated that ESWL will eventually be performed on an outpatient basis. FDA 
Approves Lithotripter, supra, at 620-21. 

^U.S. Dep't of Health & Human Services, HHS News 2 (Dec. 19, 1984) (statement 
by Margaret M. Heckler, Secretary of Health & Human Services). 

^Certification of need is a legislatively mandated process whereby health care providers 
and institutions must obtain approval from a state agency before making large capital 
expenditures or instituting costly new services. See infra notes 12-15 and accompanying 
text. 



1986] LITHOTRIPSY 991 

of giving the winners valuable monopolistic franchises and depriving the 
losers of patients and significant income.^ Where the regulatory system 
gave way, the possibility of overinvestment in duplicative facilities raised 
the specter of excessive costs, overuse of ESWL, and neglect of alternative 
therapies when they might be medically indicated.^ Although ESWL is 
a striking development in itself, much of its interest for policymakers 
lies in the lessons it teaches about the overall health care system and 
its ability to allocate resources and accommodate technological change. 
ESWL has had a particularly significant impact on urologic practice 
in North Carolina. That state lies in the center of the so-called '*stone 
belt," an area of the country where urinary stones are particularly 
common.^ North Carolina urologists are thus heavily committed to the 
treatment of urinary stones, devoting an estimated fifteen to twenty 
percent of their professional work to this condition. ^^ Hospitals, too, 
obtain significant income from urinary stone patients, and this business 
has been widely shared by all hospitals. ESWL thus posed an economic 
threat to both urologists and hospitals in North Carolina. If treatment 
of stones in the kidney and upper urinary tract were suddenly concentrated 
in a small number of lithotripsy centers, the impact on the providers 
losing that business would be substantial. The appearance of this new 
technology in North Carolina also threatened to accentuate a flow of 
patients away from community hospitals into the state's few, but stra- 
tegically located, academic medical centers. A major "town/gown" con- 
flict thus quickly developed as community urologists sought to keep their 
patients out of the academic institutions, which allegedly did not always 
return patients to the care of their original doctors. 



^See, e.g., Michigan News Briefs, United Press International, Feb. 11, 1986 (reporting 
that Michigan Department of Public Health had ordered Michigan's two largest hospitals 
not to bill patients for ESWL until they received CON approval); New Kidney Stone 
Crushing Technique Studied, United Press International, April 26, 1985 (stating that Virginia 
Health Commissioner announced his intent to "guard against unnecessary proliferation" 
of lithotripers despite the increasing number of applications for certificates of need for 
lithotripters). 

^See, e.g., Freifeld, The Rush to Crush, Forbes, March 11, 1985, at 170, 171 
(stating that in Chicago, health planners had succumbed to provider pressures in approving 
more lithotripters than were necessary). 

^See Brown, Living in the Stone Belt Can Be Dangerous to Your Kidneys, Durham 
Morning Herald, Jan. 13, 1987, at A9, col. 1. Apparently because of dietary factors, 
residents of southeastern states have a higher incidence of calculi of the kidney and ureter 
than other U.S. citizens. Id. In 1984, the incidence of kidney stones in North Carolina 
was 29.9 per 10,000 population contrasted with the mean incidence among states of 16.4 
cases per 10,000 population. Sierakowski, The Frequency of Urolithiasis in Hospital 
Discharge Diagnoses in the United States, 15 Investigative Urology 438, 440 (1978). 

'"Personal communication with John L. Weinerth, M.D., Associate Professor, Division 
of Urology, Duke University (July 1986). 



992 INDIANA LA W REVIEW [Vol. 19:989 

Although the struggle to capture the North Carolina ESWL market 
is interesting in itself as a spectator sport, there are more important 
reasons to focus on the North Carolina experience. First, the operation 
of the CON system was tested in significant ways, yielding lessons for 
students of this form of regulation. Second, the method of paying 
urologists for lithotripsy received an unusual degree of attention, high- 
lighted by a clash between practicing urologists and Blue Cross and Blue 
Shield of North Carolina (NCBCBS) over the proper professional fee. 
This controversy yields some lessons about how business is done in a 
state that has yet to see many of the vaunted benefits of competition 
in health care^' and suggests some serious questions about the role of 
Blue Cross and Blue Shield plans in forestalling such competition not 
only in North Carolina but in the nation as a whole. Finally, the North 
Carolina story has recently culminated, for reasons that will appear, in 
the repeal of CON requirements for lithotripters, thus presenting every- 
one — but especially NCBCBS — with a future challenge. This Article thus 
includes a discussion of what must happen now in the deregulated North 
Carolina market (and wherever else deregulation is tried) if the right 
number of lithotripters are to be appropriately located and properly 
used. Although it is far from clear that North Carolina is ready for 
deregulation of a single technology of this kind, the lessons drawn from 
the North Carolina experience may suggest to other states the merits of 
general deregulation and the urgency of encouraging the competitive 
developments that would permit it. 

II. The con Game—Winner Take All 

State CON laws were intended to contain costs and make the de- 
velopment of the health care system more rational by requiring prior 
state approval before major capital expenditures could be made and new 
health services could be introduced.'^ Because prevention of duplication 

^^See infra notes 45-63 and accompanying text. 

^^See, e.g., P. Joskow, Controlling Hospital Costs: The Role of Government 
Regulation (1981); D. Salkever & T. Bice, Hospital Certificate-of-Need Controls: 
Impacts on Investment, Costs, and Use 11-24 (1979); Bovbjerg, Problems and Prospects 
for Health Planning: The Importance of Incentives, Standards and Procedures in Certificate 
of Need, 1978 Utah L. Rev. 83, 84-90; Havighurst, Regulating Health Facilities and 
Services by "Certificate of Need;' 59 Va. L. Rev. 1143, 1155-69 (1973). Like other states. 
North Carolina has enacted a CON law, N.C. Gen. Stat. § 131E-175 to 191 (Supp. 
1985), pursuant to the National Health Planning Resource and Development Act of 1974, 
Pub. L. No. 93-641, 88 Stat. 2225, 2584-645 (codified as amended at 42 U.S.C. § 300k- 
n (1982)). An earlier North Carolina CON law was held invalid under the state constitution. 
In re Certificate of Need for Aston Park Hosp., Inc., 282 N.C. 542, 193 S.E.2d 729 
(1973). Before creating the present statute, the state resisted, unsuccessfully, the subsequent 
federal compulsion to enact a CON statute meeting federal specifications. See North 
Carohna ex rel. Morrow v. Cahfano, 445 F. Supp. 582 (E.D.N.C. 1977), aff'd mem., 435 
U.S. 962 (1978). 



1986] LITHOTRIPSY 993 

is a key regulatory goal, these laws create a powerful incentive for 
providers to put any promising new technology, tried or untried, in place 
as quickly as possible; once CON approval is obtained, there is a strong 
regulatory barrier to entry by competitors until the market expands 
enough to support a second facility without appreciable harm to the 
first. Even if the first mover purchases costly first-generation equipment, 
it will be protected against competition from a later applicant offering 
to provide the same service for less.'^ The convoluted rationale for 
protecting inefficient providers from price competition in this way is not 
addressed here,^"* but it is notable that one effect of this form of regulation 
is to encourage early investment by relieving the proponent of the concern 
that his investment will be devalued when more efficient technology 
becomes available. This point is of present interest because other lith- 
otripsy devices that are now under development are expected to cost 
substantially less than the devices currently being installed. ^^ 

North Carolina providers began jockeying for CON's soon after the 
announcement of plans for introducing the lithotripter into the United 
States from Europe, where it was first developed. Indeed, an application 
to offer ESWL in North Carolina was filed one month before Dornier- 



'^C/. C. Havighurst, Deregulating the Health Care Industry 195-202, 214-22, 
345-53 (1982) (noting the protectionist tendencies of CON regulation with respect to such 
desirable cost-saving innovations as home health care, HMO's, and ambulatory surgical 
facilities). 

'Vf/. at 277-85 (explaining and criticizing the thinking behind protectionist regulation). 

'^In addition to Dornier-System, the manufacturer of the first device approved in 
the United States, at least four U.S. companies are exploring the manufacture of litho- 
tripters. The first of these to begin clinical testing was Medstone International, Spartanburg, 
South Carolina. As of May 1985, Medstone had obtained FDA investigational device 
exemptions for five sites. American Urologic Ass'n, Report to the Executive Committee 
of the AUA: Ad Hoc Committee to Study the Safety and Clinical Efficacy of the Current 
Technology of Percutaneous Lithotripsy and Noninvasive Lithotripsy 20 (May 16, 1985) 
[hereinafter Report to the Executive Committee]. The Medstone lithotripter uses a fluid- 
filled bag for the acoustic interface; with the Dornier device, the patient is placed in a 
tub. The estimated cost of the Medstone lithotripter is about $800,000, about half the 
cost of the Dornier device. 

Two other firms have conducted in vivo studies in animals. International Biomedics, 
Inc., of Issaqua, Washington, uses a laser-driven shock wave generator and water-filled 
chest waders for the acoustic interface. Id. Another lithotripter, being developed by Dr. 
Fray Marshall and colleagues at the Johns Hopkins Medical Center, also uses a fluid- 
filled bag but differs from others in using ultrasound rather than x-rays for imaging. Id. 
at 21. The anticipated cost of the Hopkins device is between $250,000 and $500,000. The 
SD-3 lithotripter, being developed by Northgate Research, Inc., of Plattsburg, New York, 
was only in the in vitro investigational stage in 1985. Id. at 20. The cost of this device, 
if perfected, is estimated to be only $250,000. 

Because lower cost second-generation devices may become available, hospitals may 
be hesitant about purchasing costly first-generation equipment. See The Race for Competing 
Lithotripters Heats Up, Hospitals, July 20, 1986, at 30; Lithotripsy: Hospitals Take a 
Wait and See Attitude, Hospitals, May 20, 1986, at 75. 



994 INDIANA LAW REVIEW [Vol. 19:989 

System GmbH, the German manufacturer of the original lithotripter, 
filed its initial application for FDA approval of the device on February 
22, 1984. This apphcation — by North CaroUna Baptist Hospital in Win- 
ston-Salem, which is associated with The Bowman Gray School of 
Medicine of Wake Forest University — was approved in June 1984, six 
months before the FDA approved the Dornier device.'^ A second ap- 
plication — by Carolina Lithotripsy, Ltd., a limited partnership of forty- 
two North Carolina urologists — was also filed before the FDA acted. 
This Fayetteville-based partnership was organized by Dr. William Jor- 
dan, ^^ who had gone to Germany at an early date to learn the procedure 
and get a jump on the market when lithotripters finally became mar- 
ketable in the United States.'^ 

The forehandedness of these CON applications was impressive 
because FDA approval of a new technology normally takes several years. ^' 
However, in this case, the FDA, recognizing the potential benefits 
of the lithotripter and its extensive testing and use in West Germany, 
acted with extraordinary rapidity,^" approving the device on December 19, 



^^See Letter from William Vaughn, Chief, Certificate of Need Section, Division of 
Facility Services, N.C. Dep't of Human Resources, to John Lynch, President, North 
Carolina Baptist Hospitals (June 29, 1984), Dr. David McCullough, Chairman of the 
Division of Urology at Bowman Gray School of Medicine of Wake Forest University, 
explained that Bowman Gray urologists decided to pursue CON approval early because 
they were aware of the results of ESWL testing in Europe and believed that ESWL's 
potential benefits made it the "wave of the future." Personal communication with David 
McCullough, M.D. (Jan. 1987). 

^^See Carolina Lithotripsy, Ltd., Certificate of Need Application 1-5 (July 12, 1984); 
see also Big Lithotripter Venture Helps Out Small NC Hospital, Hospitals, May 20, 1986, 
at 76 (discussing the Fayetteville, N.C, partnership of urologists that purchased a lithotripter 
to be installed at Highsmith-Rainey Memorial Hospital). 

'^Personal communication with William Jordan, M.D. (July 1985). 

"Currently, the FDA estimates that the median approval time for devices since 1976 
has been approximately 8-1/2 months. Kahan, Premarket Approval Versus Premarket 
Notification: Different Routes to the Same Market, 39 Food Drug Cosmetic L.J. 510, 
518 (1984). This median is misleading, however, as an indication of the review time for 
truly new devices. Approximately 60<7o of the premarket applications (PMAA's) received 
by the FDA are not for new devices but for devices regulated under transitional provisions 
applicable to devices formerly regulated as new drugs. Id. at 518 n.44 (citing 21 U.S.C. 
§ 360j(l)(l) (1982)). The review time for these transitional devices, e.g., sutures and contact 
lenses, is generally very short. Id. In addition, many PMAA's are returned to the sponsor 
for additional data, and this time is not counted in the FDA's statistics. Id. at 518. 
Economist Henry Grabowski, a student of drug and device regulation, believes that truly 
new medical devices will be subject to an average approval time approximately equal to 
that for new drugs. Personal communication with Henry Grabowski, Professor of Economics, 
Duke University (July 1985). The FDA has taken an average of 35 months following the 
filing of a new drug application (analogous to a PMAA) to approve new drugs. H. 
Grabowski & J. Vernon, The Regulation of Pharmaceuticals: Balancing the Benefits 
AND Risks 23 (1983). 

^°The FDA approved extracorporeal shock wave lithotripsy for general use less than 
one year after the commencement of clinical trials in the United States. This was unusually 



1986] LITHOTRIPSY 995 

1984.^' Carolina Lithotripsy's CON for a lithotripter, scheduled to be 
located in a Fayetteville hospital, was issued one day later. ^^ 

Applications by other North Carolina providers followed quickly 
upon the first CON awards and the FDA action. Stone Institute of the 
Carolinas, a Charlotte-based partnership of urologists, applied for a 
CON in August 1984, and got its approval in January 1985.^^ North 
Carolina Memorial Hospital in Chapel Hill, an adjunct of the medical 
school of the University of North Carolina, received CON approval in 
May 1985.^"* Unsuccessful appHcants included St. Joseph's Hospital of 



rapid action. See supra note 19. One commentator argued, however, that the FDA's 
approval of lithotripsy was not fast enough, and that the FDA's delay in approving 
lithotripsy caused many kidney stone patients, especially those who were high-risk surgical 
candidates, to suffer. Gieringer, The FDA's Bad Medicine, 33 Pol'y Rev. 71, 71 (1985). 
One reason for the FDA's relatively speedy approval of ESWL was the extensive 
testing of the procedure in Europe before it was introduced in the United States. The 
FDA had agreed to base its approval largely on the European data. The FDA's National 
Center of Devices and Radiological Health will generally consider foreign data in support 
of premarket approval if the studies appear valid and if the rights, safety, and welfare 
of the research subjects were not violated. Shapiro, Legal Aspects of Premarket Approval 
of Medical Devices, 38 Food Drug Cosmetic L.J. 205, 211 (1983). Although the Center 
has not relied solely on foreign data in the past, the FDA has recently proposed to allow 
approval of new drugs based solely on foreign chnical data. See 47 Fed. Reg. 46,643 
(1982). In an interview, attorney Joseph Onek, who represented Domier-System in the 
FDA application process, said that testing centers in the United States were able rapidly 
to confirm the results of the extensive testing completed in Europe. Personal communication 
with Joseph Onek (July 1985). At the time that FDA began to evaluate the lithotripter, 
it had been used in Germany for five years. Gieringer, supra at 71. U.S. testing began 
less than one year prior to FDA approval. Nearly 2,000 of the 10,000 or so treatments 
worldwide had been performed in the United States. U.S. Dep't of Health & Human 
Services, News Release, HHS News 2 (Dec. 19, 1984). 

Onek also explained that Dornier was slow in introducing the lithotripter to the U.S. 
market. By the time it was introduced, urologists, nephrologists, and others knew about 
the lithotripter and its advantages and were anxious to obtain the device. Another factor 
that may have led to more rapid approval of lithotripsy was the lower per-patient cost 
of the procedure. Onek was of the opinion that although relative cost-effectiveness is not 
an explicit criterion for approval, FDA officials were aware of and motivated by the 
lower costs associated with lithotripsy. 

2'FooD & Drug Admin., U.S. Dep't of Health & Human Services, Summary of 
Safety and Effectiveness Data: Dornier Lithotripter, Model HM3 20 (1985). 

^^See Letter from Susanne Moulton, Chief, Certificate of Need Section, Division of 
Facility Services, N.C. Dep't of Human Resources, to William Jordan, M.D., Partner, 
Carohna Lithotripsy, Ltd. (Dec. 20, 1984). 

^^See Letter from Jack Brinson, Project Analyst, and Susanne Moulton, Chief, 
Certificate of Need Section, Division of FaciUty Services, N.C. Dep't of Human Resources 
to Orion Finklea, President, The Stone Institute of the CaroHnas, Inc. (Jan. 28, 1985). 

^Letter from Nancy Bres Martin, Project Analyst, and Susanne Moulton, Chief, 
Certificate of Need Section, Division of Facility Services, N.C. Dep't of Human Resources 
to Jane Rhoe- Jones, Acting Director of Planning, North Carolina Memorial Hospital (May 
30, 1985). 



996 INDIANA LAW REVIEW [Vol. 19:989 

Asheville^^ and Duke University Medical Center in Durham;^^ the CON 
applications for both facilities were denied because other facilities were 
deemed sufficient to serve patients in their respective service areas. ^"^ 

A fifth lithotripter slipped into the state through a crack in the 
regulatory defenses. A CON application by physician-owned Piedmont 
Urinary Stone Center, Inc. (Piedmont), which proposed the installation 
of a lithotripter in a Winston-Salem hospital, was reviewed together with 
the apphcation of Bowman Gray's North CaroHna Baptist Hospital. 
Piedmont's application was denied because only one service was deemed 
necessary in the Winston-Salem/Greensboro area and the CON agency 
preferred that such a service be associated with an academic institution.^^ 
Piedmont then proposed, however, to install a lithotripter in an outpatient 
facility unconnected with a hospital and successfully applied to the CON 
agency for a ruling that the CON statute did not apply to capital 
investments in major medical equipment to be installed in physicians' 
off ices. ^^ Although the legislature quickly moved to close this loophole 
by extending CON regulation to lithotripters "regardless of ownership 
or location, "^° Piedmont's plans were unaffected, and its lithotripter is 
currently operating in Winston-Salem. 

As in the comparative hearing pitting the Piedmont physician group 
against Bowman Gray's Baptist Hospital, the town/gown conflict was 
evident throughout the struggles over the provision of ESWL in North 
Carolina. The next two CON's went to physician groups that had filed 
their applications well before the other academic institutions. Subse- 



^^Letter from Dudley Stallings, Project Analyst, and Susanne Moulton, Chief, Cer- 
tificate of Need Section, Division of Facility Services, N.C. Dep't of Human Resources, 
to Les Brown, Director of Planning and Development, St. Joseph's Hospital (Aug. 27, 
1985). 

^^Certificate of Need Section, Division of Facility Services, N.C. Dep't of Human 
Resources, Required State Agency Findings, Disapproval of CON for Extracorporeal Shock 
Wave Lithotripter, St. Joseph's Hospital 2-3 (Aug. 27, 1985). 

"Letter from Nancy Bres Martin, Project Analyst, and Robert Fitzgerald, Assistant 
Director, Certificate of Need Section, Division of Facility Services, N.C. Dep't of Human 
Resources, to WiUiam Anlyan, M.D., Chancellor of Health Affairs, Duke University 
Medical Center (May 30, 1986). 

^^See Letter from Everette Jenkins, Assistant Chief, Certificate of Need Section, 
Division of Facility Services, N.C. Dep't of Human Resources, to Keith Christian, President, 
CV, Inc. (July 17, 1984). 

^^See Declaratory Ruling, In re Request for Declaratory Ruling by Piedmont Stone 
Center, P.A., Piedmont Stone Joint Venture, and Carolina Medicorp., Inc. (Mar. 28, 
1985); Letter from Jack Brinson, Project Analyst, Certificate of Need Section, Division 
of Facility Services, N.C. Dep't of Human Resources, to Charles Hauser, Agent, Piedmont 
Stone Center (Apr. 9, 1985). 

^°The amended statute required that all persons obtain a certificate of need prior 
to the acquisition of a lithotripter "regardless of ownership or location." N.C. Gen Stat. 
§§ 131E-176(l6)g, 178(a) (Supp. 1985). On the policy implications of regulating capital 
equipment in physician offices, see C. Havighurst, supra note 13, at 205-10. 



1986] LITHOTRIPSY 997 

quently, Memorial Hospital in Chapel Hill succeeded despite its presence 
in the same service area as the Fayetteville group, in part because it 
asserted educational and research needs. ^' (Duke, ironically, was unable 
to make this argument because it already possessed a lithotripter for 
research use, which was exempt from the CON requirement, and therefore 
sought only authority to offer a clinical service for compensation).^^ 
Perhaps in an effort to defuse opposition from community urologists, 
Memorial and Baptist hospitals made special arrangements whereby the 
former could obtain privileges to admit and treat ESWL patients. The 
claims of community urologists, asserted in a number of applications 
and challenges against the academic centers, included concern for the 
convenience of patients, the financial security of community hospitals, 
and the increasing dominance of the academic institutions.^^ 

Although the CON regulators stood firm against exceeding a total 
of five lithotripters in the state, certain powerful interests were unhappy 
with the outcome of the CON process, which resulted in inconvenience 
for citizens in the western part of the state and left one prestigious 
institution (Duke) barred from charging for the use of a lithotripter 
already in place. Several legislators took up the cause of Duke and St. 
Joseph's Hospital in Asheville and explored the possibility of legislation 
that would bypass the CON agency. Because North Carolina, unlike 
some states, does not allow "special legislation" favoring named private 
interests, ^^ it was necessary to write the exception in generic terms that 
bespoke a plausible legislative objective. In about two days' time, a bill 
was written and passed by the House of Representatives defining con- 
ditions for exemption that only Duke and St. Joseph's could meet.^^ 
Shortly thereafter, however, the Senate took a different view, and both 



^^See North Carolina Memorial Hospital, Certificate of Need Application, Attachment 
3, 5 (Dec. 11, 1985). 

^^See Certificate of Need Section, Division of Facility Services, N.C. Dep't of Human 
Resources, Required State Agency Findings, Disapproval of Conversion of Research 
Lithotripter to Clinical Use, Duke University, 6 (May 30, 1986). 

"See, e.g., Letter from Raymond Joyner, Chairman, Dep't of Urology, Durham 
County General Hosp., to Susanne G. Moulton, Chief, Certificate of Need Section, Division 
of Facility Services, N.C. Dep't of Human Resources (Jan. 31, 1985). 

'^5ee N.C. Const, art. II, § 24; cf. Commissioner of Public Health v. Bessick M. 
Burke Memorial Hosp., 366 Mass. 734, 323 N.E.2d 309 (1975) (upholding constitutionality 
of exemptive legislation applied to CON); D. Altman, R. Greene & H. Sapolsky, Health 
Planning and Regulation 28, 53, 186-87, 200-01 (1981) (discussing special legislation 
exempting named private interests from CON in Massachusetts). 

^^Oliver & Andrews, House OKs Bill to Let Duke Use Kidney-Stone Machine, Durham 
Morning Herald, July 2, 1986, at IB, col. 2. Many other states have discovered that 
technocratic regulation of the health care industry frequently gives way whenever it becomes 
necessary to offend powerful interests that can effectively appeal to political leaders for 
assistance. See D. Altman, R. Greene, & H. Sapolsky, supra note 34, at 26-31, 153, 
177-87, 202-10, 233-36 (noting ways providers circumvent the certificate of need process). 



998 INDIANA LAW REVIEW [Vol. 19:989 

houses, in a surprising move, finally decided to repeal altogether the 
CON requirement for lithotripters and ESWL services. ^^ 

This sudden deregulatory move by North Carolina has somewhat 
startling implications. Many states, no longer bound by federally imposed 
requirements to maintain CON laws, have cut back on such regulation. ^^ 
Although a few states have repealed their CON laws altogether, ^^ most 
have maintained controls over large capital investments in hospital-based 
facilities, ostensibly on the theory that capital-intensive institutional serv- 
ices are least amenable to allocation by market forces. ^^ North Carolina's 
deregulation of ESWL, which obviously was not the product of a well- 
considered policy judgment, is peculiar in that it preserves the basic 
scheme of comprehensive regulation but makes an exception for a tech- 
nological development of the kind that most observers would agree is 
a prime candidate for regulatory allocation. 

The North Carolina experience reveals once again the political di- 
mensions and debatable premises of CON regulation. Despite numerous 
objective studies of the question, CON regulation has never been shown 
to control health care costs. "^ Indeed, substantial evidence suggests that 
CON laws were put in place not primarily to control costs but to protect 
the most powerful existing institutions against competitors skimming 
profitable business^^ and to legitimize rapidly rising costs in the eyes of 



^^See Lineberry, Duke Lithotripter Use Gets Senate Approval, Durham Morning 
Herald, July 12, 1986, at IC, col. 5. Because North Carolina had not contracted with 
the federal government under section 1122 of the Social Security Act, 42 U.S.C. § 1320a- 
1 (1982), to perform planning services, leading to possible denial of Medicare reimbursement 
of capital costs, this legislative action removed all governmental constraints on the in- 
stallation of lithotripters. 

"Simpson, Full Circle: The Return of Certificate of Need Regulation of Health 
Facilities to State Control, 19 Ind. L. Rev. 1025 (1987). 

''Id. at 1061, 1079-81. 

^'^See C. Havighurst, supra note 13, at 4-5. In the National Health Planning and 
Resources Development Amendments of 1979, Congress identified the provision of "inpatient 
health services and other institutional health services" as being particularly subject to the 
market failure that it viewed as necessitating CON regulation for new health facilities and 
services. Legislative findings accompanying the 1979 amendments stated that "the prevail- 
ing methods of paying for health services by public and private health insurers" make com- 
petition an unreliable allocative mechanism and singled out institutional services as most 
likely to be among those "for which competition does not or will not appropriately allocate 
supply." 42 U.S.C. § 300k-2(b)(i)-(2) (1982); see also H.R. Rep. No. 190, 96th Cong., 1st 
Sess. 51-54 (1979). 

*°See generally C. Havighurst, supra note 13, at 63-74 (summarizing analytical and 
descriptive studies of CON's effect on costs); P. Joskow^, supra note 12, at 138-68; Sloan, 
The Track Record of Certificate-of-Need Programs (paper presented at the third annual 
Health Policy Symposium, "The Role of Health Planning in a Competitive Environment," 
Vanderbilt University, May 15-16, 1986). 

"'"In North CaroUna, improvement of the borrowing capacity of the hospitals — by 
protecting them from competition — was an explicit purpose" behind the enactment of the 
state's first CON law. Havighurst, supra note 12, at 1164 n.77 (citing Durham Morning 



1986] LITHOTRIPSY 999 

an increasingly concerned public/^ Moreover, some have argued that the 
main effect of entry regulation has been to protect payers and providers 
from having to alter their traditionally nonadversarial relationships by 
embarking, respectively, on prudent buying and competitive selling of 
health services/^ North Carolina's deregulation of lithotripsy suggests 
that legislative support for CON regulation is weakening and that the 
public is running out of patience with a regulatory scheme that protects 
estabhshed institutions. 

The natural question that arises is what happens next in North 
Carohna. Unless the market conditions that were deemed to warrant 
CON regulation have changed or can now change readily, there may 
be a proliferation of unneeded, overutilized lithotripters. According to 
the scenario visualized by advocates of health planning and CON reg- 
ulation, the public can expect to pay a high price and receive inappro- 
priate, even unnecessary, medical care. Whether this vision will be fulfilled, 
however, depends upon those who pay for medical care and their will- 
ingness and ability to defend themselves against the predictable higher 
costs. Later discussion, following examination of payment issues that 
have already arisen in North Carolina, will consider what actions payers 
might take in this regard and the actual prospects for their taking them."^ 
That discussion will also consider whether the scenario may instead fulfill 
the predictions of deregulation advocates, who argue that unlimited entry 
will trigger prudent purchasing and effective price competition among 
providers, creating a market deterrent to replace the barrier that CON 
regulation supposedly erected to the creation of technological overca- 
pacity. 

III. Playing for Money 

The active pursuit of CON's for ESWL facilities in North Carolina 
indicated that providers, particularly physicians, anticipated that the 



Herald, June 25, 1971, at IC, col. 1). See also Payton & Powsner, Regulation through 
the Looking Glass: Hospitals, Blue Cross, and Certificate-of-Need, 79 Mich L. Rev. 203, 
255-56 (1980). 

. ''^Payton & Powsner, supra note 41, at 247-48. This source shows that the main 
proponents of CON regulation were not themselves interested in cost containment but 
stood to gain if the public could be satisfied that continued cost escalation was justified. 
They may even have anticipated the great political difficulty encountered by public regulators 
in saying "no" to "needs" asserted by reputable providers. See supra note 35; C. Havighurst, 
supra note 13, at 25-52. 

''The crucial observation of Payton & Powsner, supra note 41, is that CON laws 
perpetuated a financing system that served the interests of the dominant payers and 
providers. See also Havighurst, supra note 12, at 1156 ("Viewed in the light of possibilities 
for more fundamental changes in the market for insurance and health services, certificate- 
of-need laws may appear as conservative measures, designed to preserve the very institutions 
which create the problems to which they are addressed."). 

*^See infra notes 76-127 and accompanying text. 



1000 INDIANA LA W REVIEW [Vol. 19:989 

ESWL game would be highly profitable. However, what profits would 
be earned and to whom they would accrue would depend upon numerous 
factors, beginning with the policies and practices of the various payers 
and their ability to bargain for favorable rates of payment. The North 
Carolina experience featured a heated controversy over physician fees 
for lithotripsy as NCBCBS attempted to take a stand against the urol- 
ogists' proposal that they receive an allowance for their services roughly 
equal to what they previously received when kidney stones were managed 
surgically. As explored further below, both the unusual effort made by 
NCBCBS and its failure to affect fees significantly are instructive. 

The North Carolina experience with lithotripsy also focused attention 
on the economics of patient referrals from community physicians to 
ESWL centers. Although questions were raised about the ethical propriety 
of fees paid — ostensibly for follow-up services — by some centers to re- 
ferring physicians, the discussion below shows that such payments may 
not be incompatible with fair play and appropriate outcomes in the 
lithotripsy game. 

A. The UCR Game — with the Blues' Chips 

When ESWL was first undertaken in North CaroUna in 1985, NCBCBS 
had to set some limit on the urologists' professional allowance for the 
procedure. "^^ Hospitals would be reimbursed their costs under the cus- 
tomary arrangement, but a limit on reimbursable physician fees had to 
be initially established by fiat because there was no "going rate" from 
which NCBCBS could derive a "usual, customary, and reasonable" 
(UCR) rate. Because no fee was yet either "usual" or "customary," 
NCBCBS turned to its Physician Advisory Committee for guidance on 
what would be "reasonable." 

Largely on the strength of testimony by David F. Paulson, M.D., 
chief of the Division of Urology at Duke, NCBCBS's advisory committee 
determined that a fee in the range of $350 to $450 would be proper. ^^ 



"Personal communication with William DeMaria, M.D., Medical Director, NCBCBS 
(Jan, 1987). See also Medical Advisory Panel of the Health Benefits Management 
Division, Blue Cross & Blue Shield, Financl^l Analysis of Extracorporeal Litho- 
TRiPTER Services, at .05 - .07 (discussing appropriate professional fee for ESWL). Under 
the typical NCBCBS contract, the patient patronizing a "participating" physician is assured 
that the physician will accept the plan's payment to him as payment in full (subject to 
any deductible or co-payment provided for); the plan's contract with the physician so 
provides and also sets a "UCR" limit on what the plan will pay. If the patient patronizes 
a "non-participating" doctor, the plan typically does not pay the physician directly but 
instead reimburses the patient for bills incurred up to a contractually specified limit (usually 
based on the UCR formula). See generally Blue Cross & Blue Shleld Ass'n, Usual, 
Customary and Reasonable: An Explanation for Doctors 1-3; Blue Cross and Blue 
Shield of North Carolina, Cost Care: A Participating Doctor Payment Plan (1985). 

"^Personal communication with William DeMaria, M.D,, Medical Director, NCBCBS 
(Jan. 1987). 



1986] LITHOTRIPSY 1001 

This amount was considerably less than the customary surgical fee of 
$1,500 to $2,000 for an uncomplicated nephrolithotomy, which Carolina 
Lithotripsy proposed to charge/^ The higher fee would accord with the 
general position taken by the ad hoc committee on lithotripsy of the 
American Urological Association (AUA)/^ This committee was then 
chaired, coincidentally, by another North CaroHnian, William H. Boyce, 
M.D., former chairman of the Division of Urology at Wake Forest's 
Bowman Gray School of Medicine/^ Obviously, Dr. Paulson had taken 
a position very much at odds with the interests of his professional 
colleagues in the state. ^^ 

On the merits of the fee issue, the AUA's view was that the urologist 
is required to possess special knowledge and to exercise special skills in 
ESWL and that the pre- and post-procedure responsibilities associated 
with ESWL are the same as with surgery.^' In the contrary view of Dr. 
Paulson, the urologist's role in ESWL is merely to supervise the tech- 
nician, a much less demanding and extensive service than a surgical 
procedure. ^^ Adopting the latter view and recognizing that some additional 
charges for services before and after the procedure might also have to 
be paid, NCBCBS initially recognized $450 as the limit of its payment 
responsibility for the procedure itself. In response, Carolina Lithotripsy 



""Tersonal communication with William Jordan, M.D. (July 1985). One urologist noted, 
however, that the professional fee for ESWL is only one element of the total charge and 
that the relative size of the professional fees among providers may not correspond to the 
relative total price for the procedure. Personal communication with David McCullough, 
M.D., Chairman of the Division of Urology at Bowman Gray School of Medicine of 
Wake Forest University. 

"^David McCullough, Chairman of the American Urologic Association Ad Hoc 
Committee on ESWL and Chairman of the Division of Urology at Bowman Gray School 
of Medicine, explained that the larger fee was also justified by the high cost of training 
urologists to perform lithotripsy. Personal communication with David McCullough, M.D. 
(Jan. 1987). For example, he estimated that the cost of training five Bowman Gray 
urologists to perform lithotripsy, including forgone earnings, was $100,000. 

^^ American Urologic Association, Summary and Recommendations of the Meet- 
ing OF THE Ad Hoc Committee to Study the Safety and Clinical Effectiveness of 
THE Current Technology of 1) Percutaneous Lithotripsy, and 2) Non-Invasive Lith- 
otripsy 5 (May 9, 1984) [hereinafter AUA Summary and Recommendations]. The Ad 
Hoc Committee is currently chaired by North Carolinian David McCullough, M.D., who 
is also Chairman of the Division of Urology at Bowman Gray. 

'"Paulson stated that colleagues told him of the anger many urologists, particularly 
those in North CaroUna, had toward Paulson for his stand on this issue. Personal 
communication with David Paulson (Nov, 1986). Paulson beleives that some urologists 
may have retaliated, but beUeves they were too "shrewd" to make such retaliatory actions 
obvious. Id. 

^'See AUA Summary and Recommendations supra note 49 at 5; American Urologic 
Ass'n, Ad Hoc Committee to Study the Safety and Clinical Efficacy of the Current 
Technology of Percutaneous Lithotripsy and Noninvasive Lithotripsy 14, 16-17 (May 
16, 1985). 

"Personal communication with WiUiam De Maria, M.D., Medical Director, NCBCBS 
(Jan. 1987). 



1002 INDIANA LAW REVIEW [Vol. 19:989 

declared its intention to bill NCBCBS-insured patients for the balance 
of the full fee." 

Sadly, NCBCBS could not hope to carry the day for several reasons. 
First, like most other Blue Shield plans, NCBCBS was committed in its 
contracts with subscribers to pay up to the UCR limit. To NCBCBS, 
this meant that, once the procedure had been billed for in a sufficient 
number of cases, it would have to step up its allowance to whatever 
had become "usual" for the particular provider and "customary" in 
the community. Although the plan might still challenge a fee as being 
unreasonable, a plan official at one point gave the impression that the 
plan did not regard "reasonableness" as an independent check on usual 
and customary charges.^"* At another point, this official expressed doubt 
that the unreasonableness of the allowance demanded by the urologists 
could be established, because other insurers around the nation were 
paying it.^^ In making this excuse, however, plan officials still seemed 
to assume that reasonableness is to be judged by what others do, not 
by objective economic criteria. 

A second reason why the NCBCBS effort was unlikely to succeed 
was the unhkelihood that price competition by providers during the short 
period when the low Hmit on NCBCBS coverage was in effect would 
yield price reductions or reliable yardsticks for future payments. Even 
if patients, faced with paying the excess over NCBCBS's allowance, had 
known enough to seek out a lower-cost provider, no service area had 
more than one provider during the crucial period. In addition, providers 
would have known that the UCR level would jump dramatically if they 
could resist for only a short time the temptation to compete. 

Finally, NCBCBS officials were unwilling to force a showdown over 
ESWL fees because they feared that such a challenge would induce 
urologists across the state to refuse to join NCBCBS 's participating- 
physician program. ^^ Ironically, NCBCBS 's concern over attracting phy- 
sicians to this program undercut the program's ostensible cost-contain- 
ment objective, which was to be achieved by inducing physicians not 
to balance-bill subscribers. In this instance, plan officials' desire to make 
the program a success in terms of participation effectively prevented 
them from vigorously negotiating with physicians over an important cost 
item. Of course, the plan may have sensed accurately that no urologists 
(other than perhaps those at Duke, which may have higher costs in 

"Personal communication with William Jordan, M.D. (July 1985). This meant that the 
physicians associated with Carohna Lithotripsy would not "participate" in NCBCBS and 
that their patients would therefore not be protected from "balance billing." See supra 
note 45. 

^^Personal communication with Clifford Balin, Director of Professional Benefits, 
NCBCBS (Nov. 1986). 

^'Personal communication with CUfford Balin, Director of Professional Benefits, 
NCBCBS (Jan. 1987). 

''Id. 



1986] LITHOTRIPSY 1003 

Other respects) would agree to participate at the lower rate and that 
balance billing would not trigger price shopping and effective price 
competition in the highly concentrated ESWL market. 

Because the NCBCBS effort was doomed from the outset, the gesture 
that it made — difficult as it was for the plan officials concerned^^ — must 
strike an outsider as a pathetic demonstration of how ineffectual Blue 
Cross and Blue Shield plans generally are in challenging providers on 
economic issues. 

The NCBCBS experience with lithotripsy fees also reveals the basic 
fallacies of the UCR method of setting reimbursement limits. ^^ Essentially, 
the idea behind UCR is not, despite appearances, that market-determined 
prices can serve as a yardstick of what a proper allowance might be; 
there is in fact no pretense that only market-determined (as opposed to 
insurer-reimbursed) fees are considered in setting UCR limits. Instead, 
the premise underlying a UCR fee ceiling is simply that the great majority 
of physicians, as ethical practitioners exercising professional discretion, 
do not charge unreasonable or unconscionable prices and that it is 
therefore necessary only to compare a physician's fee with those of his 
peers to discover its reasonableness. Only a minute's reflection reveals 
how completely this conception of how professional services should be 
priced embodies the ideology of organized medicine, with its strong 
opposition to any arrangement inviting price competition among phy- 
sicians. It is apparent then how NCBCBS, like other Blue Cross and 
Blue Shield plans that have followed similar policies, serves the interests 
of a medical cartel. ^^ Only an insurer that had been bred specifically — 
as Blue Shield plans were^° — for the purpose of advancing physicians' 



"Plan personnel viewed themselves — with some justification— as being courageous in 
taking on the urologists and indicated that they would probably not have been able to do as 
much as they did had Dr. Paulson, a respected physician, not come forward as an ally. Per- 
sonal communication with William DeMaria, M.D., Medical Director, NCBCBS (July 1985). 
One plan official stated that the allowance for ESWL was finally set at an amount equal to 
NCBCBS's average for an open surgical procedure. Personal communication with Clifford 
Balin, Director of Professional Benefits, NCBCBS (Jan. 1987). This allowance was viewed 
as an accomplishment because it is 10% to 25% less than urologists' actual stated charges 
for lithotripsy. Id. However, this allowance is obviously far in excess of that which NCBCBS 
sought. 

'^See Crump & Maxwell, Health Care, Cost Containment, and the Antitrust Laws: 
A Legal and Economic Analysis of the Pireno Case 56 S. Cal. L. Rev. 913, 915-18 
(1983) (description and defense of the UCR method of payment); Roe, The UCR Boon- 
doggle: A Death Knell for Private Practice!, 303 New Eng. J. Med. 41 (1981) (stating 
that the UCR concept has failed to control escalation of medical costs because it contains 
none of the limits appUed to other services covered by insurance). 

^^See infra text accompanying notes 100-21. 

^See, e.g., Anderson, Health Services in the United States 121-32 (1985) (ex- 
plaining that Blue Shield plans were sponsored by state and county medical societies); 
Bureau of Competition, FTC, Medical Participation in Control of Blue Shield and 
Certain Other Open-Panel Medical Prepayment Plans (Staff Report and Proposed 



1004 INDIANA LAW REVIEW [Vol. 19:989 

economic interests could maintain that the UCR system is a responsible 
way to disburse the public's money to physicians. 

The long survival of the UCR method for "controlHng" physician 
fees might suggest that consumers approved the ideology supporting the 
practice of using nonmarket rather than market mechanisms for procuring 
medical services. A closer look, however, reveals that because of ethical 
and legal restraints imposed on contract and corporate practice^^ and 
the resistance of provider cartels to those payers who sought to buy 
provider services on competitive terms, ^^ consumers were rarely offered 
any alternative. Although recent years have seen the growth of such 
alternatives as health maintenance organizations (HMO's) and so-called 
preferred-provider organizations (PPO's), traditional payment mecha- 
nisms remain dominant in North Carolina." The recent experience with 
lithotripsy fees provides an example of the high cost that consumers 
bear as a consequence. As discussed below, this experience, which is 
far from an isolated instance, demonstrates the burdens that providers 
and Blue Cross or Blue Shield plans, acting together, impose on con- 
sumers. 

B. The Doctors Split Their Winnings 

In another expression of its concern about cost containment, NCBCBS 
at one point declared its opposition to payments by lithotripsy centers 
to physicians merely for referring patients for treatment. ^^ Although these 
payments were represented as being fees for follow-up services, NCBCBS 
personnel feared that the fees paid to the referring physicians were in 
fact unethical fee splitting — that is, rebates or kickbacks paid for procur- 



Trade Regulation Rule, April 1979) (describing historical origins of Blue Shield plans as 
creatures of state and local medical societies). 

^•In American Medical Ass'n v. FTC, 638 F.2d 443 (2d Cir. 1980), affd by an 
equally divided Court, 455 U.S. 676 (1982), the court enforced an FTC decision condemning 
professional societies' ethical prohibitions on "contract practice" — that is, physicians con- 
tracting with lay-controlled intermediaries that might be viewed as retaiUng professional 
services to the public. Common-law and statutory restrictions on corporate intermediation 
in the doctor/patient relationship have also interfered with the ability of consumers to 
employ a sophisticated agent to select health care providers and bargain with them on 
consumers' behalf. See, e.g., Att'y Gen. Op. No. 81-1004 (Calif., April 7, 1982); Rosoff, 
The "Corporate Practice of Medicine" Doctrine: Has Its Time Passed?, Health Law 
Digest, Dec. 1984, at 1 (Supp.). 

^^See, e.g., Havighurst, Professional Restraints on Innovation in Health Care Fi- 
nancing, 1978 Duke L.J. 303, 306-19. 

"5ee infra notes 119-20; see also Conn, Health Maintenance Organizations Arrive 
in North Carolina, N. C. Insight, Feb. 1985, at 58, 62 (noting that there were 36,600 
enrollees in North Carolina HMO's in January 1985). 

^Personal communication with William DeMaria, M.D., Medical Director, NCBCBS 
(July 1986). 



1986] LITHOTRIPSY 1005 

ing the patient's business for the center/^ NCBCBS later accepted 
urologists' assurances that appreciable services were indeed being provided 
following treatment with ESWL/^ At least one physician receiving such 
a fee viewed it as a payment for the referral, however/^ In any event, 
the practice has not been discontinued/^ 

The medical profession has long regarded fee splitting as an unethical 
practice, and it has been the object of attention by licensing authorities 
and professional associations concerned with professional conduct. ^^ A 
primary concern has been that rebates will distort a physician's profes- 
sional judgment in referring a patient to a specialist, causing either 
referrals for unnecessary care or the selection of a specialist on a basis 
other than exclusive concern for the patient's welfare. The issue is more 
complex, however, than it first appears, and indeed it is possible that 
a referral fee may actually improve the chances that a patient will get 
optimal treatment. Without such an inducement to refer the patient, a 
primary physician may be tempted to provide a service himself rather 
than allow another more qualified or better equipped physician to earn 
the fee.^^ In the case of a patient with a kidney stone, for example, a 
physician might be induced to exaggerate his doubt about how the case 
should be managed and then to resolve such doubt in favor of medical 
management or surgery rather than referral for ESWL. As economist 
Mark Pauly has observed, prohibitions on fee splitting may leave the 

^Tlan personnel had two concerns about payments for follow-up services to a referring 
physician for "post-procedure" care. First, they sought assurance that this payment was 
not merely a referral fee but was for care actually provided. Second, they wanted to 
ensure that patients had full knowledge of these fee arrangements. Personal communication 
with CHfford BaUn, Director of Professional Benefits, NCBCBS (Jan. 1987). 

^"•Id. 

^Tersonal communication with John Weinerth, M.D., Associate Professor of Surgery, 
Duke University Medical Center (July 1986). 

^*NCBCBS, in paying the physician's charge or reimbursing a patient for a cost 
incurred, had no easy way of knowing whether the physician was sphtting the fee with 
another physician. NCBCBS did, however, refuse to reimburse the portion of the lithotripsy 
professional fee designated for "after care" by the primary urologist unless such care was 
actually provided. Personal communication with WiUiam DeMaria, M.D., Medical Direc- 
tor, NCBCBS (Aug. 1986). 

"See, e.g., American Medical Ass'n, Principles of Medical Ethics § 6.03 (1982); 
53 Ops. Cal. Att'y Gen. 117, 118 (1970) (interpreting the California prohibition). The 
American College of Surgeons has adopted an interpreting statement explaining that it 
considers a form of fee splitting the practice of billing a patient a single fee for lithotripsy 
and then distributing a portion of the fee to the referring physician. Regents Issue Statement 
on Fees for Lithotripsy, Am. College Surgeons Bull., April 1986, at 21. The College 
stated that the charge for services and identity of the provider should be disclosed to the 
patient. Id. 

^"As the supply of physicians grows and primary physicians become less busy, they 
may feel greater pressure to keep patients rather than refer them to specialists. Pauly, 
The Ethics and Economics of Kickbacks and Fee Splitting, 10 Bell J. Econ. 344, 348 
(1979). 



1006 INDIANA LA W REVIEW [Vol. 19:989 

patient no less dependent upon the primary physician's ethical ability 
to subordinate self-interest in making professional judgments. ^^ In ad- 
dition, Pauly notes that other forms of reciprocity — cross-referrals and 
conferral of other benefits — are practiced and are condoned or at least 
ignored by Ucensing and professional authorities. It is not clear that 
patients' interests would be adversely affected if fee splitting were per- 
mitted and openly practiced. ^^ 

From the perspective of NCBCBS and other, particularly govern- 
mental, third-party payers, fee splitting naturally appears as an instance 
of "fraud and abuse. "^^ Assuming, however, that the treatment itself 
was needed and of acceptable quality, it is not clear why a payer should 
be concerned how the fee that it has agreed to pay is divided among 
providers. Although the willingness of the referral specialist to rebate 
a portion of his fee is a clear sign that the fee is excessive, there is no 
reason to expect that the fee would be reduced if fee splitting were 
prohibited. The irony here is that such rebates are a manifestation of 
price competition among specialists and proof that competition can yield 
substantial benefits to anyone who controls the selection of the specialist — 
something that traditional third-party payers have been reluctant to do. 
It is of course understandable why NCBCBS would be embarrassed by 
unjustified payments to referring urologists; such payments obviously 
come out of the excessive fees that NCBCBS has been unable to resist 
paying for the procedure. Nevertheless, efforts by NCBCBS and profes- 
sional interests to suppress fee splitting would not serve to lower that 
fee or benefit consumers. 

Indeed, it appears once again that the consumer's interest may lie 
in fostering, not suppressing, fee splitting. Although at first glance it 
may not seem to matter to consumers how physicians divide their excessive 



^^Id. at 349; see also Schaffer & Holloman, Consultation and Referral Between 
Physicians in New Medical Practice Environments, 103 Annals Internal Med. 600, 601 
(1985). 

^^Tort law and possibly other legal remedies would presumably discourage the worst 
abuses. Also, if fee splitting were a known practice, patients would be on their guard, 
and some physicians might disclose their practice and share the savings with patients. 
Pauly, supra note 70, at 349. 

"Indeed, section 1877(b)(1)(A) of the Social Security Act, added by the Medicare- 
Medicaid Anti-fraud and Abuse Amendments of 1977, expressly prohibits the receipt of 
"kickbacks," "bribes," and "rebates" made "directly or indirectly, overtly or covertly, 
in cash or in kind ... in return for referring an individual to a person for the furnishing 
or arranging for the furnishing of any item or service for which payment may be made 
in whole or in part under this title." 42 U.S.C. § 1395nn (1985) (Medicare). See also id. 
§ 1396h(b) (Medicaid). In United States v. Greber, 760 F.2d 68 (3d Cir. 1985), the court 
held that this statute was violated if the fee was to induce the physician to use the service, 
even if the fee was also intended to compensate the physician for professional services. 
See generally Gebhard, Lithotripsy Referral Fees: Medicare Fraud and Abuse?, Am. College 
Surgeons Bull., April 1986, at 16. 



1986] LITHOTRIPSY 1007 

profits, the matter is not so simple. If a primary physician expects a 
rebate for referring stone patients for ESWL, he is Hkely to increase 
his competitive efforts to attract such patients, offering price and other 
inducements that will lower his net return and confer benefits on con- 
sumers. Again as Pauly has observed, the medical profession's historic 
opposition to fee splitting represents, in some measure, a desire to 
suppress price competition among specialists and to remove the desta- 
bilizing effects of rebates in markets for primary care.^'' By the same 
token, consumers would probably be better off if fee splitting were 
acknowledged as a legitimate competitive practice. Indeed, competition 
in fee splitting could compensate in some measure for the failure of 
NCBCBS and other payers to force ESWL centers to compete for the 
opportunity to serve their insureds. 

It would be claiming too much to suggest that the problem of 
obtaining optimal treatment for stone patients at a competitive price 
would disappear if fee splitting were tolerated. Questions would still 
exist concerning the incentives and professional integrity of referring 
physicians and the ability of patients or insurers to detect and thus deter 
physician abuse. Moreover, the high level of concentration in ESWL 
markets suggests that competition may not be effective in forcing ESWL 
fees down to truly competitive levels. ^^ Finally, some of the competitive 
strategies employed by primary physicians to attract stone patients would 
undoubtedly involve wasteful nonprice inducements, adopted precisely 
because price competition is unavailing when patients are heavily insured. 
Despite these reservations, however, the problems uncovered in the ex- 
isting system make it highly probable that efficient allocation of resources 
is more likely to be approached under open competition than under the 
conventional arrangements sponsored by NCBCBS and favored and fos- 
tered by organized medicine. 

IV. The Coming Show-down — Buying and Selling ESWL 
Under the Nevs^ Rules 

North Carolina's deregulation of lithotripters prompts speculation 
about the outcome of the new hthotripsy game. Many bettors predict 



^"Pauly, supra note 70, at 348. For other instances in which prohibitions of rebating 
served anticompetitive purposes, see Department of Ins. v. Dade County Consumer Ad- 
vocate's Office, 492 So. 2d 1032 (Fla. 1986) (statute prohibiting rebates to consumers by 
insurance agents held unconstitutional); Owen, Kickbacks, Specialization, Price Fixing, 
and Efficiency in Residential Real Estate Markets, 29 Stan. L. Rev. 931, 949-55 (1977) 
(title insurer's rebates to brokers). 

^^Given the oligopohstic character of the ESWL market, the amount of the rebate 
is likely to become standardized through tacit collusion. See infra text accompanying note 
91. 



1008 INDIANA LAW REVIEW [Vol. 19:989 

that North Carolina citizens will lose, incurring substantially higher costs 
without enjoying commensurate benefits. Although a consumer victory 
can be imagined, it remains to be seen whether the players fielded by 
consumer interests, particularly NCBCBS, will change their strategy and 
improve their performance enough to produce an outcome different from 
that envisioned by the oddsmakers. 

A. Prospects for a Consumer Defeat 

If payment systems retain the forms favored by NCBCBS and pro- 
viders. North Carolinians face the prospect that they will have to pay 
in full the costs of purchasing and maintaining an excessive number of 
costly lithotripters. In a normal competitive market, consumers are ben- 
efitted, not harmed, by excess producer capacity. As sellers ignore their 
"sunk" costs — that is, those investments that cannot be recovered by 
withdrawing from the market — competition causes unit prices to fall 
below average total cost, giving consumers a bargain until equilibrium 
is restored by the withdrawal of some capacity. ^^ Competitive conditions 
also deter the creation of inefficient overcapacity because a would-be 
investor could not expect to recover his investment in new facilities 
unless existing facilities were either inadequate or relatively inefficient. 
In health care, unfortunately, because traditional reimbursement mech- 
anisms give patients little reason to shop for low prices, it has not been 
possible to count on competition to drive prices below average total 
cost and to discourage overinvestment. If would-be investors in North 
Carolina lithotripters currently believe that existing financing arrange- 
ments are not likely to change before they have recovered their capital 
outlays,''^ North Carolina consumers do indeed face unjustified higher 
costs as a consequence of deregulation. 

Higher prices to North Carolinians may also result from other causes. 
If payment systems do not threaten now or in the near future to put 
competitive or other pressure on high-cost providers, a would-be investor 



^^Under competition, prices tend to equal marginal cost, the cost of the last unit 
produced. With overcapacity, marginal cost includes no capital costs. On the other hand, 
if production is at full capacity, marginal cost includes the cost of the capacity that must 
be added to increase production. See generally P. Areeda, Antitrust Analysis t 114- 
16 (3d ed. 1981). 

^^An issue arises concerning the period over which an investor can recover his 
investment. In North CaroUna, ESWL providers have pressed to have NCBCBS reimburse 
hospitals for lithotripter depreciation on the basis of a two-year useful life; NCBCBS has 
argued for amortization over five years. Personal communication with Clifford Balin, 
Director of Professional Benefits, NCBCBS (Aug. 1986). NCBCBS has resolved the 
dispute. Id. Obviously, a longer period of payback increases the risk that market conditions, 
including insurer practices, will change in ways detrimental to providers and will thus 
discourage overinvestment in lithotripters. 



1986] LITHOTRIPSY 1009 

has no reason to await the availabihty of a lithotripter less costly than 
the Dornier device. In addition, consumers cannot expect to enjoy across- 
the-board cost savings when lower-cost devices do appear; they would 
instead, under prevalent cost-reimbursement formulas, continue to pay 
the full depreciation costs of obsolete equipment. ^^ Finally, the absence 
of effective price competition would also allow providers who are not 
reimbursed strictly on the basis of costs actually incurred — physicians, 
in particular — to charge prices well in excess of their costs. It has already 
been shown how UCR allowances in North Carolina represent excessive 
payments for professional services. The ability of physicians to overcharge 
for their role in ESWL reflects the noncompetitive conditions prevalent 
in that market. Unfortunately, unless changes occur in payment systems, 
ehminating CON-protected monopolies of ESWL may not bring prices 
down. 

A proliferation of lithotripters might also trigger higher health care 
costs in the form of overuse of the devices to treat stone patients who 
could be managed satisfactorily at much less expense without resorting 
either to the device or to surgery. ^^ Traditional payment systems offer 
only weak defenses against such overutilization. One theory supporting 
CON regulation was that supply could be curtailed to an extent that 



^^The Medicare program's position regarding capital costs is very much in limbo at 
the moment, contributing substantially to the uncertainty facing would-be investors in 
North Carohna lithotripters. Currently, under Medicare's prospective payment system, 
capital costs (depreciation, interest, and return-on-equity for for-profit institutions) are 
not included as part of per-case payment rates, but are reimbursed at actual cost. See 
E. Power, Extracorporeal Shock Wave Lithotripsy and the Medicare Prospective 
Payment System 8, 14 (1985). Because hospitals are assured coverage of the acquisition 
costs, hospitals are encouraged to acquire new technologies. Id. at 19. 

However, the Reagan Administration has proposed a plan to phase Medicare capital 
payments into DRG's over a four-year transition period, beginning with fiscal year 1987 
cost reports. Firshein, HHS Capital Plan Arouses Provider Anxieties, Hospitals, June 
20, 1986, at 24 [hereinafter HHS Capital Plan]. Payments would be based on hospital- 
specific and national rates, with fiscal year 1983 cost reports trended forward. Firshein, 
Providers Call '87 PPS Increase 'Unacceptable', Hospitals, July 5, 1986, at 31. 

Meanwhile, hospitals and other providers are urging Congress to intervene. Id. Senator 
David Durenberger (Rep. -Minn.) has proposed a plan to fold Medicare capital payments 
into DRG's over a seven year period. HHS Capital Plan, supra, at 24. In addition, both 
the House and Senate have approved a supplemental appropriations bill that includes a 
one-year moratorium on inclusion of capital costs. Hospital Shouldn't Wait to Evaluate 
Medicare Changes for Fiscal Year 1987, 4 Prospective Payment Survival 108 (1986). 

''Even though efficiency considerations may dictate using ESWL in many cases if 
overcapacity already exists, new capital investments enabling the provision of ESWL in 
identical cases would not necessarily be indicated. This anomaly results because, if the 
capacity is not already in place, the marginal cost of additional treatments, which must 
be compared to the advantages of ESWL over alternative therapy, includes the cost of 
new capacity and is therefore significantly higher than it would be if a lithotripter were 
standing idle. See supra note 76. 



1010 INDIANA LAW REVIEW [Vol. 19:989 

would force health care providers to ration limited resources to their 
best uses. Political conditions, however, have usually made it impossible 
for CON regulators to challenge medical opinion on appropriate utiU- 
zation or to do more than try to prevent the creation of unused capacity. ^^ 
Although CON regulation has therefore probably done little to contain 
the excess demand for services induced by passive insurance plans, ^^ the 
lifting of CON restrictions, by removing the occasion for regulatory 
determinations of need, may have created some additional risk that 
physicians will extend their use of ESWL technology well beyond the 
point at which its benefits are at least equal to its cost of roughly $6,000 
per procedure. ^^ Lacking the ability to resist paying for all services that 



^'^See C. Havighurst, supra note 13, at 36 (reporting an informal survey indicating 
that CON regulators see their role only as preventing duplication, not as forcing rationing). 

^^See references cited note 40 supra. See also C. Havighurst, supra note 13, at 58- 
63 (demonstrating graphically how "inflationary pressures [attributable to passive insurance 
plans] may, like a balloon, bulge out at another place even if growth in one direction 
is effectively prevented"). 

^^Indeed, North Carolina urologists have already begun to suggest that the device 
is appropriately employed to treat stones that are small enough to pass (with some 
discomfort, to be sure) through the urinary tract. E.g., Personal communication with 
John Weinerth, M.D., Chief of Urolithiasis Service and Associate Professor of Surgery, 
Duke University School of Medicine (July 1986). Elsewhere urologists are finding other 
possible uses for lithotripsy, including its use against gallstones. See Sauerbruch, Erag- 
mentation of Gallstones by Extracorporeal Shock Waves, 314 Nev^ Eng. J. Med. 818 
(1986). The procedure may also be useful against bladder and kidney tumors. See Russo, 
High Energy Shock Waves Suppress Tumor Growth in Vitro and in Vivo, 135 J. Urology 
626 (1986); Shock Waves Being Used to Bombard Cancer, Durham Morning Herald, Nov. 
17, 1986, at IB, col. 1. 

The "need" for lithotripsy and indeed for most medical services is difficult to determine 
for several reasons. Most observers are much more comfortable in asking simply whether 
the service is at all beneficial than in judging whether beneficial treatment is appropriate 
by comparing benefits with marginal cost. Moreover, the variability of marginal cost noted 
supra notes 76 and 79 reveals that appropriateness may depend on the availability of 
unused equipment and not exclusively on medical circumstances. The resolution of the 
need question is also complicated by partisanship. In utilization review, providers tend to 
be liberal in defining the need for their own services. See generally Havighurst & Blumstein, 
Coping with Quality/Cost Tradeoffs in Medical Care: The Role of PSROs, 70 Nw. U.L. 
Rev. 6 (1975). In CON review, the "haves" tend to minimize need and the "have-nots" 
to exaggerate it. 

One Duke physician has stated that the studies used by the North Carolina CON 
agency greatly underestimated the need for lithotripsy. Personal communication with John 
Weinerth, M.D., Chief of Urolithiasis Service and Associate Professor of Surgery, Duke 
University School of Medicine (Aug. 1986). The North Carolina Work Group Report, 
prepared by physicians and administrators, estimated that approximately 20% of renal 
stone patients would be lithotripsy candidates. See North Carolina Lithotripter Work Group 
Report (June 14, 1985). Weinerth argued, however, that recent unpublished reports from 
lithotripsy centers throughout the United States indicate that 85% of all renal stone patients 
would benefit from lithotripsy. Weinerth explained that certain types of patients that were 
previously thought ineligible for lithotripsy, such as pediatric patients, patients with bilateral 
stones, and patients with staghorn calculi, may be hthotripsy candidates. However, a study 



1986] LITHOTRIPSY 1011 

physicians prescribe in good faith, traditional health insurers expose 
North Carolina consumers to yet another source of unjustified higher 
costs. 

B. Available Defenses 

If unjustified cost increases of the foregoing kinds are to be averted 
in North Carolina, insurers of ESWL must find ways of limiting the 
fees and charges they will pay and of ensuring that only justified services 
are provided. The defensive strategies available include writing insurance 
policies that restrict coverage of the procedure, limit the amount payable 
for it, or deny or limit coverage of the ESWL services of particular 
providers. ^^ Vigorous implementation of these approaches would be incon- 
sistent with the practices of traditional insurers, however, being more like 
the choice-Hmiting methods of HMO's, PPO's, and other alternative 
financing and delivery mechanisms. Because financing plans of the latter 
types enroll only a small fraction of insured North Carolinians,^^ cost 
escalation is highly Hkely unless fundamental changes occur in the coverage 
enjoyed by the great majority of citizens. The small increases in the overall 
cost of traditional health insurance that are attributable to the deregula- 
tion of lithotripters are unlikely in themselves to induce a significant shift 
to alternative health plans. 

Perhaps the easiest cost-containment strategy for controlling over- 
utilization of ESWL is a contractual Hmitation of the plan's obligation 
to pay for the service in the absence of specified medical indications. 
As a practical matter, however, such a contractual condition of coverage 
is difficult to administer. For example, enforcement of a provision 
denying coverage for the shattering of small stones below two miUimeters^^ 



at Shands Hospital of the University of Florida estimated that even fewer renal stone 
patients would be lithotripsy candidates. See Memorandum from Shands Hospital to All 
State Health Planning Agencies (April 17, 1985). Shands Hospital was involved in the 
cHnical testing of the lithotripter and thus was among the first to receive the machine. 
Weinerth explained that the Shands group may have been overly conservative in their 
estimate of the need for lithotripsy because they had no interest in having a large number 
of lithotripsy centers enter the market. 

"For a general discussion of cost-control strategies available to private financing 
programs, see Havighurst & Hackbarth, Private Cost Containment, 300 N. Eng. J. Med. 
1298 (1979). 

""^See infra note 120. 

^^See Drach, Urinary Lithiasis, in Campbell's Urology 1123 (5th ed. 1986) (stating 
most urinary stones less than 5 mm will pass spontaneously and patients with small stones 
may be treated with pain relief and instructions about recovery of stone). See also Preminger, 
The Current Role of Medical Treatment of Nephrolithiasis: The Impact of Improved 
Techniques of Stone Removal, 134 J. Urology 6, 6, 9 (1985) (stating that in a study of 
103 consecutive stone clinic patients, only 2% of the patients on medical therapy required 
an operation for newly formed stones, whereas 58% to 69% required an operation for 
new stones before beginning medical treatment; noting that the cost of management is 
less than $1,000 per year). 



1012 INDIANA LAW REVIEW [Vol. 19:989 

would require either that the plan accept the physician's representation 
of the stone's size or that x-ray evidence be obtained before the procedure. 
Enforcement of an evidentiary requirement by denial of coverage would 
be unreasonable, however, unless the patient or the physician knew of 
it in advance. Not only are patients unlikely to be aware of such 
administrative details, but physicians may also be unaware or may refuse 
to cooperate, insisting that the insurer should accept either their rep- 
resentations of the facts or their clinical judgments concerning patients' 
needs. In a similar situation, Indiana dentists organized a concerted 
refusal to provide x-rays to dental insurers for cost-containment purposes. 
Although that conspiracy was held to be an antitrust violation,^^ individual 
refusals to cooperate with insurers are to be anticipated.^^ Urologists 
might well claim that individual cases differ so that medical necessity 
cannot be determined without a fuller medical inquiry. Consequently, 
given the burdens associated with coverage restrictions and their un- 
popularity with patients and providers alike, it appears improbable that 
the possibility of saving a few dollars on claims for ESWL will alone 
trigger adoption of these strategies by North Carolina insurers. 

North Carolina insurers might bring unit prices and utilization under 
some control by increasing cost sharing by patients, by tightening limits 
on reimbursable fees, or by shifting to fixed-indemnity coverage. Each 
of these approaches would be aimed at reducing the insurer's exposure 
and increasing the consumer's financial stake in each transaction in the 
expectation that he will shop for care with cost considerations more 
prominently in mind. Consumers may not be happy, however, to accept 
these new responsibilities and increased financial burdens. Moreover, 
there is little reason to believe that consumers would be especially effective 
shoppers or that conditions conducive to price competition prevail in 
the market for ESWL. Although a fixed indemnity payment for ESWL 
would seem to be a sensible policy and one that a particular insurer 
could rather easily adopt, strategies of this kind have been freely available 
to all insurers for a long time but have rarely been employed. It is 



«^FTC V. Indiana Fed'n of Dentists, 106 S. Ct. 2009 (1986). 

*^A legal issue would arise if a physician billed for a service he had rendered 
knowingly without complying with the preconditions of the patient's insurance. Although 
precedent is scanty, cf. Eisenberg & Rosoff, Physician Responsibility for the Cost of 
Unnecessary Medical Services, 299 N. Eng. J. Med. 76 (1978), such a negligent failure 
to meet the patient's needs would seem to open the physician to professional liabiUty for 
damages equal to the amount of insurance reimbursement lost. However, even though a 
patient might thus successfully resist a suit to collect the physician's bill, an insurer would 
undoubtedly find it both awkward to deny the patient's claim and difficult to ensure that 
physicians were aware of its requirements and their applicability to particular patients. 
Nevertheless, some insurers have required patients to obtain either second opinions on 
the need for treatment or the insurer's prior authorization of coverage for such elective 
procedures. 



1986] LITHOTRIPSY 1013 

unlikely that the deregulation of ESWL poses enough of a threat of 
cost escalation to prompt significant redesign of coverage along these 
lines. 

The most practical and effective approach to cost containment in 
private health insurance would concentrate not on writing selective cov- 
erage of ESWL or shifting costs from the insurer to its insureds, but 
on excluding certain providers altogether from eligibility to provide 
covered services. This approach, however, would violate the principle 
of free choice of provider that is embedded in the standard coverage 
offered by NCBCBS and strongly favored by health care providers. Such 
exclusion would also violate North Carolina law, which permits insurers 
to cover the services of designated "preferred providers" on more fa- 
vorable terms but prohibits an insurer from excluding providers com- 
pletely from treating insured patients at the insurer's expense. ^^ Thus, 
although the abihty to exclude a high-cost or uncooperative provider 
altogether from plan coverage might allow an insurer to obtain even 
more favorable results. North Carolina insurers wishing to procure ESWL 
services for their insureds on favorable terms must employ the PPO 
mechanism. ^^ 

The potential value to consumers of letting the insurer act as a 
middleman in procuring hospital and physician services is powerfully 
demonstrated by the ESWL situation in North Carolina. If an insurer 
could deliver paying patients to a provider by designating it as either 
the exclusive or a preferred provider of insured services, the insurer 
could bargain for a fair price both from the hospital for use of the 
lithotripter and from the physician presiding over the procedure.'" In 
addition, the insurer could seek providers' cooperation with its efforts 
to control overutilization. Conversely, an insurer, such as NCBCBS, that 
feels constrained to cover care at all centers on equal terms lacks the 
ability to steer patients away from a high-cost provider and therefore 
has no bargaining power. 



«8N.C. Gen Stat. §§ 57-16.1, 58-260.5 -.6 (1985). 

^^On the PPO concept, see generally P. Lindsey, State Laws and Regulations 
Governing Preferred Provider Organizations: Annotated Bibliography on Preferred 
Provider Organizations (1986); E. Rolph, State Laws and Regulations Governing 
Preferred Provider Organizations (1986); E. Rolph, State Laws and Regulations 
Governing Preferred Provider Organizations: Executive Summary (1986). 

'"The practice of fee splitting, see supra text accompanying notes 73-75 suggests 
that price competition is indeed feasible if a payer is willing to influence insured patients 
to select the low-cost provider. NCBCBS claims that it has been able to negotiate with 
providers on the machine use fee. Under the plan's provider contracts, the professional 
fee is reimbursed at a UCR rate, but the facility fee is negotiated, taking into account 
the provider's costs. Personal communication with WilUam DeMaria, M.D., Medical 
Director, NCBCBS (Aug. 1986). See supra note 77. Because NCBCBS does nothing to steer 
its insureds to lower-priced centers, however, its bargaining power is minimal. 



1014 INDIANA LAW REVIEW [Vol. 19:989 

Despite the theoretical potential for obtaining competitive terms from 
providers through hard bargaining, the small number of providers of 
ESWL makes the real-world prospects for effective bargaining proble- 
matic. In any oligopolistic industry, the danger exists that each of the 
few competitors will realize that any aggressive competitive move that 
it might make in search of a short-run advantage would simply cause 
its competitors quickly to follow suit, making all of them worse off in 
the long run. With this perception of their "interdependence," the 
oligopolists are each likely to refrain from competitive moves, producing 
essentially the same result as if they had agreed explicitly not to compete. ^^ 
In addition to creating conditions conducive to tacit collusion, the small 
number of competitors in the market also facilitates explicit agreements 
in restraint of trade. Even if ESWL providers did not actually fix prices, 
they might well agree, tacitly or overtly, to eschew competitive contracting 
with insurers. It is highly probable that an insurer seeking a beneficial 
contract for ESWL services in a market with few sellers would encounter 
substantial resistance to its proposals. 

In keeping with the prediction that a concentrated provider market 
is unlikely to be competitive. North Carolina HMO's reported before 
deregulation that they anticipated no success in obtaining lithotripsy on 
special terms for their patients. Deregulation of lithotripsy may have 
significantly improved the prospects for competitive bidding, however. ^^ 
With deregulation, a payer may now shop not only among the five 
providers originally in the market, but also among providers who were 
previously barred from entry. Indeed, Duke, which already has a lith- 
otripter and has signified a willingness to accept a small professional 
fee, may be a lower-priced source of treatment. Even if Duke turns out 
to be no cheaper overall or inadequately cooperative with insurers' 
utilization-control efforts, the possibility remains that an insurer, acting 



"On oligopolists' interdependence, see generally 6 P. Areeda, Antitrust Law 
1 1428-36 (1986). 

^^The CON program previously hindered the efforts of payers to obtain lithotripsy 
at competitive prices. Dr. Lawrence Oakes, Medical Director for the Kaiser-Permanente 
plan in North Carolina, explained that if there are a number of providers of a medical 
service in a given area. Kaiser can award an exclusive contract to the lowest-cost provider. 
Personal communication with Lawrence Oakes, M.D. (June 1985). This type of bargaining, 
however, is impossible in a monopolistic situation. Dr. Samuel Warburton, Vice President 
of the Health America plan in North Carolina, reported that prior to deregulation, he 
was unable to negotiate a urologist's fee for lithotripsy that was close to what he believed 
to be a competitive price. Personal communication with Samuel Warburton, M.D. (June 
1985). Since deregulation, the plan has obtained a more satisfactory price. Warburton 
explained that, with prices for ESWL as high as $12,000 per procedure. Health America 
has been able to obtain a $4,300 total fee for an uncomplicated renal stone procedure. 
Personal communication with Samuel Warburton, M.D. (Oct. 1986). Warburton said he 
anticipates that he may be able to bargain for a total fee of $2,500 in 1987. Id. 



1986] LITHOTRIPSY 1015 

independently or in concert with others, could stimulate the entry of 
yet another, lower-cost provider by offering it a long-term contract as 
the exclusive or preferred provider of ESWL services to its subscribers. 
Armed with the threat to pursue this newly available strategy, an insurer 
should find existing providers more willing to bargain for its business. 
It is paradoxical but crucial that repeal of CON requirements can generate 
pressure for lower prices even if no new entrant actually materializes.^^ 
Potential competition is frequently more effective than actual competition 
in keeping prices down in concentrated markets. 

Despite the foregoing theoretical possibilities for effective cost con- 
tainment, NCBCBS has so far made no move to change its methods 
of purchasing ESWL,^"^ and other insurers, with a smaller overall stake, 
are even less likely to take specific steps to control the costs of ESWL 
in a deregulated environment. The financing system thus remains, as it 
was before deregulation, an invitation to overinvestment in lithotripters. 
Because North Carolina payers lack the ability or the will to control 
overutilization of ESWL and to buy cheaply in an overstocked market, 
North Carolina consumers face the prospect of a costly defeat in the 
new phase of the lithotripsy game. 

V. Making the Game Competitive 

An informal survey following the 1986 deregulation of ESWL by 
the North Carolina legislature revealed no provider with plans to install 
a Hthotripter in the state other than the seven original aspirants, each 
of which was finally successful in negotiating the regulatory/poUtical 
path to market entry — four by obtaining CON's, one (Piedmont) by 
exploiting a statutory loophole for nonhospital-based equipment, and 
two (Duke and St. Joseph's) by getting legislative assistance. ^^ It is a 
mistake to conclude, however, because deregulation failed to trigger a burst 
of new investment, that market forces are satisfactorily controlling ESWL 
costs in North Carolina. Instead, because seven lithotripters appear 
themselves to be too many to service the state efficiently, it can be 
observed that regulation itself failed to prevent the creation of excess 
capacity. "^^ More generally, it can be suggested that CON regulation, 



"C/". C. Havighurst, supra note 13, at 234-36 (discussing how allowing HMO's to 
build new hospital facilities without a CON stimulates not new hospitals, but greater 
willingness of existing institutions to bargain with HMO's). 

^''Personal communication with WiUiam DeMaria, M.D., Medical Director, NCBCBS 
(Nov. 1986) (stating that NCBCBS was contractually bound in its subscriber contracts to 
pay the UCR reimbursement to providers). 

^^See supra notes 16-36 and accompanying text. 

^^It seems appropriate to count the Duke and St. Joseph's lithotripters as entering 
the market under regulation, not deregulation. See supra notes 25-36 and accompanying 
text. 



1016 INDIANA LAW REVIEW [Vol. 19:989 

almost inevitably politicized, provides unreliable protection for consumer 
interests whenever the financing system creates a lucrative market op- 
portunity for providers. But whatever the final conclusion concerning 
regulation's value, ^^ North Carolina's ESWL experience underscores that 
the fundamental source of the problem of overspending on health care 
is the dominant system of financing services. Under regulation, that 
system created powerful incentives for North Carolina providers to ov- 
erexpand ESWL and gave rise to pressures that were impossible for the 
regulators and the political system to contain or to resist. Following 
deregulation, the financing system's chronic inability to take advantage 
of what should be a buyer's market for ESWL leaves North CaroUna 
providers free to create unneeded, inefficient capacity and to operate it 
profitably at the pubhc's expense. 

Health care financing in North Carolina is typical of that found in 
most other markets for health services. Although there are increasing 
reports of major outbreaks of competitive buying and selling of provider 
services in many places throughout the nation, traditional financing as 
found in North Carolina remains the norm, and truly independent and 
competitive systems remain exceptional.^^ Despite the hopeful signs of 
effective competition in some markets, the ineffectiveness of the dominant 
health insurance mechanisms in controlling the price and cost of all 
health services, not just ESWL, has been notable for so long that one 
must wonder whether the game being played was or is a fair one^^ and 
whether a fundamental change in its rules may be necessary. 

A. Is the Game Rigged?— ''Say It Ain't So, Joe!'* 

The historical failure of conventional health care financing systems 
to defend consumer interests invites attention to the possibility that some 
of the players whom the fans have been supporting against providers 



^^Deregulation might be safer if prepared for in advance. Recent deregulation in 
Arizona and Utah is alleged to have triggered a burst of capital spending. See Arizona 
Deregulation Spurs Growth in Medical Facilities, Am. Med. News, September 19, 1986, 
at 7 (Arizona is experiencing an "unprecedented growth" in health care facilities as a 
result of repeal of CON regulations for hospitals and nursing homes). Although no objective 
evaluations of these experiences (by persons other than the displaced planners and regulators 
themselves) have been done, there may be some reason for concern. For a full statement 
of the case for deregulation and strategies for achieving it, see generally C. Havighurst, 
supra note 13. 

''See infra notes 119-20. 

^A major source of unfairness to consumers has been providers' success in establishing 
the rules of competition in the health care sector. See, e.g., Havighurst, supra note 62 
(discussing restrictions imposed by providers on insurers' freedom to control costs and 
the potential value of antitrust law in eliminating such restrictions). Blue Cross and Blue 
Shield plans are also implicated in providers' efforts to make and enforce the rules of 
the game. See infra text accompanying notes 104-09. 



1986] LITHOTRIPSY 1017 

may not have been playing to win. Unthinkable as this hypothesis may 
seem, the failure of NCBCBS to defend effectively against providers of 
ESWL is not just an isolated collapse attributable to one plan's poor 
management and lack of skilled players. Other teams in Blue uniforms 
have also consistently failed to strive for a consumer victory, appearing 
instead to have joined with providers to rig the outcome. Not only did 
the Blues themselves perform badly in the cost-containment field, but, 
as the following discussion briefly explains, their policies were instru- 
mental in handicapping HMO's and commercial health insurers — other 
teams on which consumers might have placed their bets.^^° 

The reason why many Blue Cross and Blue Shield plans did not 
battle providers successfully for lower costs and prices is, quite simply, 
that favoring consumers over providers was usually not in their corporate 
interest. Even after Blue plans were no longer controlled by the dominant 
hospital and physician organizations that created them, they generally 
adhered to a business policy of respecting and even furthering the 
economic interests of their original sponsors. '°' Indeed, many Blue plans 
appeared to prosper in the ensuing years, not because they offered 
consumers good value in insurance products, but because of the close 
relationships they maintained with organized providers. '^^ Together with 



^°^See generally Havighurst, Explaining the Questionable Cost-Containment Record of 
Commercial Health Insurers, in The Political Economy of Health Care (H.E. Freeh 
ed., to be published). The machinations of providers and Blue Cross and Blue Shield 
plans somewhat excuse the poor cost-containment record of commercial health insurers. 
Although numerous factors affect the supply of and demand for insurers' cost-containment 
services and although the issue is complex, Blue/provider alliances, many of them informal, 
explain why consumer cost concerns have not been effectively transmitted to providers in 
the marketplace. Id. For a recent and more positive (and conventional) view of the Blues, 
see Greenberg, The Evaluation of Blue Cross in a Competitive Marketplace, Business & 
Health, Nov. 1986, at 44. 

'°' Although the FTC's efforts largely ended direct physician control over Blue Shield 
plans, see Bureau of Competition, supra note 60; FTC, Statement of Enforcement Policy, 
46 Fed. Reg. 48,982 (1981), that control was already attenuated by the time the FTC 
acted. Blue Cross plans had gradually withdrawn from direct affiliation with state hospital 
associations somewhat earlier. It is most unlikely that providers would have released the 
Blue plans from their direct control without more compulsion if they had not anticipated 
that once independent, the plans, as nonprofit corporations, would continue to pursue 
pro-provider policies in their own self-interest. See infra note 102. 

'"^Because the Blues, as nonprofit corporations, were more interested in maximizing 
their gross revenues and market shares than in maximizing short-run corporate profits, 
there was a solid basis for an enduring and mutually advantageous relationship with 
providers. Nonprofit firms have somewhat different incentives than for-profit firms. Man- 
agers are more interested in increasing their market shares than increasing profits because 
the manager's salary and prestige is more closely associated with firm size than with 
profitability. Freeh & Ginsburg, Competition Among Health Insurers, in Competition in 
The Health Care Sector: Past, Present and Future 175 (W. Greenberg ed. 1974). 
In non-profit firms, such as Blue Cross and Blue Shield, the desire for growth is even 
stronger because there are no profits to distribute or shareholders to object. Id. at 175, 
184. 



1018 INDIANA LAW REVIEW [Vol. 19:989 

government-conferred tax and other benefits, ^^^ these relationships gave 
the Blues a substantial competitive advantage over actual and potential 
competitors. 

The pattern of Blue/provider relationships over many years and in 
many markets was one in which the Blue plan and the dominant or- 
ganization of hospitals or physicians each used its own market position 
in such a way as to preserve and strengthen the market position of the 
other. Mutual accommodation was assured through liaison and committee 
structures. Most importantly, the most successful Blue Cross plans gen- 
erally enjoyed large discounts from the hospitals, ^°^ and Blue Shield 
plans almost universally received comparable concessions from "partic- 
ipating" physicians. '°^ Because these concessions were granted by prov- 
iders acting in concert rather than extracted by the Blues in competitive 
bidding, ^^^ they left providers in a position to function as a cartel vis- 



'°^For tax purposes, the IRS long exempted Blue Cross and Blue Shield plans as 
social welfare organizations. See I.R.C. § 501(c)(4) (1982). In the Tax Reform Act of 
1986, however. Congress eliminated the tax exemption granted to Blue Cross and Blue 
Shield plans. See H.R. 3838, 99th Cong., 1st Sess. §1012 (1985). Commercial health 
insurers and other proponents of this reform contended that special tax treatment of Blue 
Cross and Blue Shield plans is inappropriate because the plans employ business practices 
of commercial insurers and are engaged in an inherently commercial activity. General 
Accounting Office, Health Insurance: Comparing Blue Cross and Blue Shield Plans 
w^iTH Commercial Insurers 8-10 (1986). The Blue Cross and Blue Shield Association 
contended that the exemption is warranted because the exemption permits Blue Cross and 
Blue Shield plans to cross-subsidize coverage to high-risk individuals and small groups. 
Id. at 9. 

State law also often confers valuable advantages on Blue plans in the form of 
exemptions from premium taxes and special privileges with regard to direct contracting 
with providers. 

'""Adamache & Sloan, Competition Between Non-Prof it and For-Profit Health In- 
surers, 2 J. Health Economics 225, 227-29, 240-41 (1983). The mean relative Blue Cross 
discount is four percent and ranges as high as 27 percent. Id. at 229. Large discounts 
frequently correspond to large market shares. 

A commercial insurer unsuccessfully challenged a typical Blue Cross discount in 
Travelers Ins. Co. v. Blue Cross, 481 F.2d 80 (3d Cir. 1973). For an analysis of this 
case pointing out its relevance to this discussion, see Havighurst, supra note 100. 

'°The concessions usually take the form of acceptance of payments under the UCR 
formula as payment in full. See supra note 45. See generally Bureau of Competition, 
supra note 60 (describing Blue Shield payment arrangements and characterizing them as 
price fixing when the plan is under physician control). For a case in which physician 
organizations offered similar collective concessions to any payer that obtained the orga- 
nizations' approval (presumably by refraining from unfriendly acts), see Arizona v. Mar- 
icopa County Medical Soc'y, 457 U.S. 332, 356-57 (1982) (doctors' agreement on maximum 
fees held unlawful price fixing under the antitrust laws). 

'°*See, e.g.. Travelers Ins. Co. v. Blue Cross, 481 F.2d 80, 84 (3d Cir. 1973) (discounts 
"negotiated jointly" by hospital association). Restrictions placed by physician organizations 
on individual physicians directly contracting with unapproved insurers were condemned in 
American Medical Ass'n v. FTC, 638 F.2d 443 (2d Cir. 1980), affd by equally divided 
Court, 455 U.S. 676 (1982); see also Havighurst, supra note 62, at 336-42. 



1986] LITHOTRIPSY 1019 

a- vis the Blues' competitors. Although most Blue plans could have 
obtained larger price concessions by using their buying power to destroy 
the provider cartel, doing business with it usually proved more advan- 
tageous, yielding the Blues a net cost advantage over their competitors 
that was both larger and more permanent than they could have enjoyed 
under competition; as long as the cartel was effective, HMO's and 
commercial insurers could get no concessions from providers at all.^°^ 
Consumers were thus unable to obtain coverage from plans that purchased 
provider services on truly competitive terms. ^°^ The Blues' greatest com- 
mercial successes were therefore gained, not by efficient operation in a 
competitive market, but by cultivating provider cartels that inflated the 
costs of their competitors.'^^ 

Organized providers, for their part, were generally glad to cooperate 
with and even to subsidize their biggest customer as long as it adhered 
to cartel-protective policies and provided insurance coverage in forms 
that obviated provider price competition' '° and kept demand for hospital 
and physician services artificially high.''' Although providers complained 



'"^Until very recently, non-Blue payers were unable to bargain with providers for 
price discounts or concessions of any kind. For a full discussion of provider-imposed 
restraints, including boycotts of plans that offended providers, see Havighurst, supra note 
62, at 336-42. Many commentators are noting the changing character of today's health 
care market. See, e.g.. Managed Care: Will It Push Providers Against the Wall?, Hospitals, 
Oct. 5, 1986, at 66. The new pressures on providers to grant competitive discounts and 
to accept undesired cost controls result from a combination of circumstances, including 
antitrust enforcement against provider cartel behavior; state PPO legislation and PPO 
development; the increased cost-consciousness and aggressiveness of larger purchasers; 
increased competitiveness on the supply side of the market because of surpluses of both 
physicians and hospital facilities; government's example as a prudent purchaser of services; 
and realization in the private sector that government is not likely, as it threatened to do 
throughout the 1970's, to regulate private health care costs. Despite widespread observations 
of intensified competition, however, competition's potential has not yet been reahzed in 
every market, and indeed has probably not been fully realized anywhere. 

'°^The perception that consumers freely chose Blue-style coverage, with free choice 
of provider, etc., in preference to other kinds of coverage is mistaken because alternative 
types of coverage were seldom offered with price tags reflecting the full cost advantage 
obtainable though limitations on choice and competitive purchasing. See infra note 111. 

'"Tor recent scholarship focusing specifically on exclusion of rivals by raising their 
costs, see Krattenmaker & Salop, Anticompetitive Exclusion: Raising Rivals' Costs to Achieve 
Power over Price, 96 Yale L.J. 209 (1986). 

""Hospital cost reimbursement, payment of physicians under UCR and similar for- 
mulas, limited use of cost sharing, and guaranteed free choice of providers make consumers 
largely indifferent to price considerations, thus freeing providers to compete in other, cost- 
increasing ways. 

'"The Blues have systematically offered broader coverage than other insurers. This 
coverage benefits providers by giving broad scope to "moral hazard" — that is, insurance- 
induced demand and insensitivity to price. It has been hypothesized that the Blues squander 
much of their cost advantage over other carriers by writing coverage in forms most 
advantageous to providers. Freeh & Ginsburg, Competition Among Health Insurers, in 



1020 INDIANA LAW REVIEW [Vol. 19:989 

from time to time about a Blue plan's practices, such complaints were 
usually not inconsistent with the existence of powerful Blue/provider 
alhances.^^^ Even when a major confrontation occurred between a dom- 
inant provider organization and a Blue plan, the triggering event was 
usually a minor matter, hardly a sign that the plan had gone over entirely 
to the consumer's side.^^^ Indeed, the Blue plan's disputed policy was 
usually inspired, not by the plan's own corporate initiative, but by the 
irresistible demand of a state insurance commissioner""* or major cus- 
tomer."^ For many years, virtually all cost-containment initiatives by 
Blue Cross and Blue Shield plans that were not exogenously compelled 
were carefully negotiated with the affected provider interests before being 
announced as a Blue victory on the consumer's behalf. 

The action of NCBCBS in tying its own hands in the fight to get 
ESWL services for North Carolina consumers at competitive prices was 
therefore not atypical. Most Blue Cross or Blue Shield plans have similarly 
maintained payment systems that weaken consumers' incentive to econ- 
omize while simultaneously eschewing the role of an aggressive purchasing 
agent procuring providers' services for consumers at competitive prices. 



Competition in the Health Care Sector: Past, Present, and Future 210, 216-19 
(1978). This insurance is overbroad (inefficient) in the sense that few consumers would 
buy it if its added costs, instead of being subsidized by providers, were reflected in its 
price relative to alternative coverage. The result of inefficient insurance is an overallocation 
of societal resources to health care. 

"^One should not attach undue significance to complaints about NCBCBS practices 
that emanate from provider camps; within any conspiracy in restraint of trade, there are 
always differences of opinion, sometimes serious ones, over the best collective strategy. 
Thus, complaints and even lawsuits challenging plan practices by individual providers are 
to be expected even if the Blue plan is faithfully serving cartel interests. Conceivably, 
even such striking cases as Kartell v. Blue Shield, 749 F.2d 922 (1st Cir. 1984) (unsuccessful 
challenge to a plan's alleged monopsonistic exploitation of physicians), cert, denied, 105 
S. Ct. 2040 (1985), and Ball Memorial Hosp. v. Mutual Hosp. Ins., Inc., 784 F.2d 1325 
(7th Cir. 1986) (unsuccessful challenge to a Blue Cross-sponsored PPO as an exercise of 
monopsony power against hospitals), may involve only a difference of opinion concerning 
the best strategy for pricing provider services under emerging market conditions rather 
than the Blue plan's permanent defection from the old alliance. But see sources cited in 
note 117 infra. 

"'In In re Michigan State Medical Soc'y, 101 F.T.C. 191 (1983), a state medical 
society threatened a Blue plan with a statewide physician boycott because the plan attempted 
to control the cost of vision and hearing care. The medical society's vigorous and seemingly 
disproportionate reaction was prompted, not by the particular initiative itself, but by the 
Blue plan's unprecedented departure from the principle of free choice of physician. Id. 
at 216-21. 

"^In Kartell v. Blue Shield, 749 F.2d 922 (1st Cir. 1984), cert, denied, 105 S. Ct. 
2040 (1985), the plan's refusal to allow balance bilhng was in part a function of state 
legislation and regulation. 

"^In Michigan State Medical Society, the initiative of Michigan Blue Cross and Blue 
Shield that was so offensive to physicians was dictated by the auto companies and the 
United Auto Workers. 101 F.T.C. at 216-21. 



1986] LITHOTRIPSY 1021 

Although there have recently been some impressive departures by Blue 
plans from such pro-provider practices, ^^^ these defections have almost 
always occurred only because other prepayment mechanisms, primarily 
HMO's and PPO's, had already breached the defenses of the hospital 
and doctor cartels in the particular market. Facing price competition 
from efficient purchasers for the first time, the Blues had little choice 
but to abandon their old strategy and turn on their old allies. '^^ Despite 
these notable breakdowns of Blue/provider collaboration, it is far from 
clear that competition is yet so intense and uninhibited in many health 
care markets that Blue/provider alliances are no longer effective or worth 
worrying about. Although the coming of competition has generated a 
great deal of discussion and consternation, its effects are still hard to 
detect in anything but anecdotes.''^ Most Blue Cross and Blue Shield 
plans have not yet definitively changed sides in the contest between 
consumers and providers. 

There are few signs that competition has yet made enough headway 
in North Carolina markets to force NCBCBS to enter the fray on the 
consumer's side. Most NCBCBS contracts still embody free choice of 
provider, cost reimbursement for hospitals, UCR fee limits for physician 
services, and limited cost sharing, indicating that the plan has yet to 
break significantly with its tradition of catering to providers' essential 
interests. Although NCBCBS has introduced such innovations as HMO 
and PPO arrangements of its own,''^ these mechanisms do not yet face 
enough competition from independent health plans to induce them to 
bargain with providers as adversaries rather than as allies. '^^ Indeed, 

"^See, e.g., Greenberg, supra note 100. 

"'5ee supra note 111; infra note 126. The precise inspiration for the Blue initiatives 
challenged in Kartell, 749 F.2d 922, and Ball Memorial, 784 F.2d 1325, is difficult to 
determine, but it is probable that these were competition-inspired departures from the 
Blues' historic policy of cooperating with provider interests. But see supra notes 112 & 
114. If so, they should be regarded as exceptions that prove the rule. Why, for example, 
did such cases not appear much earlier? 

"^See supra note 107. 

'"Blue Cross's Personal Care Plan of North Carolina, Inc. (PCP) is an HMO of 
the individual practice association variety. In addition, Blue Cross has transferred some 
standard HMO contracts to PCP. As of April 1986, PCP had 21,000 enrollees, and it 
subsequently added 73,784 state employees. N.C. Dep't of Insurance, Health Main- 
tenance Organizations: Status in North Carolina (April 1986 & Supp. July 3, 1986). 
Although NCBCBS officials claim that such recent innovations as a preadmission certification 
program, PPO and HMO arrangements, the participating physician program, and a program 
to encourage ambulatory surgery are evidence of their willingness to challenge providers, 
the text gives reasons for disputing this claim. 

'^"Enrollment in active alternative health plans in North Carolina totalled 134,791 in 
April 1986, with 78,913 state employees added subsequently, for a total of 213,704. Id. 
Of these subscribers. Blue Cross's PCP enrolled 94,784. Several of the remaining plans 
were sponsored by dominant physician interests. Thus, the only truly independent plans 
able and philosophically willing to purchase physician services on a competitive basis were 
Health America, Kaiser, and PruCare, which enrolled 43,116, 23,366, and 11,877 sub- 
scribers, respectively (out of a state population of 5.9 million). Id. 



1022 INDIANA LAW REVIEW [Vol. 19:989 

these mechanisms may serve primarily as '* fighting ships," weapons that 
allow NCBCBS and their provider alHes to repel or discipline independent 
plans that seek to enter the market and to force providers into unwanted 
competition.*^' If so, the alliance's newly forged strategic capacity to 
slash prices to meet a competitive threat is more an impediment to than 
a manifestation of the emergence of effective competition in the state. 
Certainly NCBCBS' s inability to control the price and cost of lithotripsy 
in North Carolina suggests that the old alliance is still very much intact. 

B. Revising the Rules— "On Your Mark, Get Set, Go!*' 

If ESWL costs in North Carohna should rise in the aftermath of 
the repeal of CON requirements for lithotripters, the natural impulse 
will be to blame the legislature for deregulating this new technology. 
Nevertheless, because the true source of the problem lies in antiquated, 
pro-provider payment mechanisms, it can be argued that the legislature's 
greater failure was in deciding to deregulate only lithotripsy. Because 
payments for lithotripsy are only a very small percentage of insurers' 
overall payments for health care services, the threat of higher costs for 
this one service is unlikely to trigger the fundamental changes in financing 
arrangements that are needed if costs are to be brought under effective 
control by market forces. Across-the-board deregulation, however, would 
be such a dramatic change in the rules that all players on the demand 
side of the market, particularly NCBCBS and its customers, would have 
little choice but to reexamine their game plans. The sudden need of 
consumers and major purchasers of health insurance to find better allies 
in the cost-containment effort would bring about a competitive rush to 
find new defenses against provider overcharging, overspending, and ov- 
erinvestment. 

The main policy reason why most states are continuing CON reg- 
ulation today, after the theoretical argument for it has been largely 
disproved, '^^ is their belief that their local health care markets are not 



'^'A prepayment plan controlled by dominant provider interests presents the same 
hazard to competition that is presented by an informal Blue/provider alUance. On the 
antitrust and policy implications of prepayment plans controlled by dominant provider 
organizations, see FTC, supra note 101; Havighurst & Hackbarth, Enforcing the Rules 
of Free Enterprise in an Imperfect Market: The Case of Individual Practice Associations, 
in A New Approach to the Economics of Health Care 377 (M. Olson ed. 198 ). For 
evidence of how a financing plan and a provider cartel, operating together, can exclude 
or discipline other payers, see Goldberg & Greenberg, The Effect of Physician-Controlled 
Health Insurance: United States v. Oregon State Medical Society, 2 J. Health Pol. Pol'y 
& L. 48 (1977). Because the same problems could also arise where the Blue/provider 
alliance was of the informal variety, Blue Cross's PCP may be more anticompetitive than 
procompetitive. 

'^^The theory of CON regulation was that payment systems inevitably and inefficiently 
distort spending. See references cited supra note 12. Changes in purchasing practices can 



1986] LITHOTRIPSY 1023 

yet sufficiently competitive to entrust them with the task of allocating 
resources and discouraging overinvestment. ^^^ Many states, however, are 
moving toward deregulation in small increments by raising the capital 
investment thresholds of CON requirements and exempting additional 
categories of providers and investments. ^^"^ Although these steps may 
seem desirable in the general sense that they get government off providers' 
backs, deregulation is more likely to represent a pro-consumer change 
in the rules of the game if it is done on a wholesale rather than a 
piecemeal basis. '^^ Only then would the legislature's move constitute a 
clear message to players who purchase and players who sell obsolete 
forms of health insurance that they can expect to be losers in future 
competition unless they change their strategies in fundamental ways. 
Only if that message is sent, received, and acted upon will consumers 
be in a position to hold their own in struggles over the uses of medical 
technology, old and new. A totally deregulated market is most likely 
to generate the radical rethinking and restructuring that is needed to 
force NCBCBS and other Blue Cross and Blue Shield plans finally to 
break with their provider allies and to use their bargaining power on 
the consumer's behalf. '^^ 

Because introducing meaningful change in health care financing mech- 
anisms seems to be a slow and difficult process requiring the reeducation 
of many players and the devising of intricate new strategies, the best 
policy option available to North Carolina and other states is probably 
to announce the expiration of their CON laws as of some fixed future 



offset many of these distortions, however, and those that remain should be regarded as 
a cost of having insurance, not as inefficiency. See supra text accompanying notes 83- 
94; P. JosKOW, supra note 12, at 21-31. 

'^^An alternative justification for CON regulation of hospitals and their competitors 
is the alleged necessity to preserve cross-subsidization of indigent care, education, and 
research. Curbing competition enables hospitals to overcharge some patients and thereby 
to generate revenues to fund these worthy purposes. For arguments against using regulation 
for this purpose, see e.g., Havighurst, The Debate Over Health Care Cost-Containment 
Regulation: The Issues and the Interests, in Incentives Versus Controls in Health Policy 
9 (J. Meyer ed. 1985). The case for controlling nursing home investments is unique to 
that industry, because of its heavy involvement with the Medicaid program, and is not 
considered here. See C. Havighurst, supra note 13, at 353-63. 

^^See Simpson, supra note 37. 

^^^See discussion of a "market-forcing" regulatory strategy in C. Havighurst, supra 
note 13, at 321-44. 

i26Xhere is a degree of irony in unleashing the market power of the Blue plans, which 
were created to serve providers and which served their interests so well for so long, against 
their original sponsors. See Ball Memorial, 784 F.2d 1325; Kartell, 749 F.2d 922, discussed 
supra notes 112 and 117. But there is a potential paradox as well. Where a Blue plan 
possesses market power, it might be vulnerable to attack under section 2 of the Sherman 
Act because of exclusionary practices of the type noted supra text accompanying notes 
100-09. But to raise such a challenge, providers would have to claim that a Blue plan 
unlawfully monopoUzed the market by fostering the providers' own cartel. 



1024 INDIANA LAW REVIEW [Vol. 19:989 

date. The setting of such a sunset date should be done in a way that 
clearly warns purchasers and providers of health insurance of the need 
to find alternative means of cost containment, while providing them 
time to change their allegiances and to consider and install the defenses 
they prefer. '^^ Such a legislative move, if accompanied by efforts to free 
the local market of legal and other restrictions on innovation, would 
materially improve the chances for a consumer victory not only in the 
lithotripsy game but also in the larger battle against wasteful health care 
spending. 



'^^The object would be to avoid problems similar to those allegedly encountered in 
Arizona and Utah when CON was repealed. See supra note 97. In particular, the federal 
government itself needs more time to change its current approach to reimbursing capital 
costs, which still invites excessive investment. See supra note 78. 






Full Circle: The Return of Certificate of Need Regulation 
of Health Facilities to State Control* 



James B. Simpson** 

''Each certificate of need proceeding is an exercise in the inherently 
inexact science of determining how society's scarce health care resources 
might best be allocated.''^ 

I. Introduction 

Certificate of need (CON) programs are federally-funded, state-ad- 
ministered regulatory mechanisms providing for review and approval by 
health planning agencies of capital expenditures and service capacity 
expansion by hospitals and other health care facilities. Their primary 
purpose is to discourage unnecessary investment in health care facilities 
and to channel investment into socially desirable uses. At the beginning 
of 1986, forty-two states and the District of Columbia had statutes 
authorizing such programs, and four of the eight states without certificate 
of need statutes operated similar programs authorized under the Social 
Security Act.^ A majority of states have administered such programs 
for over a decade. 

State certificate of need programs generally operate in the following 
manner. A health care facility covered by the program must submit a 
permit application to an official state health planning agency before 
undertaking those capital expenditures and other projects subject to 
review. The average proposed expenditure is $1.7 million, and states 
review an average of 127 applications each year.^ The state agency 
transfers the application for initial review to a local health planning 
organization, comprised of consumers and medical care providers in the 



*This article has been funded by the Health Resources Administration, Department 
of Health and Human Services, under contract HRA 232-79-0037. The contents of the 
article do not necessarily reflect the view or policies of the Department of Health and 
Human Services, nor does mention of trade names, commercial products, or organizations 
imply endorsement by the U.S. Government. 

**Director, Legal Resources Program, Western Consortium for Public Health, San 
Francisco, Cal. B.A., Lawrence University, 1972; M.P.H., University of California, Los 
Angeles, 1974; J.D., University of California, Berkeley (Boalt Hall), 1978. 

'Kansas Dep't of Health & Env't v. Banks, 230 Kan. 169, 170-71, 630 P.2d 1131, 
1133 (1981). 

'State laws relating to health planning and certificate of need are frequently amended. 
Except as otherwise indicated, the information on state certificate of need programs 
presented in this article is current as of January 1, 1986. 

^Office of Health Planning, U.S. Dep't of Health «& Human Services, Status 
Report on State Certificate of Need Programs 9-10 (1985). 

1025 



1026 INDIANA LAW REVIEW [Vol. 19:1025 

community to be served by the proposed project. Review criteria include 
consideration of community need, financial feasibility, expected quality 
of care, less costly alternatives, and accessibility of the project to un- 
derserved and indigent populations. The local organization conducts a 
public meeting at which interested persons may comment on the proposal. 
It then conveys its recommendation to approve or deny the project to 
the state health planning agency. The state agency conducts an admin- 
istrative adjudicatory hearing on the application and renders a formal 
decision as to the need for the project. Administrative and judicial 
appeals may follow, and often do when multiple applicants compete to 
serve an identified community need. The ultimately successful applicant 
is awarded a "certificate of need" entitling it to proceed with its project. 

A. Federal Involvement 

Over the years, federal control over state health planning and cer- 
tificates of need has waxed and waned. In the late 1960's, the federal 
government financed voluntary, non-regulatory health service planning 
programs at the local community and state levels. In 1972, Congress 
adopted section 1122 of the Social Security Act, providing for review, 
by states choosing to participate, of proposed capital expenditures by 
health care facilities reimbursed under Medicare and Medicaid. "• Most 
states have participated in section 1122 at some time.^ In 1975, Congress 
passed the National Health Planning and Resources Development Act 
of 1974' (NHPRDA or Act). The Act provided substantial funding for 
state and local health planning activities and effectively required states 
to adopt certificate of need laws conforming to federal standards. 

After the passage of NHPRDA, states without certificate of need 
began to adopt statutes complying with the Act. States with pre-existing 
statutes took steps to comply with the federal requirements, which 
mandated a certificate of need program of extremely broad regulatory 
scope, subjecting a wide range of health care facilities and projects to 
a complex review and approval process. In a few years most states had 
programs resembling the federal model. ^ 

With the advent of the Reagan administration in 1980, federal support 
for certificate of need fell on hard times. The administration entered 
office with an anti-regulatory platform and a strong interest in using 



"Social Security Amendments of 1972, § 221(a), 86 Stat. 1386 (codified as amended 
at 42 U.S.C. § 1320a-l (1982 & Supp. I 1983)). 

^See infra note 73 and accompanying text. 

*Pub. L. No. 93-641, 88 Stat. 2225 (1975) (codified as amended at 42 U.S.C. 
§§ 300k-300n-6 (1982)). 

^See Cohodes, The State Experience with Capital Management and Capital Ex- 
penditure Review Programs, in Bureau of Health Facilities, U.S. Dep't of Health & 
Human Services, Health Capital Issues 87-88 (DHHS Pub. No. (HRA) 81-14531 (1980)). 



1986] CERTIFICATE OF NEED 1027 

market incentives rather than regulatory controls to restrain the rising 
costs of health programs. It proposed to delete funding under NHPRDA, 
and although Congress did not fully concur, funding for health planning 
dropped sharply.* At the same time, however, the prescriptive terms 
under which the federal government awarded monies to states for cer- 
tificate of need programs were greatly relaxed.^ 

Consequently, state certificate of need programs have begun to 
diverge from the federal model and from each other. Some states have 
entirely repealed their certificate of need laws.'^ Others have increased 
the scope and forcefulness of their regulatory controls." The vast majority 
of states have modified their programs in recent years by streamlining 
the review process and narrowing the range of health care facilities and 
projects subject to review. In doing so, they appear to have shifted the 
goals of their certificate of need programs from systematic management 
of all institutional health care delivery to several more narrowly conceived 
purposes. 

This Article describes changes in state certificate of need programs 
from their origins to the present. It concentrates on the types of health 
care facilities and categories of projects that have been subject to cer- 
tificate of need review, because scope of coverage is the aspect of 
certificate of need that has changed the most over the years in response 
to changing state and federal regulatory policies. 

A number of recent studies have considered procedural aspects of 
state certificate of need programs.'' Several have attempted to evaluate 
the impact of such programs on health care expenditures.'-* Evaluations 

'In fiscal year 1982, annual NHPRDA funding was reduced by one half to $64.4 
million. H.R. Rep. No. 218, 98th Cong., 1st Sess. 10 (1983). It has remained at that 
level ever since. 

^See infra note 166 and accompanying text. 

^°See infra Table 1 and text accompanying note 192. 

"See infra Table 2; noets 194-245 and accompanying text. 

'^Brown, Common Sense Meets Implementation: Certificate of Need Regulation in 
the States, 8 J. Health Pol. Pol'y & L. 480 (1983); Cohodes, supra note 7, at 68; 
Consedine, Jekel, & Dunaye, Certificate of Need and the Pitfalls of Due Process, 17 
Inquiry 348 (1980); Nutt & Hurley, Factors That Influence Capital Expenditure Review 
Decisions, 18 Inquiry 151 (19S\), see. e.g., Colby & Begley, The Effects of Implementation 
Problems on Certificate of Need Decisions in Illinois, 3 Health Pol'y Educ. 303 (1983). 

'■E.g., Ash by. The Impact of Hospital Regulatory Programs on Per Capita Costs, 
Utilization, and Capital Investment, 21 Inquiry 45 (1984); Howell, Evaluating the Impact 
of Certificate of Need Regulation Using Measures of Ultimate Outcome: Some Cautions 
from Experience in Massachusetts, 19 Health Services Reg. 587 (1984); Joskow, The 
Effects of Competition and Regulation on Hospital Bed Supply and the Reservation Quality 
of the Hospital, 11 Bell J. Econ. 421 (1980); Sloan, Rate Regulation as a Strategy for 
Hospital Cost Control: Evidence for the Last Decade, 61 Milbank Mem. Fund Q. 195 
(1983); Sloan & Steinwald, Effects of Regulation on Hospital Costs and Input Use, 23 
J. Law & EcoN. 81 (1980). A survey and critique of other, unpublished studies may be 
found in Congressional Budget Office, Health Planning: Issues for Reauthorization 
19-30, 57-64 (1982). 



1028 INDIANA LAW REVIEW [Vol. 19:1025 

of the regulatory "toughness" of state certificate of need programs and 
variations in performance have also been undertaken."* However, there 
have been no recent reports examining in detail project coverage under 
certificate of need programs.'^ 

II. Purposes of Certificate of Need 

States undertake certificate of need programs to achieve various 
goals, which may differ from state to state and from one type of covered 
project to another. The major premise underlying certificate of need is 
that the market for institutional health services contains incentives to 
excess capital investment for which certificate of need programs are 
intended to compensate by limiting entry to facilities and services found 
to be medically necessary and affordable.'^ Every state certificate of need 



^*E.g., Policy Analysis, Inc. and Urban Systems Research & Engineering, Inc., 
Evaluation of the Effects of Certificate of Need Programs - A Report on Twelve 
State C/N Programs (1981) (Report prepared for Health Resources Administration, U.S. 
Dep't of Health & Human Services under Contract No. 231-77-0114); Begley, Schoeman 
& Traxler, Factors That May Explain Interstate Differences in Certificate-of-Need Decisions, 
1982 Health Care Fin. Rev. 87. 

'■Surveys comparing certificate of need expenditure thresholds are distributed from 
time to time. E.g., Division of Regulatory Activities, Office of Health Planning, 
U.S. Dep't of Health & Human Services, Status Report on State Certificate of 
Need Programs (1985), distributed in Office of Health Planning, U.S. Dep't of Health 
& Human Services, Program Information Letter 85-34 (1985) (expenditure thresholds 
as of July, 1984); Congressional Budget Office, Health Planning: Issues for Reau- 
thorization (1982) (expenditure thresholds as of March, 1982). However, published reports 
identifying health care facilities and types of projects subject to certificate of need review 
date back several years. See Chayet & Sonnenreich, P.C, Certificate of Need: An 
Expanding Regulatory Concept 5 (1978) (survey of certificate of need and section 1122 
coverage through approximately January, 1978); Cohodes, supra note 7 (survey of certificate 
of need coverage as of October, 1978); Curran, A National Survey and Analysis of State 
Certificate-of-Need Laws for Health Facilities, in Regulating Health Facilities Con- 
struction 88-89 (1974) (CON coverage as of the end of 1972 state legislative sessions); 
Havighurst, Regulation of Health Facilities and Services by "Certificate of Need, " 59 
Va. L. Rev. 1143 (1973) (CON coverage as of 1973). 

""Proponents of certificate of need programs cite several reasons for market failure 
in institutional health care. See, e.g., 42 U.S.C. § 300k-2 (1982) (market failure rationale 
for implementation of NHPRDA certificate of need function). First, such care is covered 
by private insurance or governmental benefit programs for most consumers, making them 
indifferent to the choice between treatments of differing costs and equal benefit, and in 
favor of all treatments with any marginal benefit, regardless of cost. Second, federal and 
state tax subsidies encourage individual consumers and employees, when bargaining col- 
lectively, to purchase more health insurance than they otherwise would, exacerbating the 
"moral hazard" of insurance coverage. Third, the prevailing methods by which insurers 
and government benefit programs pay for institutional health services discourage attention 
to costs and price competition by providers. Fourth, medical care delivery is organized 
in a manner that tends to allocate and expend resources without regard to cost. Hospitals, 
in particular, are organized so that a physician, acting as an insured patient's agent and 



1986] CERTIFICATE OF NEED 1029 

program implicitly incorporates this idea by providing for issuance of 
certificates on the basis of community '*need." Some also contain express 
findings of market failure or of excess capacity in the health sector.'^ 
The second major rationale for certificate of need is to protect public 
health by preserving and improving the quality of institutional health 
care. Many state certificate of need statutes include the preservation of 
quality of care as an express justification for their adoption.'*^ In addition, 
quality of care considerations appear in many states' certificate of need 
review criteria as factors to be taken into account in approving or 
denying applications. For example, eight state certificate of need statutes 
expressly identify quality of care in existing facilities (either those of 
the applicant or other health care providers) as a review criterion.'*^ Six 
certificate of need statutes explicitly require consideration of the expected 



lacking an independent incentive to limit volume or costliness of care, decides what services 
the patient receives. Fifth, there has traditionally been little competition among health 
insurance companies of the sort that would lead them to bargain with institutional health 
care providers over price and volume controls. 

The foregoing characteristics cause institutional health care to exhibit excess demand 
for and consumption of medical technologies, high rates of introduction of new technologies 
and low rates of introduction of cost-reducing innovations, duplication of facilities and ser- 
vices with consequent unused capacity and failure to exploit economies of scale, and general 
organizational slack and inefficiency. Certificate of need programs are intended to prevent 
facility duplication and excessive rates of introduction of new technologies and services. 
They are not targeted at the underlying causes of market failure, nor are they designed 
to affect directly the demand for existing services or to improve efficiency and reduce operating 
costs in health care facilities. See generally P. Joskow, Controlling Hospital Costs: The 
Role of Government Regulation 56-88 (1981). 

''E.g., Colo. Rev. Stat. § 25-3-502 (1982); Fla. Stat. Ann. § 381.493(2) (Supp. 
1985); III. Ann. Stat. ch. 111-1/2 1 1152 (Smith-Hurd Supp. 1985); Ky. Rev. Stat. 
§ 216B.010 (Supp. 1982); Neb. Rev. Stat. § 71-5802 (Supp. 1984); N.H. Rev. Stat. Ann. 
§ 151-c:l (Supp. 1983); N.C. Gen. Stat. § 131E-175 (Supp. 1983); Or. Rev. Stat. 
§ 442.025(2) (Supp. 1983); Pa. Cons. Stat. Ann. § 448.102 (Purdon Supp. 1985); S.D. 
Codified Laws Ann. § 34-7A-22 (Supp. 1985); Vt. Stat. Ann. tit. 18, § 2400 (1983); 
Wash. Rev. Code Ann. § 70-38-015 (Supp. 1986); W. Va. Code §§ 16-2D-5(c), (d) (1985). 

''See, e.g., Colo. Rev. Stat. § 25-3-502(4)(a) (1982); 1977 Hawaii Sess. Laws Ch. 
178, § 1 (1977); Ky. Rev. Stat. § 216B.010 (Supp. 1982); Md. Health-General Code 
Ann. § 19-102(a) (Supp. 1985); Neb. Rev. Stat. § 71-5802 (Supp. 1984); N.H. Rev. 
Stat. Ann. § 151-c:l (Supp. 1983); N.J. Stat. Ann. § 26:2H-1 (West Supp. 1985); N.Y. 
Pub. Health Law § 2800 (McKinney 1985); N.C. Gen. Stat. § 131E-175 (Supp. 1983); 
Or. Rev. Stat. § 442.025(1) (Supp. 1983); 35 Pa. Cons. Stat. Ann. § 448.102 (Purdon 
Supp. 1985); Vt. Stat. Ann. tit. 18, § 2400 (1983). 

"Alaska Stat. § 18.07.041 (Supp. 1984); B.C. Code Ann. § 32-304(a) (1981) 
(incorporating by reference 42 C.F.R. § 123.412(a)(18) (1985)); Fla. Stat. Ann. 
§ 381.494(6)(c)(2) (Supp. 1985); Mont. Code Ann. § 50-5-304(d) (1985), § 50-5-304(h) (1985) 
(incorporating by reference 42 C.F.R. § 123.412(a)(18) (1985)); S.D. Codified Laws Ann. 
§ 34-7A-38(12) (Supp. 1984); Wash. Rev. Code Ann. § 70-38-115(2)0) (Supp. 1985); W. 
Va. Code § 16-2D-6(a)(22) (1985); Wis. Stat. Ann. § 150.39(10) (West Supp. 1985) 
(nursing homes). 



1030 INDIANA LAW REVIEW [Vol. 19:1025 

quality of care in proposed facilities and services.^" Most other states 
include quality of care considerations in their certificate of need regu- 
lations, often by incorporation of NHPRDA past quality standards.^' 

The quality protective function of certificate of need may be merged 
with its cost containment role. A number of epidemiological studies have 
demonstrated an association between volume of services provided in 
health facilities and reduced mortality rates, suggesting that as well as 
controlling costs, preventing excess, underutilized capacity improves qual- 
ity of care.^^ The optimum service size standards found in certificate of 
need review criteria are based on these quality considerations." 

Third, certificate of need programs may be used to achieve a uniform 
geographic distribution of health services^"* or an equitable distribution 



-"Ark. Stat. Ann. § 82-23 11(d) (Supp. 1985); Fla. Stat. Ann. § 381.494(6)(c)(3) 
(Supp. 1985); Ga. Code Ann. § 31-6-42(a)(13) (1985); Ky. Rev. Stat. § 216B.040(2)(a)(2)(e) 
(Supp. 1982); Me. Rev. Stat. Ann. tit. 22, § 309(1)(A) (Supp. 1985); R.I. Gen. Laws 
§ 23-15-4(d)(7) (1985). 

-'See 42 U.S.C. § 300n-l(c)(14) (1982); 42 C.F.R. § 123.412(a)(18) (1985). 

-See, e.g.. Flood, Scott & Ewy, Does Practice Make Perfect? Part I: The Relation 
Between Hospital Volume and Outcomes for Selected Diagnostic Categories, 22 Med. 
Care 98 (1984); Flood, Scott & Ewy, Does Practice Make Perfect? Part II: The Relation 
Between Volume and Outcomes and Other Hospital Characteristics, 11 Med. Care 115 
(1984); Luft, The Relations Between Surgical Volume and Mortality: An Exploration of 
Causal Factors and Alternative Models, 18 Med. Care 940 (1980); Luft, Bunker & 
Enthoven, Should Operations Be Regionalized: The Empirical Relation Between Surgical 
Volume and Mortality, 301 New Eng. J. Med. 1364 (1970). It is postulated that increased 
volume is associated with diminished mortality rates because of a "learning curve" effect. 
Flood, Scott & Ewy, supra, at 123. 

-'E.g., Or. Admin. R. 409-03-010(1 3)(b) (1985) (quality of care of proposed projects 
measured by sufficiency of expected volume to maintain staff skills); see also Humana, 
Inc. V. Department of Health «fe Rehabilitative Servs., 469 So. 2d 889 (Fla. Dist. Ct. 
App. 1985) (quality concerns justified criterion basing need for new facilities on full 
utilization of existing facilities); National Guidelines for Health Planning (a set of national 
"need" standards required to be considered by all state and local health planning agencies) 
regarding neonatal special care units, open heart surgery, cardiac catheterization, and 
radiation therapy, 42 C.F.R. §§ 121.204, .205, .207, .209 (1985). Each specifies a minimum 
volume of services identified by medical authorities as necessary to maintain quality of 
care. 

-^Standards for acceptable patient travel time to health facilities and acceptable risks 
of queuing at the facility are incorporated into states' criteria for identifying community 
need for new projects. E.g., Ala. Code § 22-21-264(4)(0 (1984) (certificate of need criterion 
of "evidence of the locational appropriateness of the proposed facility or service such as 
transportation accessibiHty . . ."); Iowa Code Ann. § 135.64(1)(8) (West Supp. 1985); 
Mont. Code Ann. § 50-5-304(1 )(m) (1985) (CON criteria of distance, convenience, cost 
of transportation, and accessibility of health services for persons living outside urban 
areas); Va. Code § 32. 1-102. 3(B)(6) (1985) (certificate of need criteria of topography and 
highway facilities in area proposed to be served); see also 4,1 C.F.R. § 121.201(b) (1985) 
(National Guidelines for Health Planning recommended 30 minute travel time to the nearest 
hospital for general acute care). 



1986] CERTIFICATE OF NEED 1031 

of health services among social and economic groups. ^^ In such cases, 



--The foremost example is the use of certificate of need programs to encourage and 
protect health care facilities that internally subsidize socially desirable but unprofitable 
lines of business. For reasons of legal obligation or conscience, facilities may offer emergency 
or routine services to persons unable to pay, or accept Medicaid or other public program 
beneficiaries for whom reimbursement is less than cost or less generous than private payer 
reimbursement. Presumably, such facilities price other services or charge other payers 
above cost to recover their losses. When they do, it creates an opportunity for other 
facilities not so charitably inclined to undercut their prices and capture the paying market. 
Certificate of need programs can protect charitable subsidizers from cream skimmers by 
denying cream skimmers entry into the marketplace. See, e.g.. Collier Medical Center v. 
Department of Health and Rehabilitative Servs., 462 So. 2d 83 (Fla. Dist. Ct. App. 1985) 
(new hospital's certificate of need application denied to protect existing hospitals with 
high indigent patient loads from loss of paying patients, needed to subsidize indigent care, 
to new hospital). NHPRDA requires state programs to use several criteria designed to 
achieve this effect by expressing a preference for health care facilities that serve low- 
income and other "medically underserved" patients. 42 C.F.R. § 123.412(a)(6) (1985). See 
also 42 C.F.R. §§ 123.412(a)(5); 123.413 (1985). Numerous state certificate of need statutes 
also have medically-underserved access criteria. E.g., Cal. Health & Safety Code 
§§ 437.11(b)(4)(c), 437.116 (Deering Supp. 1985) (certificate of need exemptions for facilities 
participating in Medicaid or providing certain volume of free care); D.C. Code Ann. 
§ 32-305(a)(2) (Supp. 1984) (certificate of need requirement that facilities provide a reasonable 
volume of uncompensated care); Fla. Stat. Ann. § 381.494(6)(c)(8) (Supp. 1985); Ga. 
Code Ann. § 31-6-42(a)(7), (c) (1985) (waiver of strict adherence to certificate of need 
criteria for minority administered hospital facilities serving socially and economically 
disadvantaged urban populations); Mich. Comp. Laws Ann. § 333.22131(l)(j), (e) (Supp. 

1985) (certificate of need criteria of access to residents and physicians, nondiscrimination 
in employment, patient admission or care, room assignment, training programs, and medical 
staff membership); Neb. Rev. Stat. § 71-5853(1), (3) (Supp. 1985); 1985 N.H. Laws ch. 
378, § 6 (to be codified at N.H. Rev. Stat. Ann. § 51-C:7(III)) (certificate of need 
criterion of degree to which proposed facility is accessible to medically underserviced, 
including handicapped and indigent); N.C. Gen. Stat. § 131E-183(3), (3a), (13) (Supp. 
1983); N.D. Cent. Code § 23-17.2-05 (Supp. 1983) (incorporating by reference NHPRDA 
access review criteria); Okla. Stat. Ann. tit. 63, § 2652.1(B)(3)(e), (6) (West 1984); Pa. 
Cons. Stat. Ann. § 448.707(a)(9), (19) (Purdon Supp. 1985); Va. Code § 32. 1-102. 3(B)(5) 
(1985); Wash. Rev. Code Ann. §§ 70.38. 115(2)(e), (k) (Supp. 1986) (certificate of need 
criterion of hospital meeting or exceeding regional average level of charity care); W, 
Va. Code § 16-2D-6(a)(4), (14), (18), (25) (1979); Executive Budget Bill, Act 29, 1985 
Wis. Legis. Serv. 391 (West) (to be codified at Wis. Stat. § 150.69(13) (certificate of 
need requirement of acceptable plan for provision of health care to indigent); see also 
Idaho Admin. Code § 02.11400.01(a)(v) (1983) (Idaho section 1122 regulations); N.J. 
Admin. Code tit. 8, § 33-2. 1(a), (b) (1985) (prohibition on issuance of certificate of need 
to any facility that fails to provide or contractually commit itself to provide services to 
medically underserved populations residing or working in its service area as adjusted for 
indications of need). For court decisions upholding certificate of need decisions based on 
the performance in assuring access to medical care to the indigent or medically underserved, 
see Collier, 462 So. 2d 83 (Fla. Dist. Ct. App. 1985); Doctors Hosp. of Prince George's 
County v. Maryland Health Res. Plan Comm'n, 501 A. 2d 1324 (Md. Spec. App. 

1986) (hospital's record of lower Medicaid and indigent patient load than other area hospitals 
supported denial of its certificate of need application); Chambery v. Axelrod, 101 A.D.2d 
610, 474 N.Y.S.2d 865 (1984) (certificate of need preference for facilities participating in 



1032 INDIANA LAW REVIEW [Vol. 19:1025 

certificate of need regulation finds its justification not in market failure, 
but in compensation for undesirable consequences of market functioning. 

Fourth, states may adopt certificate of need programs to limit public 
outlays for benefit programs, primarily Medicaid, or as adjuncts to state 
programs regulating health facility operating expenses. ^^ For example, 
states have used certificate of need to control or to limit the supply of 
nursing home beds in order to limit Medicaid outlays for nursing home 
care.^^ 

Fifth, certificate of need laws may be adopted to assure public 
participation in decision-making respecting major health facility projects 
and, by extension, in the overall configuration of institutional health 
care delivery. For example, the Maryland health planning statute provides 
that **The citizens of this State have a fundamental interest in planning 
the development of quality health services . . . ."^^ It establishes local 
health planning agencies and a consumer-dominated state health planning 
commission, and gives the local agencies and the general public roles 
in certificate of need review. ^^^ NHPRDA's provisions for local health 
planning agencies evince similar purposes.^" 



Medicaid upheld). The ultimate effect of employing certificate of need in this fashion is 
to tax indirectly the private paying patients of charitable health care facilities and to shield 
public budgets from the full costs of socially desirable services. 

-''See Mahler, Barriers to Coordinating Health Services Regulatory Programs, 6 J. 
Health Pol. Pol'y & L. 528 (1981). 

^'Me. Rev. Stat. Ann. tit. 22, § 307(6-A) (Supp. 1985) (comparative review of new 
nursing home bed addition projects based on availability of legislative appropriations); Mich. 
CoMP. Laws Ann. § 333.22131(2)(f) (Supp. 1985) (certificate of need criterion, for nursing 
home bed addition, of consideration of Medicaid agency plans); Mont. Code Ann. § 50-5-430(2) 
(1985) (authority to condition nursing home bed additions on availabihty of Medicaid 
funding); 1985 N.H. Laws Ch. 378, § 378:6 (to be codified at N.H. Rev. Stat. Ann. 
§ 151-C:5(II)(b)) (coverage of all health facility transfers of ownership except those subject 
to federal restrictions on asset revaluation for Medicare/Medicaid reimbursement purposes); 
Pa. Cons. Stat. Ann. § 448.707(c)(7) (Purdon Supp. 1985) (nursing home bed addition 
criterion of consistency with Medicaid agency plans); Vt. Stat. Ann. tit. 18, § 2406(a)(4) 
(Supp. 1985) (certificate of need criterion for nursing home bed addition of consideration 
of Medicaid agency plans); Wis. Stat. Ann. § 150.39 (West Supp. 1985) (nursing home 
project criteria of sufficient Medicaid funds appropriated to reimburse for care to be 
provided, and statutory ceiling on approveable nursing home beds to enable the state to 
accurately establish Medicaid budget); 1985 Wise. Legis. Serv. Act 29, § 1975 (West) (to 
be codified at Wis. Stat. Ann. § 150.31). See generally Feder & Scanlan, Regulating The 
Bed Supply in Nursing Homes, 58 Milbank Mem. Fund Q. 54 (1980). 

=^Md. Health-General Code Ann. § 19- 102(a)(2) (Supp. 1985). 

'"Id. at (b)(5), 19-114, 19-118. 

'"42 U.S.C. §§ 300/-l,2, 300n-l (1982) (establishment of consumer-dominated "health 
systems agencies" with formal role in certificate of need review); see also Del. Code 
Ann. tit. 16, § 9301 (1984); Fla. Stat. Ann. § 381.493(2) (Supp. 1985); 1975 Hawaii 
Sess. Laws ch. 178, Sec. 1; Mich. Comp. Laws Ann. § 333.22131(l)(m) (Supp. 1985) 
(certificate of need criterion of non-profit health facility governance by body composed 
of a majority consumer membership broadly representative of the population served); 



1986] CERTIFICATE OF NEED 1033 

Until recently, another purpose for certificate of need in a few states 
was to avoid financial penalties threatened by the federal government 
if the state failed to adopt a certificate of need statute. From 1975 
through 1982, NHPRDA required states to adopt certificate of need 
laws complying with its model provisions in order to receive funding 
under the Act and to avoid severe financial penalties.^' Several certificate 
of need laws passed after 1975 cite NHPRDA compliance and avoidance 
of financial penalties as a reason for their adoption. ^^ 

III. Certificate of Need Before NHPRDA 

A. Early Federal Support for Health Planning 

Federal support for non-regulatory governmental planning of hospital 
and other health facility services began with the Hospital Survey and 
Construction Act of 1946, popularly known as the Hill-Burton Act.^^ 
During its three decades of operation, the Hill-Burton Act provided 
grants in participating states for construction and modernization of 
hospital and other health care facilities. A state Hill-Burton agency was 
required to prepare a medical facilities plan setting forth the number 
of facilities of various kinds in the state, the relative need for new 
facilities, and their appropriate distribution. In turn, construction grant 
applicants had to conform to the plan and were required to secure the 
approval of the Hill-Burton agency. When first enacted, Hill-Burton 
provided grants only to hospitals and public health centers.^"* The list 
of eligible facilities expanded over the years to include, at one time or 
another, nursing homes, rehabilitation facilities, chronic disease hospitals, 
diagnostic or treatment centers,^^ outpatient facilities, hospital-related 



Wash. Rev. Code Ann. § 70.38.015(1) (Supp. 1986) (state policy to encourage consumer 
and provider involvement in health planning);W. Va. Code § 16-2D-6(a)(26) (1985) (cer- 
tificate of need criterion of existence of a mechanism for soliciting consumer input into 
the health care facilities decision-making process). 

"See infra note 81 and accompanying text. 

^^975 Hawaii Sess. Laws ch. 178, Sec. 1 (purpose of certificate of need legislation 
is to conform to NHPRDA requirement); N.C. Gen. Stat. § 131E-175(5) (Supp. 1983) 
(legislative finding that failure to adopt certificate of need law would cause state to lose 
in excess of $55 million in federal funds); Tex. Rev. Civ, Stat. Ann. art. 4418h, § 1.01 
(1976) (repealed 1985) (purpose of certificate of need statute is to meet requirements of 
NHPRDA). C/. Colo. Rev. Stat. § 25-3-502(6) (1982) (legislative finding that certificate 
of need provisions differ from federal requirements, but advance state's own goals of 
quality assurance, access, and cost -effectiveness). 

^Tub. L. No. 79-725, 60 Stat. 1040 (1946) (codified as amended at 42 U.S.C. § 
291-2910-1 (1982)). 

'^Pub. L. No. 79-725 § 2, 60 Stat. 1040 (1946). 

'Tub. L. No. 83-482, 68 Stat. 461 (1954). 



1034 INDIANA LAW REVIEW [Vol. 19:1025 

extended care facilities and home health services, equipment acquisitions, 
and emergency rooms. ^^ In later years, authority for grants to voluntary 
local health planning agencies to assist in the process of planning for 
community needs was incorporated into Hill-Burton.^^ 

In 1966, Congress authorized new funding for state and local public 
or non-profit planning agencies to perform * 'comprehensive health plan- 
ning," an activity with broader implications than disbursement of con- 
struction funds. -'^ The state agencies identified public and private facilities, 
services, and personnel required both to meet the health needs of the 
state's population and to encourage cooperative efforts among health, 
education, welfare, and rehabilitation providers and agencies. Local agen- 
cies developed comprehensive regional or metropolitan plans for coor- 
dination of existing and projected services. In 1967, the comprehensive 
health planning laws were amended to require the state comprehensive 
health planning agency to assist health care facilities in developing in- 
dividual programs for capital expenditures consistent with an overall 
state plan, and to provide for periodic state review of the facilities' 
capital expenditure programs. ^'^ The comprehensive health planning agen- 
cies were expected to provide consultation, not to control or regulate 
facility expenditures. "*" Nevertheless, the amendment clearly authorized, 
through the health planning process, official oversight of health facility 
expenditures and projects not financed with Hill-Burton or other federal 
funds. In this sense, this change was the progenitor of federal require- 
ments for health planning regulation through certificate of need. 

Regulations implementing the 1967 amendments listed the health care 
facilities whose capital expenditures were subject to review to include: 

All hospitals, sanitariums, nursing homes, and other facilities 
for the inpatient care of the sick, injured, or disabled, which 
are licensed or formally approved for such purposes by an 
officially designated state standards-setting authority, and all 
public or private non-profit clinics, health centers, and other 
facilities a major purpose of which is to provide diagnostic. 



"•Pub. L. No. 91-296, 84 Stat. 336 (1970). 

'Tub. L. No. 88-443, § 2, 78 Stat. 447 (1964). 

"^Comprehensive Health Planning and Public Health Services Amendments of 1966, 
Pub. L. No. 89-749, 80 Stat. 1180 (codified as amended at 42 U.S.C. § 246 (1982)). 

^'Partnership for Health Amendments of 1967, Pub. L. No. 90-174, 81 Stat. 533. 

'"See S. Rep. No. 724, 90th Cong., 1st Sess., reprinted in 1967 U.S. Code Cong. 
& Admin. News 2076, 2078 ("This new requirement is intended to provide for assistance 
in the planning activities of health-care facilities, but is not intended to serve as a vehicle 
for control of the capital expenditure plans of any institution. The paragraph is designed 
to aid health care facilities in providing for more orderly planning so as to aid them in 
eliminating duplications and overlaps between the services they provide and the services 
provided by other facilities serving the same general area."). 



1986] CERTIFICATE OF NEED 1035 

preventive, or therapeutic outpatient health care by or under the 
supervision of doctors of medicine, osteopathy, or dentistry; 
provided, that such term shall not include facilities operated by 
religious groups relying solely on spiritual means through prayer 
and healing and in which health care by or under the supervision 
of doctors of medicine, osteopathy, and dentistry is not pro- 
vided/' 

The regulations also provided that the expenditures subject to review 
would include all capital expenditures of any amount for "replacement, 
modernization, or expansion. "'•^ 

These provisions drew virtually every type of institutional health care 
provider and expenditure within the purview of comprehensive health plan- 
ning. Their inclusivity arose out of comprehensive health planning 's origin 
in Hill-Burton planning (the scope of which naturally encompassed all 
the facilities and services Hill-Burton would fund) and out of a desire 
on the part of the federal government and the health planning commun- 
ity to oversee every aspect of health service delivery."*^ This viewpoint was, 
in turn, an outgrowth of the widely-held expectation among health policy- 
makers at the time that prevailing economic and social forces would lead 
to centralized control of health services delivery in the United States along 
the lines of the national health services or universal health insurance 
systems of western European countries.'*'* If such developments were in- 
evitable, comprehensive health planning with very broad jurisdiction and 
built-in input from local communities seemed to be a logical prelude to 
their implementation in an American setting.'*^ 

Notably absent from these early federal ventures into health planning 
is any evidence of concern with distortions in the health care marketplace 
that might lead to excess capacity. The Hill-Burton program was intended 
to solve the opposite problem — insufficent private investment in health 
facilities. The comprehensive health planning legislation speaks of encourag- 
ing efficiency and economy through planning, but in the sense of rational 
resource management rather than of compensation for market defects. ''^ 



^'42 C.F.R. § 51.4(i) (1969) (repealed 1976). 

'-Id. 

^'Applicable regulations defined the scope of comprehensive health planning to en- 
compass the "health services, facilities and manpower to meet the physical, mental, and 
environmental health needs [of the populace] and the financial and organizational resources 
through which these needs may be met . . ." 42 C.F.R. § 51.4(cXl) (1967) (repealed 1976). 

^See generally The Region alization of Personal Health Services (E. Saward ed. 
1976). 

''See M. RoEMER, Comparative National Policies on Health Care 202 (1977). 

'"See Comprehensive Health Planning and Public Health Services Amendments of 
1966, Pub. L. No. 89-749, § 2, 80 Stat. 1180 (legislative findings and declaration of 
purpose to promote health through public/private partnership planning for health 
services, manpower, and facilities). 



1036 INDIANA LAW REVIEW [Vol. 19:1025 

However, a concern for preservation of quality of care and assurance of 
geographic and income-related access is evident in these programs/^ 

B. Adoption of Certificate of Need Laws by the States 

While voluntary health planning agencies were appearing in the states 
and beginning to receive federal funding, several states had adopted 
certificate of need laws. The first was New York, which enacted its 
statute in 1966 after promoting regional voluntary planning since 1946/^ 
Converting voluntary health planning into a regulatory mechanism ap- 
pealed to other states/*^ in the next six years, twenty states adopted 
some kind of certificate of need program. ^° By the end of the 1973 
legislative sessions, four more states had added certificate of need re- 
quirements and a total of twenty-three states had such programs.^' 
Administrative responsibility for certificate of need programs was often 



^The Hill-Burton Act conditioned the receipt of grant funds on a health facility's 
agreement to provide a reasonable volume of uncompensated services and to make its 
facilities available to all persons residing in the area without discrimination on account 
of race, creed, or color. Pub. L. No. 79-725. § 2, 60 Stat. 1041 (1946). See generally 
Rose, Federal Regulation of Services to the Poor Under the Hill-Burton Act: Realities 
and Pitfalls, 70 Nw. U.L. Rev. 168 (1975); Wing, The Community Service Obligation 
of Hill-Burton Health Facilities, 23 B.C.L. Rev. 577 (1982). The Act also mandated 
minimum maintenance and operation standards for funded projects, and prompted many 
states first to adopt health facility licensure programs. See A. Somers, Hospital Regu- 
lation: The Dilemma of Public Policy 118-32 (1969). The comprehensive health planning 
program combined these concerns in its announced goal of assuring "comprehensive health 
services of high quality for every person." Id. 

^"Hearings on H.R. 6084 Before the Subcomm. on Health and Environment of the 
House Comm. on Energy and Commerce, 97th Cjng., 2d Sess. 58 (1982) (testimony of 
James R. Tallon, Jr., Chairman, Committee on Health, Nev^ York State Assembly). 

^''Differing opinions as to the reason states adopted certificate of need laws have 
been offered. According to Curran, state legislators grafted CON programs onto voluntary 
health planning programs in response to public concern for rising hospital and health 
insurance costs. Curran, supra note 15, at 88-90. Havighurst suggests that certificate of 
need laws were adopted to strengthen voluntary health planning and, in some states, to 
limit proprietary hospital expansion. Havighurst, supra note 15, at 1148-50. Payton and 
Powsner attribute the passage of CON legislation to the efforts of the voluntary hospital 
establishment to forestall rate regulation and solidify its dominance of the hospital market. 
Payton & Powsner, Regulation Through the Looking Glass: Hospitals, Blue Cross, and 
Certificate of Need, 17 Mich. L. Rev. 203 (1980). Certificate of need legislation was 
supported by the health planning establishment, the American Hospital Association, Blue 
Cross, state insurance commissioners, and various business and labor groups, and opposed 
by medical professional organizations, proprietary hospitals, and nursing home operators. 
Curran, supra note 15, at 90. The legislatures themselves appear to have been motivated 
by multiple concerns for cost containment, quality preservation, access assurance, and 
public participation in health facility decision-making. See supra notes 16-30 and accom- 
panying text. 

■"Curran, supra note 15, at 85. 

"Havighurst, supra note 15, at 1143-44. 



1 



1986] CERTIFICATE OF NEED 1037 

assigned to comprehensive health planning agencies, which were often 
instrumental in securing passage of the certificate of need laws.^^ 

Certificate of need programs adopted at this time varied considerably 
in their scope of coverage. They generally covered a narrower range of 
facilities and projects than were to be covered under subsequent federal 
regulatory health planning initiatives. A contemporary survey reported 
that nineteen programs subjected hospitals and nursing homes to reg- 
ulation." One state (Oklahoma) covered nursing homes, but not hos- 
pitals. ^"^ Three states (Michigan, Oregon, and Rhode Island) covered 
hospitals, but not nursing homes. ^^ About half subjected freestanding 
outpatient facilities to review. None extended coverage to individual 
physician's offices. 

Under project coverage, most states reviewed "capital expenditures" 
or similarly-labeled expansions of physical plants. Virtually all states had 
expenditure '^thresholds," dollar amounts below which capital expend- 
itures by health facilities were not subject to review. The expenditure 
thresholds varied widely from $25,000 to $350,000.^^ Over half of the 
states expressly covered increases in bed supply whether or not associated 
with a capital expenditure. All appeared to cover substantial expansion 
in services, sometimes without regard to expenditure thresholds. Ac- 
quisitions of medical equipment were expressly subjected to review in 
about half of the states, frequently with expenditure thresholds. However, 
several states exempted replacement of equipment. Finally, ten states 
covered both reductions in bed supply and/or termination of services." 

C. Section 1122 

Congressional concern with the costs of institutional health services 
rose as the costs of the Medicare and Medicaid programs, established 
in 1965, increased. Among the reasons for increasing Medicare and 
Medicaid costs was the programs' open-ended payment to providers on 
the basis of costs incurred in the provision of services to beneficiaries.^^ 
In addition to paying for reasonable costs directly associated with patient 
care. Medicare and Medicaid paid for "capital costs," i.e., actual costs 
of interest on capital indebtedness, an allowance for depreciation on 
capital assets, and a fixed rate of return on equity capital used by 



"H.R. Rep. No. 231, 92d Cong., 2d Sess., reprinted in 1972 U.S. Code Cong. & 
Admin. News 4989, 5065-66. 

''Havighurst, supra note 15, at 1144. 

''Id. at 1145. 

'Ud. at 1146 n.lO. 

'''Id. at 1146 n.9. 

''Id. at 1145-47. 

"''See Kinney & Lefkowitz, Capital Cost Reimbursement to Community Hospitals 
Under Federal Health Insurance Programs, 1 J. Health Pol. Pol'y & L. 648 (1982). 



1038 INDIANA LAW REVIEW [Vol. 19:1025 

proprietary health facilities for patient care.^'^ The Social Security Amend- 
ments of 1972 contained several measures designed to restrain Medicare 
and Medicaid program cost increases caused by incurred-cost reimburse- 
ment. They included mandatory utilization review, ceilings on payment 
for routine hospital inpatient costs, and the so-called **section 1122" 
program.^ Section 1122 authorized the Secretary of Health, Education 
and Welfare to contract with individual states for a review and rec- 
ommendation to the Secretary on the community need for capital ex- 
penditures proposed by or on behalf of health care facilities or health 
maintenance organizations.^' State recommendations were to be based 
on state health plans, including those adopted by comprehensive health 
planning and Hill-Burton agencies. A negative state recommendation 
usually would lead to withholding by the Secretary of payment under 
Medicare and Medicaid for capital costs associated with the project. ^^ 
Although section 1122's enforcement sanction — denial of federal pro- 
gram reimbursement — differed from that of state certificate of need 
programs, its purpose was similarly to deter unnecessary capital invest- 
ment by health facilities. An additional purpose was to assure that 
Medicare and Medicaid reimbursement supported state health planning 
programs. ^^ 

J. Section 1122 Coverage. — Despite its origin in congressional 
concern over distorted incentives in Medicare and Medicaid reimburse- 
ment, as implemented by the Department of Health Education and 
Welfare, the section 1122 program extended the federal government's 
practice, begun under the comprehensive health planning program, of 
imposing extensive review requirements on virtually all categories of 
health facilities. Health care facilities subject to review under the De- 
partment's regulations encompassed the following: hospitals, psychiatric 
hospitals, and tuberculosis hospitals, skilled nursing facilities, intermediate 
care facilities, home health agencies, providers of outpatient physical 
therapy services (including speech pathology services), kidney disease treat- 
ment centers (including freestanding hemodialysis units), and organized 
ambulatory care facilities such as health centers, family planning clinics, 
and surgicenters, which are not part of a hospital but are organized and 
operated to provide medical care to outpatients.^'* 

In addition to health care facilities, health maintenance organizations 
were subject to review.^^ Projects were subject to review when undertaken 

'-'Id. 

'•"Social Security Amendments of 1972, Pub. L. No. 92-603, § 221, 86 Stat. 1329 
(codified as amended at 42 U.S.C. § 1320a-l (Supp. I 1983)). 
''See generally 42 C.F.R. §§ 100.101-100.109 (1985). 
"-42 U.S.C. § 1320a-l(d) (1982). 
'•'42 U.S.C. § 1320a-l(a) (1982). 
'M2 C.F.R. § 100.103(a)(1) (1974). 
"^42 C.F.R. § 100.103 (1974). 



1986] CERTIFICATE OF NEED 1039 

by or on behalf of health care facilities or health maintenance orga- 
nizations and when they involved capital expenditures that: (1) exceeded 
$100,000; (2) changed the bed capacity of the facility with respect to 
which such expenditures were made; or (3) substantially changed the 
services of the facility with respect to which such expenditures were 
made.^^ Capital expenditures that changed bed capacity and substantially 
changed services were defined by the Department of Health, Education, 
and Welfare in the following manner: 

[A] Capital expenditure that * 'changes the bed capacity" of a 
facility means a capital expenditure that results in any increase 
or decrease in licensed capacity under applicable state or local 
law, or, if there is no such law, the number of beds in a given 
facility as of January 1, 1973, as determined by the designated 
planning agency. 

[B] Capital expenditure that '^substantially changes the services" 
of a facility means a capital expenditure that results in the 
addition of a clinically related (i.e., diagnostic, curative, or 
rehabilitative) service not previously provided in the facility or 
the termination of such a service that had previously been pro- 
vided in the facility.^^ 

The extreme breadth of section 1122 coverage may have been justified 
from a comprehensive health planning perspective, but the connection 
between section 1122's broad coverage and the cost containment concerns 
that led to the program's adoption was difficult to identify.^^ The list 
of health care facilities covered under section 1122 seems to have been 
taken from the list of institutional providers eligible to participate in 
Medicare or Medicaid.^' However, excessive capital investment of acquisi- 
tion of costly new technology had never been associated with several of 
these providers, including home health agencies, outpatient physical therapy 
providers, or ambulatory care facilities. In fact, such providers were eligible 
for Medicare reimbursement in part because they offered less capital- 
intensive, lower-cost substitutes for hospital or nursing facility care.^" It 



'M2 U.S.C. § 1320a-l (Supp. II 1972). 

"'42 C.F.R. §§ 100.103(a)(2)(iii),(iv) (1974). 

""Reflecting the linkage of the two programs, the original section 1122 regulations 
also amended the comprehensive health planning regulations to conform their definitions 
of covered health care facilities. 38 Fed. Reg. 31,281 (1973) (amending 42 C.F.R. § 
51.4(i)(4) (repealed 1976)). 

"''The list duplicated the list of Medicare-eligible providers in large part, and repeated 
the facility definitions in Medicare or Medicaid regulations. 

'"The Department of Health and Human Services eventually revised its interpretation 
of the purposes of section 1122 with regard to service and bed terminations. In 1983, it 



1040 INDIANA LAW REVIEW [Vol. 19:1025 

would have been more consistent with Medicare and Medicaid cost con- 
trol concerns to have exempted these facilities from section 1122 in order 
to channel investment toward them and away from institutional providers. 
Similarly, health maintenance organizations were a then-unusual form of 
organized health care delivery favored by the federal government because 
they appeared to operate with internal incentives for cost containment 
and reduced investment. They would also have been likely candidates for 
exemption from section 1122 coverage. 

The Department's interpretation of the statutory phrases "substantial 
change in services'' and "change in bed capacity" to include decreases 
as well as increases in bed capacity and to include terminations of 
services as well as service additions seems clearly inconsistent with the 
role of the section 1122 program to compensate for distorted Medicare 
incentives to excess capacity. The purpose for covering terminations of 
beds and services is presumably to maintain existing services, not to 
reduce capacity. Like the decision to cover a very broad array of non- 
institutional facilities, the Department's decision to cover terminations 
probably arose out of the perception that section 1122 was comprehensive 
health planning's successor, with the same broad purposes.^' 

D. Pre-NHPRDA State Participation in Capital Expenditure Review 

State participation in the section 1122 program was optional. ^^ By 
the beginning of 1975, thirty-nine states and two territories, many of 
which already had certificate of need programs, had agreed to enter the 
program. ^^ The states' willingness to do so may have been due in part 
to the fact that section 1122 regulations and policy guidelines offered 
a means by which a state could participate in section 1122, but waive 
review of some of the exceedingly broad range of health care facilities 
and projects covered by section 1122. A state was permitted to "elect 

proposed to amend the section 1122 regulations to delete coverage of decreases in bed 
capacity and termination of services that are not associated with capital expenditures in 
excess of the current expenditure threshold. 48 Fed. Reg. 36,395 (to be codified at 42 
C.F.R. §§ 3 125. 102(a), (b) (1983)). The preamble to the proposed regulations stated that 
such a deletion would be "consistent with Section 1122's central purpose of assuring that 
Medicare and Medicaid funds are not used to pay higher health care costs that result 
from duplication or irrational growth of health care facilities, while at the same time 
advancing the policy of the new Medicare prospective payment system, which provides 
health care facilities with incentives to eliminate inefficient services." Id. at 36,391. 

^-42 U.S.C. § 1 320a- 1(6)( 1982). 

"Lewin & Assocs., Inc., The Experience with the Section 1122 Capital Ex- 
penditure Review Program 14-15 (1985) (report prepared for Office of Health Planning 
and Evaluation, Office of the Assistant Secretary for Health, U.S. Dep't of Health & 
Human Services, under Contract No. 282-83-0072) distributed in Office of Health Plan- 
ning, U.S. Dep't of Health & Human Services, Program Information Letter 85-17 
(1985). 



1986] CERTIFICATE OF NEED 1041 

not to review" categories or classes of projects identified in advance.^"* 
Although the extent to which states elected not to review in order to 
avoid the broad requirements of section 1122 prior to the passage of 
NHPRDA is not known, states' frequent election after NHPRDA suggests 
that states did resort to this provision to limit review scope7^ 

Twenty-six states had certificate of need programs, and seventeen 
states had both certificate of need and 1122 in early 1975.^^ By the end 
of 1975, every state except West Virginia and the District of Columbia 
had either a certificate of need or section 1122 program. ^^ In short, well 
before the adoption of the NHPRDA, the vast majority of states had 
chosen to implement certificate of need or capital expenditure review. 
Their programs were generally more limited in scope than the broad 
programs favored by the federal government at the time. All these states 
later accepted NHPRDA funding, obliging themselves to conform to its 
requirements. However, for most states, the initial choice to adopt 
certificate of need or participate in section 1122 was independent of 
federal requirements. 

IV. Certificate of Need Requirements of NHPRDA 

Although regulatory health planning through certificates of need 
began in the states, it became fully established as national policy with 
the passage of NHPRDA. As originally adopted, NHPRDA embodied 
the ideal of comprehensive health planning: management of the health 
care delivery system by publicly-controlled, decentralized planning or- 
ganizations. It was designed to induce every state to adopt a certificate 
of need law conforming to federal requirements; to give local planning 
agencies an official role in state planning and certificate of need review; 
and to enhance the regulatory toughness of state programs by improving 
the plans, criteria, and methodologies on which certificate of need de- 
cisions were based and providing for a more skilled professional staff 
for planning agencies. ^'^ 



'"Bureau of Health Planning, U.S. Dep't of Health & Human Services, Election 
Not to Review Under the Section 1122 Program, Program Information Letter 82- 
04 (1981); Division of Comprehensive Health Planning, U.S. Dep't of Health, Ed- 
ucation & Welfare, DPA Manual: Guidance and Procedures for Designated Plan- 
ning Agencies in Administering Section 1122 of the Social Security Act 13 (1974). 
In August 1983, the Department proposed to codify this poHcy in amended section 1122 
regulations. See 48 Fed. Reg. 36,396 (1983) (to be codified at 42 C.F.R. § 125.03). 

''E.g., Ga. Admin. Comp. § 272-3-.03 (1984); Iowa Admin. Code § 470-201.9 (1982) 
(election not to review under section 1122 all projects not required to be reviewed by 
certificate of need program). 

'"Chayet & Sonnenreich, P.C, supra note 15, at 5-6. 

'"A good account of the adoption of NHPRDA is B. Lefkowitz, Health Planning: 
Lessons for the Future (1983). 



1042 INDIANA LAW REVIEW [Vol. 19:1025 

NHPRDA's local health planning agencies, denominated Health Sys- 
tems Agencies (HSA's), replaced voluntary local health planning boards. 
Elaborate requirements for public participation on HSA governing boards 
were established to assure that HSA's would be consumer-controlled and 
representative of all segments of the population. ^'^ HSA's had the task 
of providing community based health planning for specified geographical 
areas. Typically, there were three or four such health service areas, each 
served by an HSA, within each state. HSA's also were required to be 
allowed to participate in state certificate of need reviews by conducting 
a public meeting on proposed projects and submitting recommended 
findings with respect to projects. 

NHPRDA provided for designation of state agencies, denominated 
State Health Planning and Development Agencies (SHPDA's), to develop 
a state health plan incorporating HSA plans and to administer certificate 
of need programs. A state advisory panel made up of HSA representatives 
was mandated. Certificate of need programs were required to provide 
for review of capital expenditures, substantial changes in services, and 
additions of beds by health care facilities. NHPRDA also prescribed 
detailed review procedure requirements and a laundry list of criteria for 
evaluating certificate of need applications. As the first of many attempts 
over the years to merge the two programs, a state participating in section 
1122 was required to designate its SHPDA as the agency to perform sec- 
tion 1122 reviews. 

NHPRDA did not literally compel states to adopt certificate of need 
programs consistent with its provisions.**" Instead, it offered financial 
inducements to do so, in the form of federal funding for SHPDA's, 
and penalties for failure to do so. The penalties initially announced were 
severe. If a state did not have a certificate of need program in compliance 
with NHPRDA by a specified date, grants and contracts under numerous 
other federal health programs to state, local, and private entities in the 
state would be abruptly cancelled.**' The funding at risk could amount 
to tens or even hundreds of millions of dollars in some states."^ Because 
the funding at risk benefitted such diverse groups as community health 



^"Pub. L. No. 93-641, § 3, 88 Stat. 2225, 2232-35 (1975) (current version at 42 
U.S.C. § 300/-1 (1982)). 

^"North Carolina ex rel. Morrow v. Califano, 445 F. Supp. 532 (E.D.N.C. 1977), 
aff'd mem., 435 U.S. 962 (1978). 

"^See Health Planning and Resources Development Amendments of 1979: Hearings 
on H.R. 3041 and 3167 Before the Subcomm. on Health and the Environment of the 
House Comm. on Interstate and Foreign Commerce, 96th Cong., 1st Sess. 108 (1979) 
(statement of Hale Champion, Undersecretary of HEW) (NHPRDA relies on "atomic 
bomb theory of penalty"). 

"-Manor Healthcare Corp. v. Northwest Community Hosp., 129 111. App. 3d 291, 
295, 472 N.E.2d 492, 494 (1984) (Illinois would lose $465 million over four years if not 
in compliance). 



1986] CERTIFICATE OF NEED 1043 

centers, medical students, academic health researchers funded by various 
national institutes of health, and medical, dental, and nursing schools, 
NHPRDA created a constituency strongly concerned with bringing state 
certificate of need programs into compliance. Although as a result of 
repeated congressional postponement of effective dates," the compliance 
requirements of NHPRDA never became effective, the threat of their 
enforcement was sufficient to induce every state to make concerted, 
more or less successful, efforts to comply. 

A. NHPRDA Coverage 

NHPRDA's certificate of need coverage provisions were a revised 
version of those in section 1122, which were based on comprehensive 
health planning and Hill-Burton. Their source thus lay in the concept 
of systematic management of health care delivery, not in any theory of 
economic regulation. Although eventually scaled back, their broad scope 
and mandatory nature led states to adopt certificate of need programs 
with more extensive coverage than states would otherwise have chosen. 

1. NHPRDA Coverage of Facilities. — Regulations adopted in 1977 
to implement NHPRDA defined the health care facilities subject to 
certificate of need review to include: hospitals, psychiatric hospitals, 
tuberculosis hospitals, skilled nursing facilities, intermediate care facilities, 
kidney disease treatment centers including freestanding hemodialysis units, 
and ambulatory surgical facilities. In addition, health maintenance or- 
ganizations were subject to review.^ 

Although the source of this set of covered facilities was the prior 
section 1122 coverage provisions, there were several deletions from the 
pre-NHPRDA definitions.*^^ First, providers of outpatient physical therapy 
were no longer required to be covered. Second, coverage of home health 
agencies was deleted."^ The reason seems to have been a belief that 
market forces would adequately regulate the supply of these two types 
of facilities. *^^ Third, coverage of organized ambulatory health care fa- 
cilities was deleted. The reasons given were that '*the variety of forms 



^'^See infra note 166 and accompanying text. 

^M2 C.F.R. §§ 123.401, 404 (1977). 

"^The original NHPRDA regulations for certificate of need programs also amended 
the section 1 122 regulations, making their health care facility coverage identical to NHPRDA's. 

'^'•Home health services were also excluded from the health services subject to review, 
in order to exclude from coverage both home health agencies and home health services 
offered in or through a health care facility or health maintenance organization. 42 C.F.R. 
§ 123.404(a)(4) (1977). 

"'A later effort to reinstitute coverage of home health agencies was rejected in 
Congress in part on the grounds that "the supply of those services would not be excessive 
if they were not regulated and that market forces of supply and demand may appropriately 
allocate them." H.R. Rep. No. 190, 96th Cong., 1st Sess. 53, 76 (1979). 



1044 INDIANA LAW REVIEW [Vol. 19:1025 

in which organized ambulatory health care facilities manifest themselves 
resulted in serious definitional difficulties under Section 1122'' and that 
**in light of the uneven national distribution of organized ambulatory 
health care facilities in the states, the Secretary has decided against 
establishing a uniform national method for dealing with the problem at 
this time."*^^ In fact, there was considerable debate in the Department 
of Health, Education and Welfare over the merits of ambulatory facility 
coverage, with attention focused on the costs associated with their ac- 
quisition of sophisticated medical equipment. A proposal was advanced 
to cover organized ambulatory health care facilities that generated annual 
revenues in excess of $1,000,000/^ Although this proposal was not 
adopted, NHPRDA was later amended in response to these concerns to 
require certificate of need review of costly medical equipment used for 
inpatients but located in non-inpatient settings. "^^ 

Since 1977, the set of entities subject to certificate of need review 
under NHPRDA and section 1122 has remained substantially unchanged.*^' 
To its credit, the Department of Health and Human Services has resisted 
requests to reimpose coverage by regulation of home health agencies, 
physician offices, and various types of ambulatory care facilities originally 
covered under section 1122 or comprehensive health planning programs. ^^ 

2. Projects Subject to Review. — Over the years, the set of projects 
subject to review under NHPRDA has been amended frequently, usually 
but not invariably to reduce the range of projects subject to review. 
The Act originally required states to review **new institutional health 
services," as defined by the Secretary. *^^ New institutional health services 
were defined by regulation as: 

1. Construction, development, or establishment of a new health 
care facility or health maintenance organization; 

2. Capital expenditures by or on behalf of a health care facility 
or health maintenance organization in excess of $150,000; 

3. Increases in health care facility or HMO bed capacity, bed 
category changes, and bed relocations; and 

4. New clinically-related health services offered in or through a 
health care facility or health maintenance organization.*^"* 



'*'*41 Fed. Reg. 11,691 (1976) (preamble to proposed regulations). 

'"Iglehart, The Cost and Regulation of Technology: Future Policy Directions, 55 
MiLBANK Mem. Fund Q. 25, 40-43 (1977). 

^°See infra notes 237-40 and accompanying text. 

'''See 42 C.F.R. § 123.401 (1985). Rehabilitation facilities were added to NHPRDA 
coverage in 1979 and have been proposed to be added to section 1122. 

""See. e.g., 50 Fed. Reg. 2009 (1985); 45 Fed. Reg. 69,755 (1980). 

■^'42 U.S.C. § 300m-2(a)(4)(A) (1976). 

^42 C.F.R. § 123.404 (1977). 



1986] CERTIFICATE OF NEED 1045 

3. New Construction and Acquisition Coverage. — Coverage of con- 
struction, development, etc., was a catch-all phrase for coverage of 
new hospital construction. It was probably included to clarify that new 
facilities as well as expansion of existing facilities were subject to review. 
Most pre-NHPRDA state certificate of need laws contained a similar 
term, and although it was deleted from the federal requirements in 
1980,*^^ most continue to do so.*^^ 

Capital expenditures for acquisitions of existing health care facilities 
or health maintenance organizations were exempt from mandatory review; 
states had the option of covering such transactions.*^^ A rationale for 
this exemption was not announced. The Department had previously taken 
the position that section 1122 coverage of capital expenditures in excess 
of $100,000 by or on behalf of a health care facility included coverage 
of acquisitions of facilities, and it was not apparent why the same 
language would have a different meaning in the NHPRDA context. "^^^ 
The basis for the exemption was probably the absence of a strong 
justification for health planning agency review of transactions that did 
not necessarily involve changes in patient care services. "^"^ 

4. Health Maintenance Organization Coverage. — As first adopted, 
much like section 1122, NHPRDA required coverage of new institutional 
health services offered by or on behalf of health maintenance organi- 
zations.'^^' Both the health care delivery component of a health main- 
tenance organization and its administrative and insuring aspects were 
apparently covered, as were physicians and other providers who con- 
tracted to serve HMO beneficiaries. An incidental effect of the coverage 
of health maintenance organizations themselves rather than health care 
facilities sponsored by HMO's was to require coverage of certain service- 
related projects offered by health maintenance organizations which were 
not required to be covered when offered by other health care facilities. 
For example, the establishment of a non-surgical ambulatory care facility 
component of a health maintenance organization was required to be 
covered regardless of cost, although establishment of such a facility by 
any other proponent would not have been subject to review unless 
associated with at least a $150,000 capital expenditure. 



■^^45 Fed. Reg. 69,746 (1980) (amending 42 C.F.R. § 123.404 (1977)). 

"^See Table 3. 

'''See 42 Fed. Reg. 4008 (1977). 

'''See 41 Fed. Reg. 11,706 (1976) (proposing 42 C.F.R. § 100.103(c)). 

■^Subsequent NHPRDA amendments added a provision requiring coverage of ac- 
quisitions if the SHPDA found that the services or bed capacity of the facility being 
acquired would be changed in the process. Health Planning and Resources Development 
Amendments of 1979, Pub. L. No. 96-79, 117, 93 Stat. 592, 617-18 (codified at 42 U.S.C. 
§ 300m-6(d) (1982)). 

'"•'42 U.S.C. § 300n(5) (1976). 



1046 INDIANA LAW REVIEW [Vol. 19:1025 

From the time of their adoption, the HMO coverage requirements 
of NHPRDA and section 1 122 were criticized as overbroad and a potential 
hindrance to the spread of HMO's.'"' Congress and the Department of 
Health and Human Services soon began to cut back the HMO coverage 
provisions. In 1978, all references to HMO's were deleted from section 
1122.'"' In 1979, a broad HMO exemption from NHPRDA was adopted. 
It required state certificate of need programs to exempt HMO's and 
inpatient health care facilities controlled or leased for a period of years 
by an HMO if the HMO enrollment was at least 50,000, 75% of the 
facilities' patients would be enrollees, and the facility would be geo- 
graphically accessible to the enrollees.'"^ The 50,000 enrollee requirement 
was deleted in 1981."*^ A similar but even broader exemption for facilities 
used by HMO's was placed in section 1122 in 1983.'"^ 

5. Increase in Expenditure Threshold. — The $150,000 NHPRDA 
capital expenditure threshold represented an increase over the $100,000 
level under the section 1122 program. This was the first of repeated 
NHPRDA and section 1122 expenditure threshold increases over the 
years. The rationales offered for this first, modest increase were essentially 
the same as those offered each time the thresholds have been increased 
— that few significant capital expenditures cost less than the new, elevated 
threshold, and that due to inflation, the increase retained coverage 
unaltered in constant dollars.'"^ Though not articulated by the Depart- 
ment, an additional justification for this and subsequent threshold in- 
creases was to remove certificate of need programs' authority over 
projects not involving major expansion of clinical health services. Health 
facilities, particularly hospitals, routinely incur capital expenditures for 
physical plant maintenance and improvement of non-patient care areas 
and equipment. Health planning agencies tend to be drawn into reviewing 
these costs by thresholds at the $100,000 level. Yet the agencies possessed 
no particular expertise to oversee the decisions of health facilities on 
the timing and amount of such transactions, the relationship between 
such projects and the rationales for certificate of need regulation were 
attenuated, and the delay caused by even cursory review of such projects 
generated considerable objection from regulated facilities.'"^ 



'"^See Havighurst, Health Maintenance Organizations and the Health Planners, 1978 
Utah L. Rev. 123, 141. 

'"-See Health Maintenance Organizations Amendments of 1978, Pub. L. No. 95-559, 
§ 14(b)(l)-(3), 92 Stat. 2141. 

'"^Health Planning and Resources Development Amendments of 1979, Pub. L. No. 
96-79, Sec. 117(a), 93 Stat. 614 (codified at 42 U.S.C. § 300m-6(b)(l) (1982)). 

'""Omnibus Budget Reconciliation Act of 1981, Pub. L. No. 97-35, § 949(c), 95 Stat. 
578. 

'"^Social Security Amendments of 1983, Pub. L. No. 98-21 § 607(c), 97 Stat. 172. 

"M2 Fed. Reg. 4008 (1977). 

'"'See, e.g.. Brown, supra note 12, at 485-86. 



1986] CERTIFICATE OF NEED 1047 

6. Changes in Bed Capacity. — Regulation adopted after NHPRDA's 
passage defined bed capacity changes subject to review as 

[a] change in bed capacity of a health care facility or health 
maintenance organization which increases the total number of 
beds (or distributes beds among various categories or relocates 
such beds from one physical facility or site to another) by more 
than ten beds or more than ten percent (10%) of total bed 
capacity as defined by the state, whichever is less, over a two 
year period. '^'*^ 

Bed category changes and bed relocations had not been subject to review 
under the 1122 rules. However, the Department decided to subject such 
transactions to certificate of need coverage on the grounds that substantial 
conversions could affect the delivery and cost of health services.'"*^ 

Like the capital expenditure threshold increase, the exemption for 
'insubstantial" changes, i.e., bed capacity and other changes of ten 
beds or less or ten percent of total bed capacity, whichever was less, 
over a two-year period, was intended to shift regulatory review away 
from relatively minor projects. The Department had considered several 
versions of this exemption. It initially proposed to cover any addition, 
relocation, or category change."" Then, an extremely generous insub- 
stantial change exemption was announced in the adopted regulations. It 
exempted bed capacity changes of less than forty beds or twenty-five per- 
cent of total bed capacity, whichever was less, over a two-year period.'" This 
was a potentially major exemption from certificate of need, particularly 
for bed category conversions."^ In recognition of the size of this loophole, 
shortly thereafter the "forty beds or twenty-five percent" exemption was 
changed to the **ten beds or ten percent" provision."^ The current 
federal regulations cover substantial bed capacity changes associated with 
any capital expenditure, leaving the definition of exempt insubstantial 
changes up to individual states. ""* 



"M2 C.F.R. § 123.404(a)(3) (1977). 

'"^42 Fed. Reg. 4008 (1977). Required coverage of bed category changes and bed 
relocations was deleted from the federal regulations in 1985 in order to allow states greater 
flexibility in operating their certificate of need programs. 42 C.F.R. § 123.404(a)(2) (1985). 
See 50 Fed. Reg. 2008 (1985). 

""41 Fed. Reg. 11,702 (1976) (proposing to adopt 42 C.F.R. § 123.404(a)(3)). 

'"42 Fed. Reg. 4029 (1977) (adopting 42 C.F.R. § 123.404(a)(3)). 

"-A forty bed addition would usually generate a capital expenditure in excess of the 
threshold and therefore come under review notwithstanding the exemption. The same thing 
would probably be true for bed relocations. However, for bed conversions the provision 
would, for example, allow a 160-bed acute care hospital facility to convert into a 90-bed 
acute care facility with a 70-bed skilled nursing unit in two years and a day, assuming 
no capital expenditure in excess of $150,000. 

"H2 Fed. Reg. 18,607 (1977) (amending 42 C.F.R. § 122.404(a)(3)). 

"M2 C.F.R. § 123.404(a)(2) (1985). 



1048 INDIANA LAW REVIEW [Vol. 19:1025 

7. Coverage of Changes in Health Services. — The initial NHPRDA 
regulations provided for coverage of 

[h]ealth services, except home health services, which are offered 
in or through a health care facility or health maintenance or- 
ganization and which were not offered on a regular basis in or 
through such health care facility or health maintenance orga- 
nization within the twelve-month period prior to the time such 
services would be offered."^ 

The Department of Health and Human Services has never specified the 
services that fall within the term "health services," except to indicate 
that the term refers to clinical services."^ It has stated, somewhat un- 
helpfully, that "Ia]ny service is covered if it is included in the scope 
of coverage developed by the state. ""^ Additionally, it has never clarified 
whether increases in the volume, intensity, or type of clinical services 
provided in a department constitute a new service, or whether only a 
new department or cost center would be covered."^ 

8. Bed and Service Terminations. — Capital expenditures exceeding 
the threshold for termination or reduction of beds or health services 
were also exempted from capital expenditure coverage. This provision 
represented a departure from section 1122, under which capital expend- 
itures of any amount for termination of services or reduction of beds 
are covered."*^ Although the Department amended the NHPRDA reg- 
ulations in 1980 to require coverage of capital expenditures associated 
with bed and service terminations, it recently deleted the requirement 
once again, so that at present, states are not required to cover termi- 
nations. '^° The Department has also proposed to delete the section 1122 
requirement that terminations be covered.'^' 



"^42 Fed. Reg. 4029 (1977) (adopting 42 C.F.R. § 123.404(a)(4)). 

""50 Fed. Reg. 2014 (1985) (amending 42 C.F.R. § 123.401). 

"M2 Fed. Reg. 4008 (1977). The Department has occasionally expressed its views on 
whether certain activities should be considered new services. The 1977 regulations excluded 
home health services from the "health services" definition. In 1979, the Department 
adopted regulations requiring coverage of radiological diagnostic health services provided 
by fixed or mobile computed tomography (CT) scanning equipment under state certificate 
of need programs. 42 C.F.R. § 123.404(a)(5) (1979) (amended 1981); see also 42 C.F.R. 
§ 100.103(a)(2)(iv) (1985) (addition of CT scanning is a substantial change in services 
under section 1 122). 

'"See Community Psychiatric Centers of Or., Inc. v. Grant, Civ. No. 79-782 (D. 
Or. July 8, 1980), rev'd on other grounds, 664 F.2d 1148 (9th Cir. 1981) (interpreting 
federal regulations to cover extensive changes in the level or volume of clinical services). 
"42 C.F.R. §§ 100.103(a)(2)(iii), (iv) (1985). 
"42 C.F.R. §§ 123.404(a)(2),(3) (1985). 

'-^See 48 Fed. Reg. 36,395 (1983) (to be codified at 42 C.F.R. § 125.102). 



1 1 4^ 
1:1)/ 



1986] CERTIFICATE OF NEED 1049 

B. State Certificate of Need Coverage After Passage of NHPRDA 

Passage of NHPRDA prompted more states to adopt certificate of 
need laws so that by 1978, forty states and the District of Columbia 
had certificate of need programs. '^^ All but one of these covered hospitals 
and nursing homes. Georgia was the exception, covering only nursing 
homes. Thirty-six states covered ambulatory surgical facilities, an increase 
from earlier surveys probably due to coverage of such facilities under 
NHPRDA and section 1122.'^^ Twenty-four states covered home health 
agencies, even though such coverage was not required under either 
NHPRDA or section 1122.'^^ 

Virtually every state subjected capital expenditures to review, in- 
cluding physical plant construction and other major capital expenditures. 
Thresholds varied from state to state, though less than they had in 1973. 
All but a handful of states had $100,000 or $150,000 thresholds. '^^ This 
consensus on expenditure thresholds was undoubtedly due to the state 
participation in 1122 or NHPRDA, which had $100,000 and $150,000 
thresholds respectively. 

All but two states expressly covered increases in bed supply. '^^ This 
was a greater number than had covered such transactions in 1973, 
probably reflecting national concern with excess bed capacity and the 
coverage of such transactions under 1122 and NHPRDA. More than 
half of the states continued to cover even single bed additions, rather 
than using the insubstantial increase exception permitted by NHPRDA. 
However, two states had adopted the '*forty beds or twenty-five percent" 
increase exemption proposed by HEW in 1977.'^^ Half of the states 
covered bed supply reductions. All but three states covered additions of 
new health services. Eighteen states covered deletions of services in one 
form or another. '^^ 

C Health Planning and Resources Development Amendments of 

1979 

In late 1979, there was dissatisfaction in Congress with implemen- 
tation of NHPRDA.'^ The costs of health care had continued to increase 
at a steady pace. Congress believed that excess capacity, the target of 
NHPRDA, was one cause of the increase. However, a number of econ- 



'--Cohodes, supra note 7, at 87-88. 
'-'Id. 
'-'Id. 
''-'Id. 
'"'Id. 

'-^Chayet &. SoNNENREiCH, P.C., supra note 15, at 11. 
'-•^Cohodes, supra note 7, at 88. 

'"H.R. Rep. No. 190, 96th Cong., 1st Sess. 47-101 (1979); S. Rep. No. 96, 96th Cong., 
1st Sess. 50-93, reprinted in 1979 U.S. Code Cong. & Admin. News 1306, 1355-98. 



1050 INDIANA LAW REVIEW [Vol. 19:1025 

ometric studies circulating at the time had concluded that certificate of 
need programs, as then constituted, did not have a significant impact 
on the rate of hospital capital investment.'^" 

In addition, certificate of need programs were generating a significant 
amount of controversy and litigation. A series of well-publicized reversals 
suggested that the planning agencies wavered between rigidly applying 
numerical need formulae that ignored the statutory criteria or rulemaking 
requirements and issuing unpredictable, ad hoc rulings.'^' Legal com- 
mentators had suggested a variety of reforms in the review process. '^^ 
There was great concern that certificate of need coverage of expenditures 
for costly medical equipment was being evaded. Finally, there was concern 
that the existing pattern of certificate of need coverage in the law and 
regulations placed a very heavy workload on planning agencies and 
dictated that nearly as much time be spent on projects with small cost 
implications as on major projects. 

In response. Congress passed the Health Planning and Resources 
Development Amendments of 1979.'^^ In spirit, if not in coverage scope, 
they narrowed the focus of federally-mandated certificate of need from 
general health system management to economic regulation.'^"* Although 
cost containment was a dominant purpose of the amendments, they also 
added statutory provisions mandating as review criteria the accessibility 
of proposed services and the quality of care previously provided by a 
certificate of need applicant. '^^ A number of important procedural changes 
were adopted, including provisions requiring comparative review of com- 



""See Cohodes, supra note 7, at 76-77 and studies cited therein. 

'"See, e.g.. North Miami Gen. Hosp., Inc. v. Office of Community Medical Facilities, 
355 So. 2d 1272 (Fla. Dist. Ct. App. 1978) (inconsistent application of criterion); Huron 
Valley Hosp., Inc. v. Michigan State Health Facilities Comm'n, 110 Mich. App. 236, 312 
N.W.2d 422 (1981) (undisclosed preference for existing facilities over new construction); 
Irvington Gen. Hosp. v. Department of Health, 149 N.J. Super. 461, 374 A.2d 49 (1977); 
Sturman v. Ingraham, 52 A.D.2d 882, 383 N.Y.S.2d 60 (1976) (exclusive reliance on bed 
need formula in disregard of statutory criteria). 

'^See, e.g., Bovbjerg, Problems and Prospects for Health Planning: The Importance 
of Incentives, Standards, and Procedures in Certificate of Need, 1978 Utah L. Rev. 83, 
111-115; Schonbrum, Making Certificate of Need Work, 57 N.C.L. Rev. 1259 (1979). 

'"Pub. L. No. 96-79, 93 Stat. 592 (1979). 

'''See 42 U.S.C. § 300k-2 (Supp. Ill 1979) (legislative finding that states should 
exercise the certificate of need function under NHPRDA to allocate the supply of health 
services for which, by reason primarily of reimbursement mechanism distortions, the market 
does not or will not do so). 

"^42 U.S.C. §§ 300m-l(c)(6)(E),(14) (1982). The legislative history of these provisions 
reveals strong support for planning agency use of certificate of need programs as vehicles 
for reducing economic barriers to medical care for Medicare and Medicaid beneficiaries 
and the medically indigent. S. Rep. No. 96, 96th Cong., 1st Sess. 78, reprinted in 1979 
U.S. Code Cong. & Admin. News 1306, 1374-76 (SHPDA's and HSA's should use their 
full range of authority and influence to remedy access problems). 



1986] CERTIFICATE OF NEED 1051 

peting applications and administrative appellate review of SHPDA de- 
cisions on certificate of need applications.'^^ Several provisions were 
added to strengthen certificate of need decision-making by improving 
state health plan development and making consistency with the state 
health plan the primary review criterion. '^^ Finally, after the amendments, 
NHPRDA required states to cover capital expenditures exceeding $150,000, 
capital expenditures substantially changing the bed capacity of a health 
care facility or substantially changing the services of such facility, new 
institutional health services entailing annual operating costs in excess of 
an expenditure minimum of $75,000, and acquisitions of major medical 
equipment costing in excess of an expenditure minimum of $150,000.'^* 

1. Capital Expenditure Coverage. — Coverage of general purpose 
capital expenditures exceeding the expenditure minimum remained es- 
sentially as it was prior to the 1979 amendment. '^^ Coverage of bed 
capacity changes and service changes was modified. Previously any bed 
supply increase, decrease, category redistribution, or relocation exceeding 
the '*ten beds or ten percent*' exemption was subject to review. Now 
such transactions were covered only if a capital expenditure was incurred 
to accomplish them."*^ In practice, this change probably served to exempt 
only a few previously-covered bed supply decreases and category redis- 
tributions. 

Similarly, where previously all health service additions were covered, 
now such transactions were covered only if associated with a capital 
expenditure (or, as noted infra, if the new service's annual operating 
costs exceeded the operating cost expenditure threshold)."*' Whether or 
not this change had any noticeable effect on a state's scope of coverage 



'M2 U.S.C. §§ 300k-l(b)(12)(D),(13)(A)(iii) (1982). 

'"42 U.S.C. §§ 300m-3, 300m-6(a)(5) (1982). 

'M2 U.S.C. §§ 300m-6(a)(l), 300n(5) (1982). 

"The 1979 amendments did authorize states, in their discretion, to begin annually 
adjusting their capital expenditure (and annual operating cost) thresholds upward according 
to an index of changes in construction costs. Both the capital expenditure and annual 
operating cost thresholds were eligible for adjustment. A state opting to make full use 
of the adjustment could have increased its thresholds over the statutory maximum by a 
total of 23 percent by 1985. Applied to the increased capital expenditure threshold authorized 
in 1981, the current maximum complying capital expenditure threshold would be $736,2(X). 
See 50 Fed. Reg. 14,027 (1985). 

^'"Compare 42 C.F.R. § 123.404(a)(3) (1977) with 42 C.F.R. § 123.404(a)(2) (1981) 
(amended 1985). 

'^'The 1979 amendments were also interpreted by the Department of Health and 
Human Services to provide for coverage of capital expenditures associated with the 
termination of a health service. 42 C.F.R. § 123.404(a)(3) (1981) (amended 1985). The 
Department's rationale for covering bed and service terminations was that such coverage 
would permit states to use certificate of need programs to promote accessibility of health 
services, especially to the indigent and medically underserved. See 45 Fed. Reg. 69,757- 
81 (1980). 



1052 INDIANA LAW REVIEW [Vol. 19:1025 

depended greatly on the state's definition of * 'health service." A state 
that defined ''services" to include some clinical procedures (e.g., open- 
heart surgery) as well as brick-and-mortar departments might find some 
formerly-covered projects escaping review, since some clinical services 
can be commenced \yithout the need to incur capital costs. '^^ 

2. New Health Services Exceeding an Annual Operating Cost 
Minimum. — A new category of coverage was added by the 1979 amend- 
ments. Implementing regulations provided for coverage in the following 
terms: 

[t]he addition of a health service which is offered by or on 
behalf of a health care facility which was not offered by or on 
behalf of the facility within the twelve-month period before the 
month in which the service would be offered, and which entails 
annual operating costs of at least the expenditure minimum for 
annual operating costs. "'^ 

The expenditure minimum for annual operating cost was another ex- 
penditure threshold, set at $75,000.''^ 

The purpose of introducing an annual operating cost threshold into 
certificate of need coverage of new services was to trim review back to 
those projects with the greatest cost implications. Annual operating cost 
thresholds for certificate of need review had been under discussion for 
some time prior to the 1979 amendments. In 1978, a NHPRDA amend- 
ment bill restricting certificate of need coverage to health services entailing 
annual operating costs of $50,000 or more and acquisitions of medical 
equipment costing $150,000 or more passed the Senate but was not acted 
on by the House. '"^^ During this period, a number of health policy 
analysts argued that the institutional health services sector was not as 
capital-intensive as previously assumed and that the overall cost-inflating 
impact of capital investment came more from the additional operating 
costs generated by projects than from the capital costs of such projects 
themselves."*^ It was also observed that although high capital cost projects 



'^-However, non-capital expenditure service additions might be covered as additions 
of services entailing annual operating costs in excess of the expenditure minimum for 
annual operating costs. See infra note 202 and accompanying text. 

'^'42 C.F.R. § 123.404(a)(3)(ii) (1981). 

'^^The expenditure minimum for annual operating costs could be adjusted for inflation 
like the capital expenditure threshold. If a state made full use of the adjustment and 
increased its annual operating cost threshold to the elevated level authorized by 1981 
NHPRDA amendments, its current expenditure minimum for annual operating costs would 
be $306,750. 

'^^S. 2410, 95th Cong., 2d Sess. (1978). 

'^''See, e.g., D. Schneider, The Relationship Between Capital and Operating 
Costs in Hospitals: Implications for Regulatory Control 8-12 (Rennsalaer Polytechnic 
Inst., Final Report 1981) (estimates that six percent of hospital costs were attributable to 
capital costs). 



1986] CERTIFICATE OF NEED 1053 



were usually associated with high operating costs, some projects and 
services (e.g., renal dialysis stations) required low initial investment, but 
generated high costs of operation.''*^ This work suggested that it might 
be appropriate to substitute an annual operating cost threshold for the 
capital expenditure threshold (or to retain a high threshold only for 
non-service-related capital expenditures large enough to have a cost impact 
on their own)."*^ The coverage provisions in the 1978 Senate bill seem 
to have adopted this approach. Unfortunately, the 1979 amendments did 
not. Although they introduced an annual operating cost threshold for 
new services, they retained coverage of any service addition associated 
with a capital expenditure in any amount. Continued coverage of service 
additions associated with any capital expenditure probably rendered the 
annual operating cost threshold relatively unimportant, because most 
service additions require some capital expenditure and consequently are 
covered regardless of operating cost. 

3. Major Medical Equipment. — The 1979 amendments introduced 
another new element of coverage: acquisition by any person of major 
medical equipment costing in excess of $150,000. Equipment not owned 
by or located in a health care facility was excluded unless: (1) the state's 
SHPDA found, after notice from the person acquiring the equipment, 
that it would be used to provide services for inpatients of a hospital; 
or (2) prior to September 30, 1982, the state certificate of need program 
provided for coverage of such equipment. '^"^ 

Coverage of major medical equipment was adopted to prevent what 
was seen as a major gap in coverage giving rise to widespread evasion 
of certificate of need laws. At about the same time as NHPRDA was 
adopted, several types of expensive high-technology medical devices ap- 
peared on the market. Chief among these was the computed tomography 
(CT) scanner, a diagnostic radiological machine which typically cost in 
excess of $300,000 to acquire, generated annual operating costs in excess 
of $250,000, and (though rapidly accepted by clinicians) was of unproven 



'^7g^. ; see also Arthur D. Little, Inc., Development of an Evaluation Meth- 
odology FOR Use in Assessing Data Available to the Certificate of Need (CON) 
AND Health Planning Programs 53-95, 187-89, and studies cited at 20-22 (Final Report 
prepared for Office of the Ass't Sec'y for Health, U.S. Dep't of Health & Human Services, 
under Contract No. 233-79-4(X)3 (1982)). 

'^"^Alternatively, a very low capital expenditure threshold and no annual spending cost 
threshold could be used, but this would result in coverage of some low operating cost, 
low capital cost projects. See Cohen & Cohodes, Certificate of Need and Low Capital- 
Cost Technology, 60 Milbank Mem. Fund Q. 307, 314-15 (1982). 

'••*'42 U.S.C. § 300m-6(e)(l) (1982). The 1980 regulations specified that major medical 
equipment could be used to provide services to inpatients on a temporary basis in the 
case of natural disaster, major accident, or equipment failure without undergoing review. 
42 C.F.R. § 123.404(a)(4)(iii) (1981). 



1054 INDIANA LAW REVIEW [Vol. 19:1025 

efficacy.'^*' Reports surfaced that hospitals were evading certificate of 
need and section 1122 coverage of such devices by placing them in 
adjacent non-hospital buildings or vesting their ownership in persons or 
entities not subject to review, while using the equipment for inpatients.'^' 
In response, the Department of Health, Education and Welfare published 
NHPRDA and section 1 122 regulations requiring coverage of CT scanning 
as a new service.'" The Department and various others also supported 
NHPRDA amendments that would have covered large capital projects 
in non-institutional settings, including acquisitions of costly medical 
equipment.'" However, physician groups strongly opposed such a pro- 
vision on the ground that it would extend certificate of need review into 
physicians' offices, and argued that the states ought to be given the 
option of extending coverage to medical equipment outside the insti- 
tutional setting.'^"* The provision adopted in 1979 represented a com- 
promise between these views. 

4. Expedited Review and Low-Priority Project Exceptions. — Various 
groups testifying before Congress about the 1979 NHPRDA amendments 
or commenting on the 1980 implementing regulations suggested amend- 
ments and changes to streamline certificate of need review and exempt 
certain classes or categories of projects. The leading target for exemption 
was projects for remodeling and replacement of obsolete facilities and 
equipment. '^^ Because excess capacity is one of the primary rationales 
for adopting certificate of need statutes, such an exemption appears self 
defeating. By denying an application for a certificate of need to replace 
an obsolete facility or equipment, SHPDA's can exercise a ''de facto'' 
decertification power over existing excess capacity in the industry. '^^ The 



""American Hosp. Ass'n, CT Scanners: A Technical Report 43, 51 (1977). See 
generally U.S. Cong., Ofhce of Technology Assessment, Policy Implications of the 
Computed Tomography (CT) Scanner (1978). 

'"See Health Planning and Resources Development Amendments of 1979: Hearings 
on H.R. 3041 and 3167 Before the Subcomm. on Health and the Environment of the 
House Comm. on Interstate and Foreign Commerce, 96th Cong., 1st Sess. 521 (1979) 
(testimony of Russell Johan, Exec. Dir., Southeastern Wis. Health Systems Agency) 
($750,000 CT scanner reportedly installed by physician group in old hamburger stand). 

'^-42 C.F.R. §§ 100.103(a)(2)(iv), 123.404(a)(5) (1979) (amended 1981). 

^^^ Health Planning Amendments of 1978: Hearings on S. 2410 Before the Subcomm. 
on Health and Scientific Research of the Senate Comm. on Human Resources, 95th Cong., 
2d Sess. 128, 134 (1978) (statement of Hale Champion, Secretary of HEW). 

'^'Health Planning Amendments of 1978, S. Rep. 845 (to accompany S. 2410), 95th 
Cong., 2d Sess. 188-89 (1978). 

'"Exemption or streamlined review was not a new idea. The California certificate of 
need program had for several years provided a broad exemption for projects to remodel 
or replace facilities or equipment in existence at the time the state's certificate of need 
program was adopted. Cal. Health & Safety Code § 437.13 (West 1976) (repealed 1984). 
In addition, the Department of Health, Education and Welfare had advised states in 1977 
of the option of "expedited review" of projects. See 42 Fed. Reg. 4007, 4009 (1977). 

'"'See Kopit, Krill & Bonnie, Hospital Decertification: Legitimate Regulation or a 
Taking of Private Property?, 1978 Utah L. Rev. 179. 



1986] CERTIFICATE OF NEED 1055 

effect of placing an exemption in a certificate of need law is to forgo 
the opportunity to close down existing excess capacity and to limit the 
program's impact to new and expanded services. However, hospital decer- 
tification, whether accompHshed directly or indirectly through denial of 
remodeling and replacement project applications, usually encounters power- 
ful political opposition. '^^ In addition, generally lower costs of remodel- 
ing and replacement, as opposed to new services, and stable or increasing 
patient populations mean that such projects are seldom turned down on 
their merits by planning agencies. '^^ 

The 1979 NHPRDA amendments did not adopt a remodeling and 
replacement exemption, but they did take a step in that direction by 
authorizing a form of limited review of certain replacement and high 
priority projects. The statute and regulations provided that capital ex- 
penditures (1) to eliminate or prevent imminent safety hazards (as defined 
by federal, state, or local fire, building, or life safety codes and reg- 
ulations); (2) to comply with state licensure standards; and (3) to comply 
with the accreditation standards necessary for Medicare or Medicaid 
reimbursement should be approved unless the state agency found that 
the facility or service for which the capital expenditure was proposed 
was unneeded or that the obligation of the capital expenditure for the 
project was inconsistent with the state health plan.'-*^ 

D. Continued Implementation of NHPRDA 

Adoption of state certificate of need statutes in response to NHPRDA 
continued steadily after the passage of the 1979 amendments. By 1980, 
forty-seven states and the District of Columbia had certificate of need 
programs. Only Louisiana, Idaho, and Indiana lacked certificate of need 
statutes, and all three had 1122 programs. By the end of 1980, Idaho 
and Indiana had adopted certificate of need laws.'^" Several states ter- 
minated their 1122 agreements after they adopted certificate of need 
laws.'^' This change was due in part to the perception that the presence 
of a certificate of need program rendered section 1122 superfluous.'^^ 
Additionally, the Department of Health and Human Services did not 
provide any additional funding for the cost of administering both cer- 
tificate of need and 1122 programs.'" 

'"'See, e.g.. Carpenter & Paul-Shaheen, Implementing Regulatory Reform: The Saga 
of Michigan's Debedding Experiment, 9 J. Health Pol. Pol'y & L. 453 (1984). 

'""See infra note 174. 

'^"42 U.S.C. § 300m-6(c) (Supp. Ill 1979). 

'""American Health Planning Ass'n, Selected Data on State Health Planning 
AND Related Programs (1982). 

""Congressional Budget Office, Health Planning: Issues for Reauthorization 
14-15 (1982). 

"-S. Rep. No. 96, 96th Cong., 1st Sess. 43, reprinted in 1979 U.S. Code Cong. & 
Admin. News 1306, 1348. 

"''See 44 Fed. Reg. 44,345 (1979). 



1056 INDIANA LAW REVIEW [Vol. 19:1025 

E. Recent NHPRDA Amendments 

Since the 1979 amendments, NHPRDA has not undergone major 
revision. However, the relationship between NHPRDA's certificate of 
need requirements and state certificate of need programs has been drast- 
ically altered, and NHPRDA's coverage provisions themselves have been 
modified. 

The provision of NHPRDA authorizing appropriations for funding 
HSA's and SHPDA's expired September 30, 1982.'^ From that time 
until the present. Congress has temporarily continued the program in 
annual appropriations bills. '^^ Each year, Congress has appended a rider 
to the appropriations bills forbidding the Secretary of Health and Human 
Services from terminating or penalizing a state that fails to have a 
certificate of need program complying with NHPRDA during the fiscal 
year covered by the bill.'^^ The effect of these provisions has been to 
release states from the risk of losing federal funds by amending their 
certificate of need statutes to deviate from NHPRDA. '^^ In the wake 
of these provisions, numerous states have adopted certificate of need 
coverage provisions differing sharply from NHPRDA. 

The NHPRDA coverage provisions themselves also have been sub- 
stantially cut back. The Health Programs Extension Act of 1980 added 
a permissive exemption from certificate of need coverage for projects 
* 'solely for research. ""^*^ The NHPRDA exemption applies to projects 
solely for research that would not affect patient charges or substantially 
change bed capacity or medical and other patient care services of the 
facility (either initially or after the project has been developed). '^'^ 



"^42 U.S.C. § 300n-6 (1982). 

"•■Departments of Labor, Health and Human Services and Education and Related 
Agencies Appropriations Act, 1986, Pub. L. No. 99-178, Title II, 99 Stat. 1102, 1109 (1985); 
Continuing Appropriations 1985, Pub. L. No. 98-473, § 315(k), 98 Stat. 1837, 1963 (1984); 
Continuing Resolution 1984, Pub. L. No. 98-151, § 101(c), 97 Stat. 964, 972 (1983); Conti- 
nuing Appropriations 1984, Pub. L. No. 98-107, § 101(f), 97 Stat. 733, 736 (1983); Further 
Continuing Appropriations 1983, Pub. L. No. 97-377, § 101(e)(2), 96 Stat. 1830, 1905-6 
(1982); Continuing Appropriations Fiscal Year 1983, Pub. L. No. 97-276, § 133, 96 Stat. 
1186, 1197 (1982). 

"*E.g., Further Continuing Appropriations for the Fiscal Year 1986, § 124, 99 Stat. 
1185, 1320 (1985) ("no penalty shall be applied nor any State or agency agreement 
terminated pursuant to sections 1512, 1515, or 1521 of the Public Health Service Act 
during fiscal year 1986.") 

"•'A court has also held that the appropriations bills' riders implicitly repeal NHPRDA 
certificate of need requirements, rendering them unenforceable by third parties (who are 
not specifically barred from enforcement actions by the express terms of the riders). 
Harrisburg Hosp. v. Thornburgh, 616 F. Supp. 699 (M.D. Pa. 1985), aff'd mem., 791 
F.2d 918 (3d Cir. 1986). 

''Tub. L. No. 96-538, § 307, 94 Stat. 3183, 3191 (1980) (codified at 42 U.S.C. 
§ 300m-6(h) (1982)). 

"""42 U.S.C. § 300m-6(h)(1982). Proposals to grant special treatment for research and 
education projects had a long history. See 38 Fed. Reg. 31,380 (1973) in which the 



1986] CERTIFICATE OF NEED 1057 

In the Omnibus Budget Reconciliation Act of 1981, the NHPRDA 
capital expenditure threshold was increased to $600,000, the expenditure 
minimum for major medical equipment was increased to $400,000, and 
the expenditure minimum for annual operating costs was raised to 
$250,000.'^" The purpose of these changes was to * 'promote focusing 
the resources available for certificate of need reviews on the most ex- 
pensive and future cost-generating new investments in medical care.'"^' 

High inflation during this period clearly necessitated some threshold 
increases simply to retain coverage at the originally adopted level. A 
$150,000 capital expenditure for construction in 1977 would have cost 
in excess of $232,000 by 1982.'^^ Furthermore, many state CON programs 
were experiencing great problems keeping up with their review work- 
load. '^^ Low thresholds meant agencies were bogged down in review of 
routine replacement expenditures and expenditures for projects, such as 
acquisition of computerized medical information systems, telephone sys- 
tems, and parking structures, that were unrelated to patient care. Ap- 
proval rates for such projects tended to be very high.'^'* 

In addition, there was increasing recognition at this time that se- 
lectively raising thresholds would focus certificate of need review on the 
most costly and controversial projects. One study indicated that by 



Secretary rejected a proposal to give special consideration to health-related teaching and 
research capital expenditures under the section 1122 program. In 1978, Massachusetts 
added a provision to its certificate of need statute exempting capital expenditures and 
substantial changes in services if they were essential to the conduct of research in basic 
bio-medical or health care delivery areas or essential to the training of health care personnel, 
and would not increase capacity or charges. Mass. Gen. Laws Ann. ch. Ill, § 25(c) 
(West 1978) (amended 1980, 1981). With the Massachusetts law as a prototype, in 1979 
the Association of American Medical Colleges recommended an amendment to NHPRDA 
which would have exempted from CON review medical education and research projects 
with only minor health service impacts. Health Planning Amendments of 1979: Hearing 
on S. 594 Before the Subcomm. on Health and Scientific Research of the Senate Comm. 
on Labor and Human Resources, 96th Cong., 1st Sess. 464 (1979) (statement of John 
A.D. Cooper, President, Association of American Medical Colleges). 

'^"Pub. L. No. 97-35, §§ 936(a)(l)-(3), 95 Stat. 572 (1981) (codified as amended at 
42 U.S.C. § 3(X)n(5),(6),(7) (1982)). 

'^'Omnibus Budget Reconciliation Act of 1981, H.R. Rep. No. 208, 97th Cong., 2d 
Sess. 823 (1981). 

^''^See U.S. Dep't of Commerce, Construction Review 754 (December 1982); U.S. 
Dep't of Commerce, Statistical Abstract of the United States: 1981 754 (1981). The 
section 1122 threshold was even further out of adjustment than the NHPRDA thresholds. 
A $100,000 construction expenditure in 1973 would have cost $225,000 by 1982. Id. 

'^■The volume of certificate of need applications had increased while agency funding 
had decreased. See supra note 8; Office of Health Planning, U.S. Dep't of Health 
& Human Services, Status Report on State Certificate of Need Programs 3 (1985). 

"^For example, from 1973-82 the certificate of need application approval rates in 
Florida for equipment replacement and expansion/renovation (not involving new services) 
were 99.4 percent and 98.1 percent respectively, while the approval rate for all other 
projects was 81.4 percent. Office of Health Planning, Fla. Dep't of Health & 
Rehabilitative Services, Annual Report on Certificate of Need Activity 42 (1984). 



1058 INDIANA LAW REVIEW [Vol. 19:1025 

increasing the capital threshold in New York from $100,000 to $1,000,000 
and setting a $250,000 annual operating threshold for new services, three 
quarters of the projects reviewed in 1979 would have been exempted. 
The remaining projects subject to review, however, would account for 
77% of the capital cost and over 96% of the operating cost impU- 
cations of all projects proposed under the lower thresholds. '^^ Sim- 
ilarly, a Department of Health and Human Services study indicated that 
almost 60% of the certificate of need/section 1122 applications in 
the 1979-1980 study year were for expenditures below $500,000. These 
projects accounted for less than 10% of the proposed costs. Further- 
more, approval rates were higher for lower cost projects.''^ Build- 
ing on these studies, a number of recommendations for certificate of 
need coverage reform were put forth at this time.'^^ A common theme 
was the need to redefine coverage terms so as to focus on high priority 
projects. One study advocated high capital expenditure thresholds and 
an annual operating cost threshold for new services.'^** However, it also 
recommended covering, without regard to operating or capital cost, those 
new services or items of equipment for which quality of care rationales 
for certificate of need coverage were strongest. '^"^ Others recommended 
covering specified services or technologies rather than using expenditure 
or cost thresholds.'^" The threshold increases adopted by Congress in 
the 1981 Budget Act did not exactly follow these proposals."^' Because 



'"D. Schneider, supra note 146. 

"*E. Coleman, Volume and Value of CON/1122 Applications (Bureau of Health 
Planning, U.S. Dep't of Health & Human Services, Program Information Note 81-7 
(1981)). 

'''See, e.g., J. Howell, Regulating Hospital Capital Investment: The Experience 
OF Massachusetts (Nat'l Center for Health Serv. Res., Research Summary Series (1981)); 
D. Schneider, supra note 146; Cohen & Cohodes, supra note 148. 

'"*D. Schneider, supra note 146, at 11, 15-16. 

''-'Id. 

""'Cohen & Cohodes, supra note 148; see also J. Howell, supra note 177, at 21. 

"•'Threshold levels were negotiable items in the political debate over health planning 
in 1981, with opponents of the program seeking to reduce the number of projects subject 
to review as much as possible and proponents attempting to hold threshold increases to 
the level necessary to obtain continued political support for the program. Thus, in the 
spring of 1981, the Department of Health and Human Services drafted a legislative proposal 
to "phase-out" NHPRDA which would have increased the capital expenditure threshold 
to $500,000 and exempted non-clinical projects such as parking lots and heating systems. 
Administration Phase-out Bill Amended Consumer Majority Rule, Wash. Rep. on Medicine 
AND Health (1981). Starting with that figure, the House version of the 1981 Budget 
Reconciliation Act would have set the capital expenditure threshold at $500,000 and doubled 
the existing medical equipment and annual operating cost thresholds (then set at $150,000 
and $75,000) to $300,000 and $150,000 respectively. It would have also provided for 
modest reductions in federal health planning funding. Omnibus Budget Reconciliation Act 
of 1981, H.R. Rep. No. 158, Vol. 2, 97th Cong., 1st Sess. 383 (1981). The Senate version 
of the Budget Act would have radically defunded NHPRDA. Omnibus Budget Reconcilia- 



1986] CERTIFICATE OF NEED 1059 

the thresholds were raised across the board, they did not operate to 
select out specific classes of projects. In addition, because the federal 
regulations continued to require coverage of service additions associated 
with any capital expenditure, the effect of the annual operating cost 
threshold increase was not as great as might appear. 

F. Section 1122 Amendments and the Medicare Prospective Payment 

System 

Section 1122 program coverage had remained essentially unchanged 
from 1972. By the end of 1982, only fifteen states still had section 1122 
agreements. '^^ 

However, in late 1982, there was renewed interest in the 1122 pro- 
gram. '^^-^ From a political standpoint, the section 1 122 program had certain 
features attractive to proponents of federally-funded health planning. 
Because the law required the Department of Health and Human Services 
to enter into an 1122 agreement with any state able and willing to do 
so and provided for payment to states for the reasonable cost of running 
1122 programs, it seemed to be less vulnerable than NHPRDA to a 
hostile administration bent on defunding health planning or a Congress 
unable to decide whether to reauthorize or terminate NHPRDA. 

Additionally, because the consequence of a negative 1 122 recommen- 
dation was at most a partial reimbursement denial, not the denial of a 
permit to implement a proposed project, section 1122 programs could 
legitimately be characterized as less "regulatory" than state certificate of 
need reviews. The Medicare reimbursement sanction operated as a finan- 
cial disincentive to invest, and projects did sometimes proceed without 
section 1122 approval.'*^ These features were thought to make 1122 more 
palatable to deregulation proponents. 

Interest in the section 1 122 program was also sparked by congressional 
consideration at this time of fundamental reforms in the Medicare pro- 
gram. As part of a major social security bail-out package, Congress 
adopted a prospective payment system for Medicare. '^^ The prospective 
payment system reimburses most acute care hospitals participating in 



tion Act of 1981, S. Rep. No. 139, 97th Cong., 1st Sess. 878-79 (1981). Conference negotia- 
tions resulted in restoration of some federal funds in return for increasing each of the 
thresholds proposed in the House version by $100,000, resulting in the current $600,000, 
$400,000, $250,000 configuration. Omnibus Budget Reconciliation Act of 1981, H.R. Rep. 
208, 97th Cong., 2d Sess. 231 (1981). 

"*-Lewin & Assocs., supra note 73, at 14. 

"'See American Health Planning Ass'n, 1122 May Rise Again, IV Today in Health 
Planning, No. 8 (1982). 

'"'Lewin & Assocs., supra note 73, at 5. 

'-^Social Security Amendments of 1983, Title VI, 97 Stat. 149-152 (codified at 42 U.S.C. 
§ 1395WW (1983)). 



1060 INDIANA LAW REVIEW [Vol. 19:1025 

Medicare for acute inpatient services on the basis of a fixed amount 
per patient admission or '*case," based on average costs in a base year 
for comparable classes of hospitals, adjusted for each hospital's mix of 
high and low cost cases (represented by diagnostic clusters), and capped 
by a '^budget neutrality" ceiling under which total system reimbursement 
to hospitals may not exceed the amount that would have been paid 
under earlier payment systems. '^^ The prospective payment system was 
intended to alter the underlying financial incentives in Medicare, en- 
couraging above-average cost hospitals to economize. 

Congress was unable to decide how to incorporate capital costs into 
the per case payment formula. '^^ Consequently, incurred cost reimburse- 
ment for acute inpatient hospital capital costs (as well as capital costs 
incurred by other institutional Medicare providers not covered by pro- 
spective payment) was retained. However, Congress also provided that 
if it were unable to devise a method for incorporating capital costs into 
the per case payments by October 1, 1986, Medicare would cease to 
pay for capital costs associated with new acute inpatient hospital capital 
expenditures in a state after that date unless the state had a section 
1122 agreement, and under the agreement the state had recommended 
approval of the capital expenditure associated with the project. '^^ 

The effect of this provision is to make section 1122 participation 
effectively mandatory in all states on October 1, 1986, unless Congress 
enacts contrary legislation.'^*^ By this provision, Congress sought to assure 



'''Id. See generally 1 Medicare & Medicaid Guide (CCH) It 4200-4395 (prospective 
payment regulations updated to January, 1986). 

"*'It considered using a simple percentage increase in the amount paid to each 
participating hospital for non-capital costs. There were several difficulties with this "capital 
add-on" approach. On the average, the proportion of individual hospital total costs that 
is attributable to the cost of capital plant and equipment (i.e., interest, depreciation) is 
about seven percent. Anderson & Ginsberg, Prospective Capital Payments to Hospitals, 
2 Health Aff. 52 (1983). However, the actual proportion varies widely from one hospital 
to the next on the basis of factors unrelated to individual institutional efficiency or prudent 
business strategy, including regional location, hospital type and ownership, and age of 
capital plant. A "seven percent add-on" to the per-case payment rates would tend to 
penalize some high capital-cost facilities on the basis of these unrelated factors and over- 
reimburse some low-cost facilities. A more generous add-on would avoid the penalty 
problem, but increase over-reimbursement and raise total Medicare capital costs over 
current levels. Both alternatives violate the guiding principles of the prospective payment 
system: rational economic incentives to hospital efficiency and "budget neutrality." This 
dilemma prompted Congress' indecision. Id. 

"*'*42 U.S.C. § 1395ww(g)(l) (1983). 

""'Technically, the provision does not require states to adopt section 1122 programs. 
However, the penalty that hospitals would suffer in states without section 1122 programs 
would be so great that it is unlikely any state would opt not to participate in 1122. 
Compare the NHPRDA penalty for noncompliance described supra in text accompanying 
note 81. 



1986] CERTIFICATE OF NEED 1061 

that some mechanism for control of capital investment by health care 
facilities, either in the form of a formula-derived payment added to or 
otherwise incorporated into the per case payment, or continued payment 
at cost subject to review and approval by a planning agency, would 
always be in place. Several proposals have been advanced for incor- 
porating capital costs into the prospective payment system, both with 
and without mandated planning agency review.'*^' 

Finally, Congress also amended the section 1 122 expenditure threshold 
from $100,000 to $600,000, bringing it into line with the NHPRDA 
threshold."^' 

V. Current State Certificate of Need and Section 1122 

Programs 

A. Level of Participation in Certificate of Need and Section 1122 

Table 1 identifies the present level of state participation in certificate 
of need or section 1122 programs. Forty-two states and the District of 
Columbia have certificate of need laws. Seven states have repealed 
certificate of need statutes since 1983: Arizona, Idaho, Kansas, New 
Mexico, Minnesota, Texas, and Utah. The other state presently without 
certificate of need, Louisiana, has never adopted a statute. 

Fifteen states presently conduct section 1122 programs. Four (Idaho, 
New Mexico, Minnesota, and Louisiana) do not have certificate of need 
statutes. Idaho entered into its current section 1122 agreement when it 
repealed its certificate of need law in 1983. New Mexico and Minnesota 
retained their programs when they allowed their certificate of need statutes 
to lapse. 

Minnesota and Kansas adopted statutes imposing moratoria on new 
hospital construction, bed capacity increases, and bed relocations until 
July 1, 1987, •''2 and June 30, 1986,'^^ respectively, at the time their 
certificate of need laws expired. In effect, their moratoria reestablished 
capital expenditure regulation, with limited coverage but criteria requiring 
automatic denial. 

Thus, with the exception of Arizona, Utah, and Texas, at the 
beginning of 1986, every state had some form of health facility capital 
expenditure regulation such as a certificate of need program, a section 
1122 agreement, a moratorium on new hospital projects, or some com- 
bination thereof. 



''"'See Anderson & Ginsberg, Medicare Payment and Hospital Capital: Future Policy 
Options, 3 Health Aff. 35, 40-43 (1984). 
'•^'42 U.S.C. § 1320a-l(g) (1983). 
"'-1984 Minn. Sess. Law Serv., ch. 654, § 57 (West). 
"'M985 Kan. Sess. Laws 970. 



1062 INDIANA LAW REVIEW [Vol. 19:1025 

B. Coverage of Health Care Facilities 

Table 2 identifies the facilities subject to review in each state with 
a certificate of need or section 1122 program. ''^^ Hospitals, skilled nursing 
facilities, and intermediate care facilities are subject to review in every state 
when covered transactions are undertaken by them or on their behalf. This 
unanimity is probably due to the fact that the causes of health care 
market failure justifying certificate of need regulation — generous insurance 
coverage, reimbursement incentives to excess investment, organizational 
insulation from cost increases — are most prevalent for services provided 
in these settings. '^^ In addition, these facilities all have been required to 
be covered by either NHPRDA or section 1122 for several years. 

Somewhat surprisingly, almost all jurisdictions cover ambulatory 
surgical centers. There is accumulating evidence supporting the intuitively 
plausible idea that ambulatory surge;ry offers a less expensive substitute 
for less complicated inpatient surgery, and on that ground one might 
expect states to exclude it from certificate of need in order to encourage 
its spread. '"^^ However, the increase in ambulatory surgery facilities that 



''^Appendix A contains definitions, notes, and state supplementary comments for 
Table 2, organized by state. When the notation "N" appears in Table 2, the state-by- 
state comments in Appendix A contain explanatory information. 

'"The reasons for hospital and nursing home coverage are probably somewhat different. 
The level of private insurance or governmental third party payment for hospital care is 
very high (86*^0 of total expenditures for hospital care) while consumer out-of-pocket 
payment for nursing home care is high (44*^0 of total expenditures for nursing home care). 
High levels of patient cost-sharing for nursing home services weaken the market-failure 
argument for certificate of need coverage. However, the share of expenditures for nursing 
home care not paid out-of-pocket is borne disproportionately by public benefit and insurance 
programs (a large contributor to which are state Medicaid programs), not private health 
insurance. Gibson, Waldo & Levit, National Health Expenditures 1982, 5 Health Care 
Fin. Rev. 1, 7 (1983). Consequently, coverage of nursing facilities can probably be attributed 
to the use of certificate of need programs to limit the availability of such facilities to 
Medicaid beneficiaries for the purpose of constraining Medicaid costs and encouraging 
patients to seek less costly, non-institutional forms of care. Thus, it would be no coincidence 
that Arizona, whose Medicaid program (the Arizona Health Care Cost Containment System) 
is the only one not providing nursing home benefits, was the only state in recent memory 
that did not cover nursing facilities under its (recently repealed) certificate of need law. 
See Ariz. Rev. Stat. Ann. § 36-433 (Supp. 1975) (repealed 1985). Similarly indicative 
of the Medicaid budget control rationale for certificate of need, Indiana's statute covers 
only those skilled nursing and intermediate care facilities that participate in Medicaid, and 
North Carolina, Ohio, and Virginia have partial exemptions from certificate of need review 
for nursing beds in retirement communities that do not participate in Medicaid, presumably 
on the grounds that the high levels of out-of-pocket payment for non-Medicaid nursing 
homes mean a price-sensitive consuming public. Ind. Code Ann. § 16-1-3. 3-l(a) (West 
Supp. 1985); 1985 N.C. Adv. Legis. Serv. ch. 445 (to be codified at N.C. Gen. Stat. 
§ 131E-183(c)); 1985 Ohio Legis. Bull, file 23, § 1 (Anderson) (to be codified at Ohio 
Rev. Code Ann. § 3702.53 (I)); Va. Code § 32.1-102.3:1 (1985). 

'"'See generally W. Valentine & B. Palmer, Ambulatory Surgery Services 15-17 
(Alpha Center Monographs: Methodological Note No. 5) (Office of Health Planning, U.S. 
Dep't of Health & Human Services, 1984) and studies cited therein. 



1986] CERTIFICATE OF NEED 1063 

would result from an exemption might have the undesirable short-term 
effect of increasing excess inpatient surgical capacity and reducing op- 
portunities for hospital internal subsidization of services such as free 
care surgery revenues. '"^^ The widespread coverage of ambulatory surgery 
centers probably reflects concerns about imperfections in the ambulatory 
surgery market, the impact of such centers on hospital utilization, quality 
issues, and simply the fact that both NHPRDA and 1122 mandate 
ambulatory surgery coverage. 

Most states have essentially exempted health maintenance organi- 
zations (HMO's) and health care facilities controlled by health main- 
tenance organizations from certificate of need by adopting the NHPRDA 
exemption provisions or similar language. A few have taken the principle 
behind the NHPRDA exemption a good deal further. For example, 
California exempts any health care facility project other than a skilled 
nursing bed addition if over twenty-five percent of the patients served 
by the project are covered by prepaid health care.'*^*^ It thus exempts 
facilities not actually controlled by health maintenance organizations if 
they are subjected to the efficiency incentives of health maintenance 
organizations or other forms of prepayment. 

Coverage of other facilities is much more varied. Twenty states cover 
medically oriented residential care facilities. The market failure rationale 
for their coverage is weak, because by definition such institutions provide 
only minimal medical care services. However, such institutions are often 
operated by government units or reimbursed almost entirely by Medicaid 
and social service agencies, and certificate of need review may be simply 
a vehicle for governmental planning and budgeting for the services these 
facilities provide. '"^"^ A similar rationale probably supports the remarkably 
widespread (thirty-one states) coverage of home health agencies. 

Fifteen states cover all organized ambulatory care facilities. Several 
others cover one or more specific types of ambulatory facility. Fifteen 
cover hospices. In each of these instances, states have consciously decided 



''''Meritorious cream-skimmers like ambulatory surgery facilities create a perpetual 
dilemma for health planning agencies, exacerbated by contradictory certificate of need 
criteria for evaluating such proposals. Cf. Collier Med. Center, Inc. v. Department of 
Health & Rehabilitative Servs., 462 So. 2d 83, 85 (Fla. Dist. Ct. App. 1985) (upholding 
the denial of a certificate of need for new for-profit hospital construction on the skimmer- 
favoring ground that an existing outpatient facility provided a less costly alternative and 
the skimmer-opposing ground that an existing public hospital would incur a revenue loss 
from the proposed facility's diversion of paying patients). 

'""Cal. Health & Safety Code § 437.10(g) (Deering Supp. 1986). Oregon has recently 
adopted a potentially even broader provision. It exempts hospitals if sixty percent of their 
inpatient revenue is received from payers employing prospectively-determined forms of 
reimbursement. 1985 Or. Laws, ch. 747, § 35 (to be codified at Or. Rev. Stat. § 442). 

''^Whether the certificate of need administrative adjudicatory process is an efficient 
means of doing so is questionable. A few states have amended their statutes recently to 
exempt government-run health care facilities. See, e.g.. Mo. Ann. Stat. § 197.315(18) 
(Vernon Supp. 1985); Mont. Code Ann. § 50-5-309(1 )(b) (1985). 



1064 INDIANA LAW REVIEW [Vol. 19:1025 

to cover health facilities that are not covered under NHPRDA and that 
the Department of Heahh and Human Services has expressly chosen not 
to cover. 

The extent to which these institutions actually undergo certificate of 
need review depends considerably on the project coverage provisions of 
their state's certificate of need law. Most of the states that cover am- 
bulatory facilities have sufficiently high capital expenditure and major 
medical equipment thresholds that the facilities' typically modest capital 
acquisitions in these areas would escape review. However, most of the 
states that cover ambulatory facilities would subject the initial estab- 
lishment or construction of such facilities to review. 

The reasons states cover ambulatory health care facilities are not 
immediately apparent. As with ambulatory surgery centers, coverage is 
probably justified by concern for impact on hospital use and cream- 
skimming or by concern for access and quality. ^''^^ 

1. Coverage of Capital and Other Projects. — The states have made 
major changes in project coverage. Going beyond recent NHPRDA 
amendments and essentially implementing the recommendations of policy 
analysts in the field, they have de-emphasized review of projects not 
directly related to patient care and have focused on large expenditures 
and additions of new technology and services. Table 3 identifies the 
capital expenditures and other projects subject to review under the states' 
certificate of need and section 1122 programs.^"' 

Project coverage varies widely among the states. However, some of 
the variation may be more apparent than real. First, states may simply 
choose different words to cover essentially the same transactions.^"^ For 
example, there is probably no difference in reviewability of bed capacity 
increases between a state that covers capital expenditures for bed capacity 
increases and a state that covers bed capacity increases without regard 
to expenditure, because a bed capacity increase almost invariably involves 
a capital expenditure (for the beds themselves if nothing else). Second, 
several states have redundant project coverage provisions. Covering both 
service additions associated with a capital expenditure and service ad- 
ditions regardless of capital or operating cost is an example. If these 
kinds of variations are set aside, it is apparent from Table 3 that most 



-""Stated rationales for ambulatory care facility coverage are extremely difficult to 
find. But see Statewide Health Coordinating Council, State of Michigan, 2 Michigan 
State Health Plan 1983-1987, at 25-26, 28 (1983), which justifies coverage of outpatient 
facilities and public health centers on quality of care and geographical accessibility grounds. 

-"'Appendix A contains definitions, notes, and state-by-state supplementary comments 
for Table 3, organized by state. When the notation "N" appears in Table 3, the state- 
by-state comments in Appendix A contain explanatory information. 

-"-Some of this may be accounted for by the fact that states drafted their certificate 
of need statutes and regulations at differing times and attempted to comply with the 
version of federal certificate of need law and regulations then in effect. 



1986] CERTIFICATE OF NEED 1065 

States with certificate of need and/or section 1122 programs cover general- 
purpose capital expenditures incurred by or on behalf of health care 
facilities, bed-related changes of various types, additions of new health 
services, acquisitions of medical equipment, and construction, develop- 
ment, or establishment of new health care facilities. This is essentially 
the coverage pattern prescribed by NHPRDA in its current form. 

The states with wholly distinct coverage provisions are few. Alaska 
and California do not have general-purpose capital expenditure thresh- 
olds; instead they cover specified transactions.^"^ All states cover bed 
and service-related projects, and the states that do not expressly cover 
equipment acquisitions or new construction probably review such trans- 
actions under capital expenditure or service addition provisions. 

2. General-Purpose Capital Expenditure Coverage. — As noted above, 
virtually every state covers capital expenditures undertaken by or on 
behalf of health care facilities. Coverage of general purpose capital 
expenditures has been a common feature of health planning agency 
review of health facility projects since the inception of comprehensive 
health planning.^**** However, the levels of state capital expenditure thresh- 
olds have increased significantly.'"^ Many states have raised their thresh- 
olds above the maximum federal level (which would be $736,200 in 
states taking full advantage of the threshold inflator).'"^ This practice 
appears most common in the western states, where Alaska and California 
have capital thresholds set at one million dollars for certain specified pro- 
jects and general purpose thresholds in several other states are at similar 
levels. ^"^ Five other states have thresholds exceeding the federal level. ^"^ 
Colorado's two million dollar threshold is the highest in the country. 

However, there have been proposals to raise thresholds still further. 
In the 97th Congress, the House of Representatives passed, but the 



-'"California has the most unusual coverage. New hospital construction, bed capacity 
increases, and additions of seven specified hospital services are the only hospital projects 
covered. By contrast, establishment of surgery clinics, any capital expenditure for expansion 
of surgical capacity, capital expenditures in excess of $1 million for medical or other 
equipment, services, or modernization by clinics and additions of services by clinics are 
covered. None of the rationales for ambulatory surgery coverage under certificate of need 
programs appear to justify more extensive coverage of ambulatory surgery than of hospitals. 
The California law also contains a bewildering array of special exemptions, and an extremely 
broad authorization for the SHPDA to issue certificates of need in disregard of the review 
criteria in individual cases. Cal. Health & Safety Code § 43 7. 10,. 11,. 11 6,. 11 8,. 12,. 15 (Deer- 
ing Supp. 1985). 

-'"See supra note 57 and accompanying text. 

-"^See Table 3. 

-'"See supra note 106. 

-"The general purpose threshold for Colorado is $2,000,000; for Montana, $750,000; 
for North Dakota, $750,000; for Oregon, $1,000,000 or $250,000 plus 0.5 percent of gross 
revenues; and for Washington, $1,071,000. See infra Table 3. 

-'"^Indiana ($750,000); Mississippi ($1,000,000); New Hampshire ($1,000,000); North 
Carolina ($1,000,000); and Tennessee ($1,000,000). Id. 



1066 INDIANA LAW REVIEW [Vol. 19:1025 

Senate did not act on, a bill to supplant NHPRDA which would have 
increased the federal capital expenditure threshold to five million dol- 
lars.^"'' In the 98th Congress, bills with capital thresholds ranging from 
one to five million dollars were introduced, and the Administration 
expressed its preference for the higher of these thresholds.^'" None of 
these bills passed. 

In the states that have not chosen to exceed the NHPRDA threshold 
level, few have retained the expenditure thresholds they had in 1980. 
Only four states have kept capital expenditure thresholds at the $150,000 
level.2" 

A state elevating its capital and other expenditure thresholds to levels 
at or above one million dollars greatly increases the temptation to health 
care facilities to attempt to evade certificate of need review by artificially 
dividing projects into two or more stages, each costing less than the 
threshold. When the expenditure threshold is $100,000, the risks of 
evasion of certificate of need by dividing, for example, a $198,000 project 
into two $99,000 stages are not likely to be worth the benefit to the 
facility. But with a five million dollar threshold, project division could 
permit a project costing nearly ten million dollars to escape planning 
agency scrutiny. In response to this problem, several states have adopted 
statutory prohibitions on project division undertaken for the purpose of 
avoiding certificate of need review. ^'^ 

3. Non-Clinical Exemptions and Streamlined Review Provisions. — 
Even more often than they have elevated thresholds, the states have 
reduced project coverage by a variety of categorical exemptions and by 
expedited review provisions. First, a number of states have adopted 
exemptions for expenditures not related to clinical services. The state 
of Washington, for example, exempts capital expenditures that will not 
substantially affect patient charges and that are for communications and 
parking facilities; mechanical or electrical ventilation, heating, and air- 
conditioning systems; energy conservation systems; repairs to physical 



-"^'H.R. 6173, 97th Cong., 2d Sess. § 5 (1982). 

-'"See H.R. 2934, 98th Cong., 1st Sess. (1983); H.R. 2935, 98th Cong., 1st Sess. 
(1983); Letter from David Stockman, Director, Office of Management and Budget to Rep. 
Edward Madigan (Aug. 4, 1983). 

-"Delaware, Michigan, Rhode Island, and Vermont. Two states, Oklahoma and South 
Dakota, have raised their capital thresholds for hospitals to current NHPRDA levels while 
retaining lower thresholds for nursing facilities. 

-'-D.C. Code Ann. § 32-302(12)(B) (1981); Ky. Rev. Stat. § 2168.061(2) (Supp. 
1982); Me. Rev. Stat. Ann. tit. 22, § 315 (1980); Miss. Code Ann. § 41-7-173(b)(ii) 
(Supp. 1984); Neb. Rev. Stat. § 71-5832 (Supp. 1984); N.H. Rev. Stat. Ann. § 151- 
C:4(I)(C),(II) (Supp. 1983); 1984 Ohio Legis. Bull. § 3702.59(B) (Anderson); Or. Rev. 
Stat. § 442.320(d) (Supp. 1983); S.D. Codified Laws Ann. § 34-7A-33 (Supp. 1984); 
Vt. Stat. Ann. §§ 2403(a)(3),(b) (1983); W. Va. Code § 16-2D-2(i)(2)(B) (Supp. 1984); 
Wis. Stat. Ann. § 150.07 (West Supp. 1985). 



1986] CERTIFICATE OF NEED 1067 

plant necessary to maintain state licensure; acquisition of data processing 
and other equipment; construction of facilities not used for direct pro- 
vision of health services; land acquisition; and refinancing existing debt.^'^ 
In addition, a significant number of states provide for expedited or 
streamlined review of various categories of projects. Most states have 
adopted the NHPRDA-authorized provision for limited review of projects 
to eliminate safety hazards or to comply with licensure or accreditation 
requirements.^"* Numerous states also provide for expedited review of 
projects such as capital expenditures not involving service or bed capacity 
increases, service terminations, expenditures below a threshold somewhat 
higher than their statutory coverage minimum, and the like.^'^ Some 



-"Wash. Rev. Code Ann. § 70.38. 105(4Kd) (Supp. 1986); see also Ariz. Rev. Stat. 
Ann. § 36-433(E)(6) (Supp. 1975-1984) (energy conservation projects); Cal. Health & 
Safety Code § 437.10(e)(5) (Deering Supp. 1985) (parking lots and structures, telephone 
systems, and non-clinical data-processing systems); Colo. Rev, Stat. § 25-3-503(7) (1982) 
(residential units, parking, telephone systems, day-care, mailroom, gift shops, printshops, 
medical office buildings or clinics organized primarily for the delivery of physician services, 
morgue, heating and air conditioning, blood bank, dietary/cafeteria, laundry and linen, 
administration, medical records, business office, housekeeping, central supply, materials 
management, library, reception, code violations in non-clinical areas, ground transport 
services (not including air), land acquisition, research, education, non-diagnostic manage- 
ment information systems); Conn. Gen. Stat. Ann. § 19a-155 (West Spec. Supp. 1984) 
(energy conservation systems); Ga. Code Ann. §§ 31-6-47, 47(c) (1985) (waiver of review 
of projects including those defined by regulation Ga, Admin. Comp, ch. 272-2, § 272-2-07 
(1984), such as site acquisitions, transfers of previously-approved major medical equipment 
not resulting in institution of a new clinical health service at the transferee facility, and 
expenditures below the capital expenditure threshold for minor repair or replacement of 
equipment associated with the physical plant); Haw^aii Rev. Stat. § 323D-54(b) (Supp. 1984) 
(projects determined not to have a significant impact on the health care system, defined 
by regulation [Haw, Admin, Code § 11-186-96 (1981)] to include acquisition of a capital 
asset by a means other than purchase; bed supply increases or decreases not exceeding the 
capital expenditure of annual operating cost threshold; addition or deletion of a service 
not exceeding an annual operating cost threshold; certain structural repairs; equipment replace- 
ment not exceeding twice the expenditure minimum; non-patient care projects such as park- 
ing lot structures not exceeding twice the expenditure minimum); Mont, Code Ann. 
§ 50-5-309(1 )(a) (1985) (expenditures for non-medical and non-clinical facilities and services 
unrelated to the operation of the health care facility); Or. Rev. Stat. § 442, 320(b) (Supp, 
1983) (statutory authorization for adoption of rules providing for waiver of review of ex- 
penditures for repairs by replacement of equipment, non-clinically related capital expen- 
ditures, and offering or development of a new health service of a non-substantive nature); 
Executive Budget Bill, Act 29, 1985 Wis, Legis. Serv. 390 (West) (to be codified at Wis, 
Stat, Ann. § 150,613 (West)) (hospital heating, air conditioning, ventilation, electrical systems, 
energy conservation, telecommunications, computer systems, or non-surgical outpatient ser- 
vices not part of an otherwise reviewable project and whose capital cost does not exceed 
20% of the hospital's gross annual patient revenue for its last fiscal year), 

-'^5ee supra note 159 and accompanying text, 

-"Ala. Code § 22-21-275(4) (Supp. 1984) (non-substantive review of capital expend- 
itures up to $500,000 which: do not result in a substantial change in a service; or propose 
equipment to upgrade or expand an existing service; or increase bed capacity by not more 



1068 INDIANA LAW REVIEW [Vol. 19:1025 

States without specific statutory procedures for expedited review have 



than ten percent); Ariz. Rev. Stat. Ann. § 36-433(G) (Supp. 1984) (abbreviated application 
for all projects except establishment of new services with annual operating costs exceeding 
$75,000; construction of new health care facilities; and capital expenditures, other than 
expenditures for equipment replacement, exceeding $150,000); Cal. Health & Safety 
Code § 437.15 (Deering Supp. 1985) (expeditious processing of applications for projects 
for sole community provider hospitals with less than 100 beds; projects for skilled nursing 
or intermediate care facility establishment, projects for addition of skilled nursing or 
intermediate care beds in facilities other than skilled nursing or intermediate care facilities); 
Fla. Stat, Ann. § 381.494(l)(n) (West Supp. 1985) (expedited review of transfer of a cer- 
tificate of need); Ga. Code Ann. § 31-6-47(c) (1985) (statutory authorization for SHPDA 
to conduct expedited review of projects, where compatible with statutory purposes); Iowa 
Code Ann. § 135.67 (West Supp. 1984-85) (summary review procedures for projects costing 
$150,000 or less; and projects for which the applicant, the state agency, and the HSA agree 
to summary review); Ky. Rev. Stat. § 216B.095 (Supp. 1982) (non-substantive review of 
applications to replace or repair five-year-old worn equipment; repairs, alterations, or im- 
provements to physical plant not resulting in a substantial change in beds/services or equip- 
ment addition; and other applications as prescribed by state agency regulations); Me. Rev. 
Stat. Ann. tit. 22, § 304-C (Supp. 1985-86) (waiver of review of new health services pro- 
jects involving a capital expenditure below $300,000, third year annual operating costs bet- 
ween $155,000 and $250,000 and no increase in reimbursement authorization by rate-setting 
commission); Mich. Comp. Laws Ann. § 333.22151 (1980) (non-substantive review of pro- 
jects for which full review could increase cost by unnecessary delay or require inefficient 
use of staff review time); Miss. Code Ann. § 41-7-205 (Supp. 1984) (non-substantive review 
of: certain transfers of ownership; replacement of equipment; general-purpose capital ex- 
penditures not exceeding $700,000; acquisition of major medical equipment not exceeding 
$460,000; certain project cost overruns; and deletion or relocation of services or facilities); 
Mo. Ann. Stat. § 197.305(12) (Vernon Supp. 1985) (non-substative review of capital ex- 
penditures due to an act of God or a normal consequence of maintaining health care ser- 
vices, facilities, or equipment which do not involve bed addition, replacement, moderniza- 
tion, conversion, or new services); Mont. Code Ann. § 50-5-302 (Supp. 1984) (abbreviated 
review of proposals that do not significantly affect the cost or use of health care or that 
have been approved by the legislature); Neb. Rev. Stat. § 71-5834 (Supp. 1984) (non- 
substantive review of replacement of equipment with equipment of similar capability; reduction 
in bed capacity or termination of a single service which does not involve the closing or 
relocation of a health facility; expenditures for energy conservation proposals); 1984 Ohio 
Legis. Bull. § 3702. 52( J) (Anderson) (expedited review of: capital expenditures less than 
$1.5 million not involving bed or service additions, equipment acquisition, new facility con- 
struction, or facility category conversion; additions of new services with capital costs less 
than the expenditure care minimum, annual operating costs less than $500,000 and no bed 
additions; non-patient-related capital expenditures not affecting patient charges; bed capaci- 
ty increases or redistributions up to nine beds or ten percent of bed capacity (or bed reloca- 
tions), whichever is less, in any two year period, and not involving a health service addition 
or a capital expenditure exceeding the expenditure minimum; acquisition of medical equip- 
ment for less than $1.25 million; replacement of medical equipment for less than $1.5 million; 
and other projects specified by regulation); Or. Rev. Stat. § 442.320(b) (Supp. 1983) 
(statutory authorization for adoption of rules providing for accelerated review of expen- 
ditures for repairs and replacement of plant or equipment; non-clinically related capital ex- 
penditures, and offering or development of a new health service of a non-substantive nature); 
Pa. Stat. Ann. tit. 35, § 448.702G)(2) (Purdon Supp. 1984-85) (exemption from comparative 
review requirements for replacement of equipment not involving a substantial change in 
functional capacity or capability; energy-saving equipment installations or renovations not 



1986] CERTIFICATE OF NEED 1069 

adopted such mechanisms by regulation. ^'^ Several states provide for 
exemption or expedited review of projects for replacement of facilities 
or equipment. 2'^ A few have implemented the NHPRDA exemption for 



involving new services or expansion of capacity); R.I. Gen. Law^s § 23-15-5 (Supp. 1984) 
(statutory authorization for adoption of regulations specifying projects eligible for expen- 
ditious review); S.D. Codified Laws Ann. § 34-7A-39 (Supp. 1984) (abbreviated review 
of projects which: increase bed capacity, redistribute beds among categories, or relocate 
beds from one facility to another, by less than ten beds or ten percent of bed capacity; 
capital expenditures to remedy emergency situations; and other projects declared eligible 
for abbreviated review by regulation); W. Va. Code § 16-2D-7(v) (Supp. 1984) (statutory 
authorization for adoption of regulations specifying applications eligible for expedited review); 
Wyo. Stat. § 35-2-206(c) (1977) (department review of temporary addition or subtraction 
of beds or equipment and replacement services or expenditures which are comparable and 
necessary to maintain services). 

-"E.g., Idaho Admin. Proc. Manual tit. 2, § 16.02, 11300, 02 (1983) (non-substantive 
section 1122 review of repair or replacement of physical plant and equipment associated 
with physical plant, i.e., boilers, air conditioning, electrical circuitry); Division of Policy, 
Planning & Evaluation, Office of Management & Finance, La. Dep't of Health & 
Human Resources, Policies and Guidelines for Review of Capital Expenditures 
Under Section 1122 of the Social Security Act 6-7 (1985) (expedited section 1122 
review of replacement or modification of equipment, sale of an existing facility with no 
change in beds or services, lease (or discontinuance of a lease) of an approved existing 
facility with no change in beds or services, renovation of an existing facility up to $1,000,000 
not resulting in a bed or service change; cost overrun; addition of non-medical equipment 
or purchase of land; addition of a new service in an existing facility not exceeding $600,000; 
incorporation, reorganization, merger, consolidation, majority stock sale or transfer or 
other changes in the person owning an approved facility; non-substantial site change; bed 
capacity reduction; and discontinuance of an approved service); N.J. Admin. Code tit. 
8, § 33-2.5 (1985) (administrative review of increase in residential health care facility beds 
of ten beds or ten percent of Hcensed capacity, whichever is less; change in bed category 
not involving a capital expenditure or an increase in total licensed capacity, additions of 
new services, fixed or moveable equipment, or renovations required by law or to prevent 
harm to patients; transfer of a patient care service in whole or part to another corporate 
entity; replacement of equipment; acquisition of telephone or computer systems in excess 
of $400,000; and acquisition of fixed equipment or renovation dealing exclusively with energy 
conservation); N.Y. Admin. Code tit. 10, § 710.1(c)(3) (1985) (administrative approval of: 
proposals not exceeding $3 million for addition or modification of a licensed service, with 
exceptions for certain specialized services; bed or service decertification; certain bed-category 
conversions, additions to existing services not involving an additional site or beds, projects 
for correction of safety deficiencies, ordinary repairs, energy conservation, and moderniza- 
tion in facilities for which there is a continuing need; replacement and updating of equip- 
ment in needed facilities; addition or deletion of approval to operate part-time clinics; opera- 
tion or relocation of extension clinics; emergency room modernization; projects identified 
as high priority in the state medical facilities plan). 

-"Ga. Code Ann. § 31-6-47(a)(10) (1985) (exemption of expenditures for replacement 
of equipment including but not limited to CT scanners); Ky. Rev. Stat. § 216B.095 
(Supp. 1982) (nonsubstantive review of replacement of equipment used for five years or 
more and repairs, alterations, and improvements to physical plant not resulting in bed 
or services changes or equipment additions); Miss. Code Ann. §§ 41-7-191(2), 205 (Supp. 
1985) (exemption from health facility expansion, construction moratorium for necessary 
repairs and renovation or replacement of an existing facility); Mo. Ann. Stat. § 197.305(12) 



1070 INDIANA LAW REVIEW [Vol. 19:1025 

research projects. ^"^ The approval rates for projects eHgible for expedited 
review tend to be very high, making expedited review effectively very 
similar to an exemption from review. 

In short, the majority of states have employed exemptions and 
expedited review to diminish substantially the range of projects subject 
to review and to focus review on projects for new or significantly 
expanded clinical service capacity. The practice is not confined to the 
states with high thresholds. Two of the four states that have retained 
thresholds at the $100,000 - $200,000 level have adopted some form of 
expedited review or non-substantive project exemption. ^''^ 

4. Bed-Related Coverage. — All jurisdictions with certificate of need 
or section 1122 programs cover bed supply increases in some fashion. 
Even states like California and Colorado, which have sharply cut back 
on coverage by repealing or greatly increasing expenditure thresholds, 
continue to review increases in bed capacity. However, over half the 
states have adopted insubstantial increase exemptions, an increase from 
the number reported in earlier surveys. ^^" Most states use the "ten beds 
or ten percent" exemption authorized by NHPRDA. California and 
Georgia exempt *'ten beds or ten percent" increases from review only 
if the facility meets certain occupancy rate minimums,^^' while Colorado 
exempts from review a twenty bed increase every two years. ^^^ 

Thirty-five states cover some form of bed category conversion or 
bed relocation, while over half the states cover bed capacity decreases. 



(Supp. 1985) (nonsubstantive review of replacement and modernization projects); Neb. 
Rev. Stat. § 71-5835 (Supp. 1984) (nonsubstantive review of equipment replacement); 
1984 Ohio Legis. Bull. § 3702. 52( J) (Anderson) (expedited review of replacement of equip- 
ment under $1.5 million); Or. Rev. Stat. § 442.320(a)(b) (Supp. 1983) (accelerated 
review of repairs or replacement of plant or equipment); Pa. Stat. ann. tit. 35, 
§ 448.702G)(2) (Purdon Supp. 1984-85) (exemption from comparative review requirements 
for equipment replacement and renovation to meet code requirements); Wyo. Stat. § 35- 
2-206(d) (Supp. 1985) (expedited review of expenditures for upgrading and replacing 
equipment, and replacement services or expenditure to upgrade, acquire, or implement 
new technology which may be comparable and necessary to maintain services); N.J. Admin. 
Code tit. 8, § 33-2. 7(a)(7) (1985) (expedited review of equipment replacement); N.Y. 
Admin. Code tit. 10, § 710.1(b)(c)(3) (1985) (administrative review of projects under $3 
million for modernization of facilities and replacement and updating of equipment for 
which there is continuing need). 

-'^Ky. Rev. Stat. § 216B.066 (Supp. 1982); Mass. Gen. Laws Ann. ch. Ill, § 25C 
(West 1983); Neb. Rev. Stat. § 71-5830.01 (Supp. 1984); N.C. Gen. Stat. § 131E-179 
(Supp. 1983); Tex. Rev. Civ. Stat. Ann. art. 4418h, § 3.01(d) (Vernon Supp. 1984); W. 
Va. Code § 16-2D-4(c) (Supp. 1984). 

^"'Michigan and Rhode Island have adopted expedited review provisions. See supra 
note 215. 

--"See supra note 109 and accompanying text. 

--'Cal. Health & Safety Code § 437.11(4) (Deering Supp. 1985); Ga. Code Ann. 
§ 31-6-47(15) (1985). 

-Colo. Rev. Stat. § 25-3-506(e) (1982). 



1986] CERTIFICATE OF NEED 1071 

The recent amendments to the NHPRDA regulations permitting com- 
plying state certificate of need programs to make their own determinations 
as to whether to cover such transactions will probably cause a decrease 
in these figures. 

C. Health Service-Related Coverage 

Table 3 indicates that all of the states with certificate of need or 
section 1122 programs cover additions of new health services. Half cover 
service terminations, but because only nine states cover terminations not 
associated with a capital expenditure and terminations do not usually 
involve capital expenditure, actual review of service terminations appears 
to be a relatively infrequent practice. 

Twenty-six states have adopted annual operating cost thresholds.-^ 
Thresholds vary widely, from $75,000 in Rhode Island to $536,000 in 
Washington. Just five states, however, cover health service additions 
only if they are associated with annual operating costs exceeding the 
threshold. ^^^ The remaining states either cover health service additions 
regardless of cost or, following the NHPRDA model, cover health service 
additions associated with any capital expenditure. Both of the latter 
approaches appear inconsistent with the policy underlying annual op- 
erating cost thresholds, which is to target the cost containment functions 
of certificate of need while minimizing the scope of coverage by reviewing 
only those service additions that generate additional long-term costs. ^^- 

A number of states have adopted a new approach to coverage of 
health service additions. These states cover additions of a small number 
of specified new health services regardless of their capital or operating 
cost, and all other new services only if their capital or operating costs 
exceed a threshold. For example, Wisconsin covers additions of organ 
transplant programs, burn centers, neonatal intensive care units, cardiac 
programs, and air transport programs without regard to cost.^^^ Other 



"The states differ in the way they define their annual operating cost thresholds. 
Maine, for example, uses the projected annual operating costs without any adjustment 
for inflation for the third fiscal year of operation, including a partial first year. "Annual 
operating costs" are defined as "total incremental costs to the institution which are directly 
attributable to the addition of a new health service." Me. Rev. Stat. Ann. tit. 22, §§ 
303(2)(A), 304-A(4)(B) (Supp. 1984-85). The District of Columbia employs an "annual 
operating budget" threshold, Maryland an "annual operating revenue" threshold. D.C. 
Code Ann. § 32-302(12)(D) (Supp. 1984); Md. Health-General Code Ann. § 19- 
115a)(2)(ii) (Supp. 1985). 

--^Maryland, Missouri, Montana, Oklahoma, and Wyoming. 

"The statutory certificate of need coverage approach of Montana and Wyoming 
appears to come the closest to accomplishing this policy. They have relatively high capital 
expenditure and major medical equipment thresholds and $100,(XX)-$150,0(X) operating cost 
thresholds. Under this approach, projects are subject to review only if they increase long- 
term operating costs or represent high, one-time capital expenditures. 

"M985 Wis. Legis. Serv. 390 (West) (to be codified at Wis. Stat. §§ 150.61(1),(2)). 



1072 INDIANA LAW REVIEW [Vol. 19:1025 

hospital service additions are covered only if capital costs exceed 
$1,000,000.22^ Similarly, Ohio covers additions of heart, lung, liver, and 
pancreas transplant programs without regard to cost and other new 
services only if their annual operating costs exceed $297,500,228 Other 
states may achieve a similar coverage pattern through exemptions or 
streamlined review. New York, for example, provides for "administrative 
approval" of service additions or modifications unless the project cost 
will exceed $3,000,000 or relates to certain specified service categories. 22*^ 
The purpose of this approach seems to be to cover without regard to 
cost the services for which non-cost containment rationales for certificate 
of need review apply and to cover the services for which cost-control 
is the paramount concern only if project costs exceed the threshold. The 



--'Id. 

--M984 Ohio Legis. Bull. § 3702.5 1(R)(2), (9) (Anderson); see also Ariz. Rev. Stat. 
Ann. §§ 36-433(A)(5),(6) (Supp. 1975-84) (repealed 1985) (coverage of additions of ob- 
stetrical units, neo-natal special care units, pediatric inpatient services, open-heart surgery 
units, cardiac catheterization services, radiation therapy services, end-stage renal dialysis 
services, computed tomographic scanning, neurological units, spinal injury units, and burn 
treatment units regardless of cost, and additions of other services only if their operating 
costs exceed $750,000); Colo. Rev. Stat. §§ 25-3-503(10), 506(l)(d) (1982) (repealed 1984) 
(coverage of tertiary services [i.e., highly specialized services frequently requiring sophis- 
ticated technology and support services and limited to open-heart surgery, organ trans- 
plantation, burn care, level III intensive care nurseries, and radiation therapy] at any cost, 
and coverage of only those other services exceeding threshold); Illinois Health Facilities 
Planning Board, Illinois Health Care Facilities Plan § 3. 02. B. 29 (1982) (coverage of 
acute mental illness, alcoholism treatment, burn treatment, cardiac catheterization, com- 
puter systems, end-stage renal disease, intensive care, medical-surgical, non-hospital based 
ambulatory surgery, obstetrical services, open-heart surgery, pediatric services, perinatal high 
risk, radiation therapy, rehabilitation services additions regardless of cost; other services 
exceeding annual operating costs threshold); Ky. Rev. Stat. § 216B.015(25) (Supp. 1982) 
(coverage of health service additions exceeding $250,000 annual operating cost or additions 
of services specified in State Health Plan, regardless of cost. The Kentucky State Health 
Plan provides for coverage of acute care services, open-heart surgery, cardiac catheteriza- 
tion, radiation therapy utilizing megavoltage equipment, end-stage renal disease services, 
CT scanners, nuclear magnetic resonance imaging, and long-term care services); Me. Rev. 
Stat. Ann. tit. 22, § 304-A(4) (Supp. 1984-85) (coverage of new services regardless of cost 
identified in regulations or new services exceeding the annual operating cost threshold; no 
regulations adopted to date); Mass. Gen. Laws Ann. ch. Ill, § 25B (1983); Mass. Admin. 
Code tit. 105, § 100.020 (1983) (coverage of "major services" without regard to cost and 
of only those other services exceeding annual operating cost threshold); 1985 Or. Laws, 
ch. 747 § 16 (to be codified at Or. Rev. Stat. § 442.015(24)); Or. Admin. R. 409-03-010(10) 
(1985) (coverage of new health services exceeding annual operating expense threshold or 
new health services, regardless of cost, which may compromise quality of care); Tenn. Ad- 
min. CoMP. § 0720-2-.02(2)(d) (1985) (coverage of specified set of major health services without 
regard to cost and other services with projected annual operating budget exceeding $500,000 
threshold). 

--■"Therapeutic radiology, open-heart surgery, cardiac catheterization, kidney and heart 
transplant, chronic and acute renal dialysis, CT scanning, burn care, and extracorporeal 
Shockwave lithotripsy require approval regardless of cost. N.Y. Admin. Code tit. 10, 
§ 710.1(c)(3) (1985). 



1986] CERTIFICATE OF NEED 1073 

Oregon provision does so most explicitly, by covering new services either 
if they exceed the annual operating expense threshold or may potentially 
compromise quality of care through insufficient volume to support needed 
specialized staff or to maintain skills.^^" 

NHPRDA and section 1122 left the states free to define which newly- 
established '^services" would be subject to certificate of need review. ^^' 
Most states appear to have never specified in their statutes or regulations 
the "health services" they subject to review. However, some have done 
so. The states listed above as covering some specified health service 
additions regardless of cost, of course, have at least a partial list. In 
addition, California's certificate of need provisions cross-reference a 
statutory list of special services subject to health facility licensure."^ The 
Georgia statute contains a non-inclusive list of clinical health services 
subject to review, which corresponds roughly to the major service de- 
partments in a typical large hospital. '^^ Finally, a few states cover 
expansions of existing services. ^^"^ However, most cover only service 
additions. 

D. Major Medical Equipment Coverage 

In most states, acquisition of medical equipment by or on behalf 
of a health care facility is subject to certificate of need review as a 
capital expenditure if the capital expenditure associated with the acqui- 
sition exceeds the expenditure threshold."^ However, the 1979 NHPRDA 



-'"Or. Admin. R. 409-03-010 (1985). 

-^^See supra notes 122-28 and accompanying text. 

-'-Cal. Health & Safety Code § 437.10(c) (Deering Supp. 1985). 

-'^Ga. Code Ann. § 31-6-2(5) (1985) provides: 

"Clinical health services" means diagnostic, treatment, or rehabilitative ser- 
vices provided in a health care facility, or parts of the physical plant where such 
services are located in a health care facility, and includes, but is not limited to, 
radiology; radiation therapy; surgery; intensive care; coronary care; pediatrics; 
gynecology; obstetrics; dialysis; general medical care; medical/surgical care; inpa- 
tient nursing care, whether intermediate, skilled, or extended care; cardiac 
catheterization; open-heart surgery; inpatient rehabilitation; and alcohol, drug abuse, 
and mental health services. 
See also Alaska Stat. § 18.07.1 1 1(8) (1981) (health service defined as major type, program, 
unit, division, or department of care, including outpatient, psychiatric wing, kidney dialysis, 
radiotherapy, burn unit, newborn intensive care unit); R.I. Gen. Laws § 23-15-2(h) (1979) 
(health services defined as "organized program components" for providing services); Minn. 
Stat. Ann. § 145.833 Subd. 3 (West 1982) (repealed 1984) (health services defined as 
cost centers recognized by generally accepted accounting principles and conforming to cost 
center definitions used by state rate-setting/price disclosure program). 

='^1985 Nev. Adv. Sh. ch. 454, § 13 (to be codified at Nev. Rev. Stat. § 439A.100(2)(c)); 
Or. Admin. R. 409-03-010(6) (1985). 

-"In some states, the acquisition of certain types of equipment may also constitute 
a covered addition of a new service. For example, acquisition of a CT scanner constitutes 
a new service in Arizona and Kentucky. See supra note 228. 



1074 INDIANA LAW REVIEW [Vol. 19:1025 

amendments authorized a distinct category of coverage, acquisitions of 
medical equipment exceeding an expenditure minimum lower than the 
all-purpose capital expenditure threshold if the equipment is owned by 
or located in a health care facility or used to provide services for 
in-patients. ^^^ Most states have adopted this coverage category, with sta- 
tutory equipment thresholds varying from $125,000 to $1,000,000. 

Seventeen states cover acquisitions of medical equipment that may 
be used for persons who are not in-patients of a health care facility. 
Virginia covers acquisition by a physician's office of equipment that is 
generally and customarily associated with the provision of health services 
in an in-patient setting. ^^^ Fifteen states and the District of Columbia 
cover equipment acquisitions in various non-in-patient settings. ^^^ Most 
of these states added their coverage of equipment in non-institutional 
settings after witnessing placement of CT scanners and, most recently. 



-"•Pub. L. No. 96-79, § 117, 93 Stat. 592, 615 (1979) (codified as amended at 42 
U.S.C. § 300m-3). 

-"Va. Code § 32.1-102.1 (Supp. 1985). 

-"*CoLO. Rev. Stat. § 25-3-506(1 )(g) (Supp. 1985) (capital expenditure exceeding $1 
million by or on behalf of any person or entity for major medical equipment to provide 
clinically related health care); Conn. Stat. Ann. § 19a-l 55(b) (West Spec. Pamp. 1984) 
(capital expenditure exceeding $400,000, by any person, to acquire imaging equipment); 
D.C. Code Ann. § 32-302(1 1)(A) (Supp. 1984) (acquisition of medical equipment with a 
value exceeding $400,000 by physicians, dentists, or other individual providers of individual 
group practice); Hawaii Rev. Stat. §§ 323D-53, 54 (Supp. 1984) (acquisition of equipment 
exceeding expenditure threshold by physicians' offices); Iowa Code Ann. § 135.61(19)(g) 
(West Supp. 1984-85) (expenditure exceeding $400,000 by individual or group of health 
care providers for equipment installed in private office or clinic); Md. Health-General 
Code Ann. §§ 19-1001 et seq. (Supp. 1985) (licensure of major medical equipment wherever 
located costing in excess of $600,000); Miss. Code Ann. § 41-7-191(l)(0 (Supp. 1985) 
(acquisition or control of major medical equipment exceeding $750,000 by any person); 
Mont. Code Ann. § 50-5-301 (d) (Supp. 1984) (acquisition by any person of medical equip- 
ment exceeding $500,00 which would have required a CON if acquired by a health care 
facility); 1985 Nevada Adv. Sh. ch. 454, §§ 9, 13 (to be codified at Nev. Rev. Stat. 
§§ 439A.015(10), .100(d) (acquisition of medical equipment exceeding $400,000 by the of- 
fice of a health services practitioner); 1985 N.H. Laws, ch. 378, § 378:6 (to be codified 
at N.H. Rev. Stat. Ann. § 151-C:5(II)(D)) (acquisition of equipment exceeding $400,000 
by a health care provider); 1985 N.C. Adv. Legis. Serv., ch. 740, § 6 (to be codified at 
N.C. Gen. Stat. § 131E-176(16)(g)) (acquisition by any person of major medical equipment 
that includes magnetic resonance imaging and lithotripters, regardless of ownership or loca- 
tion); 1985 Or. Laws, ch. 747, § 31 (to be codified at Or. Rev. Stat. § 442.320(l)(b)) 
(acquisitions of medical equipment exceeding $1 million by any person); R.L Gen. Laws 
§ 23-15-2(k) (1977) (acquisition of medical equipment exceeding $150,000 by a health care 
provider); W. Va. Code §§ 16-2D-2t, 16-2D-3(h) (Supp. 1985) (acquisition of major medical 
equipment exceeding $400,000 by any person); Wis. Stat. Ann. § 150.61(3) (West Supp. 
1984) (capital expenditure exceeding $1 million for clinical medical equipment by an in- 
dependent practitioner or medical group); Wyo. Stat. §§ 35-2-202(a)(ix), 205(a)(iii) (Supp. 
1985); Drv. of Health & Medical Servs., Wyo. Dep't of Health & Socl\l Servs., Rules 
and Regulations Governing Certificate of Need, ch. Ill §§ 2, 4 (1985) (acquisitions 
of major medical equipment exceeding $400,000 by licensed practitioners' offices). 



1986] CERTIFICATE OF NEED 1075 

magnetic resonance imaging (MRI)^^^ scanners in physician's offices and 
other non-institutional settings in order to evade certificate of need 
review. ^'^'^ States that did so after September 1982 not only breached 
NHPRDA*s ban on extension of medical equipment coverage after that 
date,^'*' but they also overcame health planners' traditional reluctance to 
extend certificate of need regulation into physicians' offices. 

E. New Facilities and Acquisitions of Existing Facilities 

Over half the states cover construction, development, or establishment 
of a new health care facility. This coverage provision probably does not 
trigger review of any projects not otherwise covered as service or bed 
additions or capital expenditures. It is possible that in states with high 
expenditure thresholds and a restrictive list of covered new services, 
establishment of inexpensive, non-bed related facilities like home health 
agencies and hospices might escape review without such a provision. 

NHPRDA does not require states to cover acquisitions of existing 
health care facilities by individual persons or entities.^' However, a 
significant minority of states appears to do so. Mississippi covers ac- 
quisitions and forbids any person or entity from acquiring more than 
twenty percent of all skilled nursing or intermediate care facility beds 
in the state. ''*^ Nebraska law contains a similar prohibition, applicable 
to short-term hospitals as well as to nursing facilities. ^'^ Twelve other 
jurisdictions cover acquisitions or transfers of ownership interests in 
health facilities. ^^^ 



-"'MRI is a non-radiological diagnostic tool that uses magnetic and radio frequency 
fields to construct an image of body tissue cind monitor body chemistry. 

-^"The presence of a certificate of need program covering institutional acquisitions of 
medical equipment tends to encourage the placement-of such equipment in non-institutional 
settings. Hillman & Schwartz, The Adoption and Diffusion of CT and MRI in the United 
States, 23 Med. Care 1283 (1985). Whether this represents a success or a failing of 
certificate of need depends on one's calculation of the relative costliness and medical 
appropriateness of the equipment in the two settings. 

-^'42 U.S.C. § 300m-6(e)(l)(B) (1982). 

'^See supra note 97 and accompanying text. 

-^'Miss. Code Ann. §§ 41-7-191(l)(b), 41-7-190 (Supp. 1984-85). 

-^^Neb. Rev. Stat. §§ 71-5830(1) (Supp. 1984). 

-^^D.C. Code Ann. § 32-303(c) (1981); Hawaii Rev. Stat. § 323D-43(a)(l) (Supp. 
1984); Ky. Rev. Stat. Ann. § 216B.061(b) (Supp. 1982); Me. Rev. Stat. Ann. tit. 22, 
§ 304-A(3) (Supp. 1984-85); 1985 N.H. Laws, ch. 378, § 378:6 (to be codified at N.H. 
Rev. Stat. Ann. § 151-C:(II)(b)); N.J. Stat. Ann. § 26-2H-7 (Supp. 1984-85); Okla. 
Stat. Ann. § 2651.1(2)(d) (Supp. 1984); S.C. Code Ann. § 44-7-320 (Law. Co-op Supp. 
1983); W. Va. Code § 16-2D-3 (Supp. 1985); Wis. Stat. Ann. § 150.61(4) (West Supp. 
1985); Ga. Admin. Comp. ch. 272-2, §§ 272-2-.01(17)(b),(g) (1982) (coverage of capital ex- 
penditure to acquire a health care facility under section 1122 and, for publicly owned or 
operated facilities, under certificate of need); Louisiana Dep't of Health & Human 
Resources, Policies and Guidelines for Review of Capital Expenditures 5 (1985); Maine 
Certificate of Need Regulations, ch. 4, § 7 (1984). 



1076 INDIANA LAW REVIEW [Vol. 19:1025 

F. Modifications in Certificate of Need Review Procedures 

As well as reducing certificate of need coverage requirements, states 
have been modifying the certificate of need review process. Some states 
have attempted to distill their review criteria down to a few critical 
considerations. New Hampshire, for example, recently amended its law 
to substitute the four criteria of financial feasibility, availability of 
resources, access, and quality for its previous laundry list of over twenty 
considerations.'''^ Other states have assigned priorities to their criteria. ^^^ 

A recurrent predicament for certificate of need agencies is the receipt 
of applications for new types of equipment or services of unproven 
clinical efficacy. For example, planning agencies received numerous ap- 
plications for MRI scanners well before the Food and Drug Adminis- 
tration had issued premarket approval for their sale.^"*^ Lacking standards 
on which to base decisions in these situations, planning agencies have 
tended either to adopt delaying tactics or to deny applications without 
properly-adopted criteria, both with disastrous results; or simply to 
approve all applicants. ^'^'^ More recently, however, some agencies have 
obtained authority to impose moratoria on review of applications for 
new, untested technology or to establish other limits regarding inno- 
vations. West Virginia's statute, for example, empowers the state agency 
to order a ninety-day moratorium on processing applications for new 
medical technology when criteria and guidelines for evaluating the need 
for the new technology have not yet been adopted. ^^" Ohio's law au- 
thorizes the state agency to condition approval of projects for tech- 



'"-Compare 1985 N.H. Laws, ch. 378, § 6 (to be codified at N.H. Rev. Stat. Ann. 
§ 151-C:7) with N.H. Rev. Stat. Ann. § 151-C:6 (Supp. 1983); compare also Hawaii 
Rev. Stat. § 323D-43(b) (Supp. 1984) (review criteria of public need, cost and cost 
effectiveness, and consistency with state health plan) with Hawaii Rev. Stat. § 323D- 
43(b), (C)(l)-(25) (Supp. 1983); Tenn. Code Ann. § 68-11 -106(h)(2) (Supp. 1985) (criteria 
of area- wide need, economical cost, and contribution to orderly development of adequate 
facilities and services) with Tenn. Code Ann. §§ 68-ll-106(h)(l)(A)-(M) (Supp. 1983). 

'''E.g., Okla. Stat. Ann. § 2652.1(c) (West 1984) (planning agency authority to 
establish relative weights of statutory certificate of need criteria); Wis. Stat. Ann. § 
150.69 (West Supp. 1985) (cost containment identified as first priority in applying criteria). 

-'"Office of Health Planning, U.S. Dep't of Health & Human Services, Summary 
Report of Responses to Nuclear Magnetic Resonance Information Request, Program 
Information Letter 83-23 (1983). 

-'"5^^ Florida Medical Center v. Department of Health & Rehabilitative Servs., 463 
So. 2d 381 (Fla. Dist. Ct. App. 1985) (MRI denial based on unpromulgated criteria 
reversed); United Hosp. Center, Inc. v. Richardson, 328 S.E.2d 195 (W. Va. 1985) (refusal 
to process MRI application enjoined). 

-^"W. Va. Code § 16-2D-5(0 (Supp. 1985); see also D.C. Code Ann. § 32-314 (1981) 
(authorization for 120-day moratorium on certificate of need review of new service if state 
agency requires additional time to develop and adopt criteria); 1985 N.H. Laws, ch. 378, 
§ 6 (to be codified at N.H. Rev. Stat. Ann. § 151-C:4) (prohibition on issuance of 
certificate of need for service for which state agency has not adopted criteria). 



1986] CERTIFICATE OF NEED 1077 

nologically innovative medical equipment on the applicant's agreement 
to supply the agency with data to establish the equipment's clinical 
efficacy."' 

States with health facility rate regulation programs have taken steps 
to coordinate the decisions of certificate of need and rate-setting agencies. 
Washington, for example, requires determination of the financial fea- 
sibility and cost impact of hospital certificate of need applications by 
the state's hospital commission, a rate-setting agency, and absent special 
findings, mandates denial of an application disfavored by the com- 
mission."^ Finally, planning agencies throughout the country are in- 
creasingly basing their certificate of need decisions on the project's 
consistency with state health plans. ^"^^ In part because certificate of need 
decision-making has become more plan-driven and in part as a result 
of planning agencies' accumulated experience with administrative adju- 
dication, certificate of need decisions are now seldom overturned for 
lack of substantive validity. '^^ 

A substantial number of states have imposed moratoria on some or 
all certificate of need applications or approvals in recent years. The 



-^'1984 Ohio Legis. Bull, file 234, § 1 (Anderson) (to be codified at Ohio Rev. Code 
Ann. § 3702.53(E)(5)); see also Iowa Code Ann. § 135.64(3) (Supp. 1985) (certificate of 
need criterion establishing special consideration for university hospitals with respect to 
technologically innovative equipment and services); Me. Rev. Stat. Ann. tit. 22, § 309(2)(m) 
(1980) (certificate of need criterion of need for utilizing new technological developments 
on a limited, experimental basis); Wis. Stat. Ann. § 150.63 (West Supp. 1985) (certificate 
of need exemption for research, development, and evaluation of innovative medical tech- 
nology). 

-^-Wash. Rev. Code Ann. § 70.38.1 15(2)(d) (Supp. 1986); see also 1985 Wise. Legis. 
Serv. 29 § 1980p (West) (to be codified at Wis. Stat. Ann. § 150.69d(5)) (hospital 
rate-setting commission to provide analysis of reasonableness of certificate of need applicant's 
proposed costs and charges). 

-''E.g., Princeton Community Hosp. v. State Health Planning &. Dev. Agency, 328 
S.E.2d 164 (W. Va. 1985). 

-"^See, e.g., Humana Medical Corp. v. State Health Planning & Dev. Agency, 460 
So. 2d 1295 (Ala. Civ. App. 1984) (area bed supply excess supports denial on need and 
cost containment criteria); Humana, Inc. v. Department of Health & Rehabilitative Servs., 
469 So. 2d 889 (Fla. Dist. Ct. App. 1985) (quality of care considerations supported need 
methodology prohibiting new cardiac catheterization facilities until existing facilities were 
fully utilized); Mercy Health Center v. State Health Facilities Council, 360 N.W.2d 808 
(Iowa 1985) (denial of application on ground of cross-subsidization of non-health care 
services upheld); In re Certificate of Need Application by Community Psychiatric Centers, 
Inc., 234 Kan. 802, 676 P. 2d 107 (1984) (determination of need on areawide basis upheld); 
Beatrice Manor, Inc. v. Department of Health, 219 Neb. 141, 362 N.W.2d 45 (1985) 
(planning agency policy to encourage non-institutional care justified denial of crowded 
nursing home's application to add beds); Chambery v. Axelrod, 101 A.D.2d 610, 474 
N.Y.S.2d 865 (1984) (certificate of need preference for facilities participating in Medicaid 
upheld); Humana Hosp. Co. v. Oklahoma State Health Planning Comm'n, 705 P. 2d 175 
(Okla. 1985) (lack of need as measured by state health plan formula justified certificate 
of need denial). 



1078 INDIANA LAW REVIEW [Vol. 19:1025 

primary reason for doing so has been to bar new services or expansion 
in areas in which state plans project no community need for an extended 
period of time. Missouri, for example, has adopted a moratorium on 
issuance of certificates of need for new skilled or intermediate care 
nursing facility beds until July 1, 1988."^ 

Several states have recently resuscitated a proposal that was a key 
element in the unsuccessful national hospital cost containment strategy 
of the Carter administration: imposition of a ceiling or *'cap" on the 
total dollar value of projects approveable through certificate of need 
programs in a given year.^^^ A capital ceiling is a mechanism for con- 
trolling the total level of capital investment by health facilities for large 
projects and for compelling health planning agencies to weigh the relative 
merits of disparate projects.'" In the presence of a "cap," projects for 
remodeling existing facilities compete with new construction, and for 
example, a new open heart surgery service must vie with a new renal 
dialysis unit for limited capital funds. By contrast, under conventional 
certificate of need programs, only contemporaneously-filed applications 
for similar projects are comparatively reviewed. ^^^ A statutory cap is in 
operation in Rhode Island and Maine. ^^"^ The Massachusetts hospital rate- 
setting statute has a maximum on increases in operating costs resulting 
from capital expenditures.-^^" Oregon's law provides for the establishment 
of a non-enforceable annual capital expenditure target for all hospitals 
in the state. ^^' 

VI. The Future of Certificate of Need 

State certificate of need and section 1122 capital expenditure review 
programs have changed significantly over the two decades they have 



-"Mo. Ann. Stat. § 197.315(1) (Vernon Supp. 1985); see also Miss. Code Ann. § 
41-7-191(2) (Supp. 1985) (moratorium on nursing home bed increases); 1985 Wis. Legis. 
Serv. Act 29, § 1980p (West) (to be codified at Wis. Stat. Ann. § 150.62) (moratorium 
on new hospital establishment or relocation). See generally Office of Health Planning, 
U.S. Dep't of Health & Human Services, Moratoria: A Continuing Process in 
Regulatory Review, Prog. Inf. Letter 85-32 (1985) (twenty-two states imposed moratoria 
at some time during 1980-85). For an article reporting on the success of a moratorium 
in limiting the diffusion of CT scanning, see Lawthers-Higgins, Taft & Hodgman, The 
Impact of Certificate of Need on CT Scanning in Massachusetts, Health Care Mgmt. 
Rev., Summer 1984, at 71. 

-""See D. Abernathy & D. Pearson, Regulating Hospital Costs: The Development 
OF Public Policy 90-92 (1979). 

-''See generally Institute for Health Planning, Methods for Establishing Capital 
Expenditure Limits (1984). 

-"''See, e.g., Bio-Medical Applications of Clearwater v. Department of Health & 
Rehabilitative Servs., 370 So. 2d 19 (Fla. Dist. Ct. App. 1979) (comparative review of 
"mutually exclusive" kidney dialysis center CON applications required). 

-"'Me. Rev. Stat. Ann. tit. 22, § 396-k (Supp. 1985). 

-'-Mass. Gen. Laws Ann. ch. 6A, § 32 (West Supp. 1985). 

-'•'1985 Or. Laws ch. 747, §§ 21-24. 



1986] CERTIFICATE OF NEED 1079 

been in operation. They were initially conceived as an adjunct to com- 
munity-wide health planning. Later, they were seen as a vehicle for 
implementation of federal health policy. Today, such programs appear 
increasingly tailored to fit narrowly-drawn individual state regulatory 
policies and to compensate for specified market defects. 

The persistence of certificate of need regulation in the face of widely- 
reported studies questioning its efficacy and open hostility from the 
Reagan administration may seem somewhat surprising. However, research 
on certificate of need programs has universally assumed that cost-con- 
tainment was the only purpose of such programs (largely because cost 
control became the dominant rationale for federal funding for state 
certificate of need by the mid-70' s). This Article has suggested that cost 
control may be only one of several mixed roles played by state health 
planning and certificate of need programs. In addition, anecdotal evidence 
at the state level on the impact of the program on the scope and direction 
of hospital and other health facility capital investment has never been 
lacking. Finally, there has probably been a greater awareness at the state 
level than in the federal government that because certificate of need 
programs require several years to develop review criteria and adminis- 
trative procedures needed to function effectively and to survive judicial 
scrutiny, they could not be evaluated simply on the basis of their first 
few years of operation. 

A. Future State Participation in Certificate of Need 

As indicated above, every state except Arizona, Utah, and Texas 
currently has some form of health facility capital expenditure regulation, 
whether certificate of need, section 1122, a moratorium, or some com- 
bination of these provisions. Eight states' certificate of need laws are 
scheduled to sunset essentially in their entirety in subsequent years. In 
addition, two states' laws would expire if NHPRDA were repealed.'^' 
If all the statutes scheduled to expire (including those linked to NHPRDA 
repeal) did so and no state entered into a new section 1122 contract or 
adopted a moratorium, thirty-seven states and the District of Columbia 
would continue to have some form of capital expenditure review. Thirty- 
two states and the District of Columbia would have certificate of need 
statutes, slightly more than had such programs immediately prior to the 
passage of NHPRDA. 

What prompted the states that repealed certificate of need programs 
to do so? The primary consideration has been recent changes in the 



-"-The Arkansas statute would automatically expire if NHPRDA were to expire or 
terminate, or if the programs instituted pursuant to NHPRDA ceased to function. Ark. 
Stat. Ann. § 82-2313.1 (Supp. 1983). The Colorado statute would sunset after the first 
state legislative session commencing after Congress repealed the state certificate of need 
requirements of NHPRDA. Colo. Rev. Stat. § 25-3-521 (1982). 



1080 INDIANA LAW REVIEW [Vol. 19:1025 

sources of imperfection in the institutional health services market. As 
indicated above, the Medicare program has begun to substitute reim- 
bursement at a predetermined rate for incur red-cost payment, and both 
state Medicaid programs and private health insurers are following suit.^^^ 
The new prospective payment mechanisms, which typically pay individual 
providers prior-year average costs incurred by all providers, offer a 
disincentive to above-average cost care and an efficiency incentive in the 
form of an opportunity to profit from providing below average cost 
care. There has also been a significant increase in patient enrollment in 
health maintenance organizations and other health care delivery systems 
that operate with internal incentives to reduce costs, and some evidence 
of price competition among such systems and between them and con- 
ventional health insurance. ^^ For these and other reasons, utilization of 
institutional health services has been declining, and as with other areas 
of the economy, the annual rate of increase in health care expenditures 
has declined. These factors, combined with a general preference for 
unregulated markets and exasperation with the controversy that often 
surrounds certificate of need decisions, seem to have prompted the 
legislatures to repeal certificate of need statutes. 

Over half the states repealing certificate of need hedged their bets 
on deregulation by retaining or re-entering the section 1122 program or 
adopting construction moratoria. In these states and others that con- 
sidered but did not repeal certificate of need, there was considerable 
concern that the increased competitiveness of the institutional health care 
market had not reached the point at which it would counteract still- 
existing incentives to capital expansion. An important issue for states 
was the effect certificate of need repeal itself would have on health 
facility capital investment and construction. State legislatures, especially 
those concerned about current spending under Medicaid programs, were 
concerned with the potential for a large increase in spending immediately 
after repeal. ^^^ Evidence from the states that have removed all restrictions 
on health facility capital investment strongly suggests that a short-term 
surge does take place when certificate of need controls are lifted. ^^^ 

In Arizona, the certificate of need law expired March 16, 1985.^^^ 
In the six months following, hospitals in Arizona obtained licensure 
permits for expansion projects, formerly subject to certificate of need 



^^^See supra notes 185-91 and accompanying text. 

'''See, e.g., Taylor & Kagay, The HMO Report Card, 5 Health Aff. 81, 82 (1986). 

-'■'A small increase seems almost inevitable, as a consequence of implementation of 
projects delayed in anticipation of repeal, projects commenced promptly in expectation 
of reimposition of certificate of need, and the increased attractiveness of the state over 
still-regulated jurisdictions to new entrants. 

'''See infra notes 267-71 and accompanying text. 

-"^1984 Ariz. Sess. Laws ch. 1, § 1. 



1986] CERTIFICATE OF NEED 1081 

review, with a total cost of $135 million. By contrast, for the same six- 
month period in 1984, during which certificate of need review was in 
effect, hospitals were issued permits for only $7.5 million worth of 
projects. ^^^ A total of 674 new hospital beds was included in the 1985 
projects, and four new open-heart surgery services were instituted. '^'^ 

Post-repeal expansion also does not seem to taper off after a few 
months. In Arizona, certificate of need review for nursing homes expired 
in July 1982. During the subsequent three and one-half year period, 
the number of facilities and beds in the state increased at a continuous 
rate. Overall, the number of nursing home beds in the state increased 
by 51.1%, compared to a 55.8% growth in the preceding nine year 
period (1974-82) during which certificate of need review was in effect.'^*' 

Post-repeal expansion appears to be taking place in Utah as well as 
in Arizona. ^^' It seems unlikely that the high level of expansion in 
Arizona and Utah will continue over the long-term. However, the ex- 
perience in these states does suggest that certificate of need repeal leads 
to a short-term increase in construction and expansion whose effects 
upon excess capacity and costs will linger for years. It also suggests that 
the recent changes in health facility reimbursement, utilization, and 
delivery have not purged the institutional health care sector of expan- 
sionist tendencies. 

The dramatic increases in health facility capital spending in the states 
that have repealed certificate of need programs will probably discourage 
a major repeal trend in the remaining states. Of course, the fate of 
state certificate of need programs is likely to be heavily influenced by 



^**G. Heller & M. Chase, A Study of the Impact of Health Care Deregulation 
ON Hospitals, Nursing Homes and Health Services in Arizona 242 (report prepared 
by Office of Planning and Budget Development, Ariz. Dep't of Health Services, Nov. 
15, 1985). 

^^'The post-repeal expansion does not appear to be attributable to relaxation of overly 
restrictive prior controls. In 1984, Arizona hospitals had a 57.8% occupancy, well below 
national averages and guidelines, and an estimated excess capacity of 2,800 beds. Arizona 
Statew^ide Health Coordinating Council, Draft Arizona State Health Plan, ch. 10, 
Appendix A (1985) (1984 Arizona non-federal hospital occupancy rate). Compare 42 C.F.R. 
§ 121.202 (1985) (National Guidelines for Health Planning recommended non-federal hospital 
occupancy rate of 80%); American Hosp. Ass'n, Hospital Statistics 22 (1985) (1984 U.S. 
non-federal hospital occupancy rate of 71.9%); Arizona Statewide Health Coordinating 
Council, Current Status/Trends in Arizona's Acute Care Nonfederal Hospital Beds 
(1984) (1984 excess bed capacity estimate). 

^'"G. Heller & M. Chase, supra note 268, at 2. 

-"One month after the repeal of Utah's certificate of need law on December 31, 
1984, six new hospitals, all previously disapproved under the certificate of need law, were 
under construction. Congress Ends Federal Health Planning, Medicine & Health Per- 
spectistes 3 (Oct. 6, 1986). Within a few months after repeal, building permit application had 
been filed for 2,800 new nursing home beds. Telephone interview with Steven Bonney, Executive 
Director, Utah Health Systems Agency, May 28, 1985. 



1082 INDIANA LAW REVIEW [Vol. 19:1025 

the status of NHPRDA and section 1122. Nevertheless, it appears that 
in the forseeable future, capital expenditure review will continue in the 
majority of states. 

B. Future of State Certificate of Need Programs 

Since the relaxation of NHPRDA requirements in 1982, state cer- 
tificate of need programs have changed considerably. It is likely that 
the direction and pace of these changes will continue. It seems likely 
that to the extent states use certificate of need as a mechanism for 
controlling increases in institutional health care costs, they will increas- 
ingly focus certificate of need review on health facility expansions and 
service additions that generate increased operating expenses. It is these 
costs, not the capital costs associated with such projects, that have the 
greatest impact on total costs. ^^^ Consistent with this focus, one would 
expect states to increase capital expenditure thresholds, to delete coverage 
of capital expenditures in any amount for service additions or bed 
increases, and to retain coverage of service additions or expansions 
associated with additional annual operating costs. Exemption of the 
various ambulatory and low-intensity in-patient facilities whose services 
represent a fraction of total institutional health care costs could also be 
expected. The recently-amended Indiana certificate of need law seems 
to follow this approach to an extent. All outpatient facilities, including 
ambulatory surgery facilities and freestanding hemodialysis units, have 
been deregulated. ^^^ Coverage is limited to capital expenditures exceeding 
$750,000 and to certain bed capacity and category changes affecting beds 
certified to participate in Medicare or Medicaid. ^^'* 

It also seems likely that states will continue to employ certificate 
of need review as a vehicle for preserving quality of care by restricting 
entry to new services having a reasonable probability of meeting minimum 
volume standards. With an increasingly competitive institutional health 
care environment and with the potential for large profits from at least 
some high-intensity, high-technology services, the rationale for this kind 
of quality-related certificate of need regulation is as great as ever.^^^ It 



-'-See supra note 146 and accompanying text. 

-"Ind. Code § 16-1-3.3-1 (Supp. 1985). Indiana's law does not, however, provide 
for coverage of new services not associated with high capital expenditures but with high 
annual operating costs, e.g., new open-heart surgery services. Compare the Montana and 
Wyoming coverage patterns discussed supra at note 215 and accompanying text. 

-^^iND. Code § 16-1-3.3-1 (Supp. 1985). 

-"The objection is sometimes raised that quality-related regulation should be the 
domain of facility licensure, not certificate of need. But as the creators of such regulatory 
regimens, states ought to be free to assign them such roles as they please, irrespective of 
their labels. Health planning agencies have both the technical tools and the jurisdiction 
to review the expected utilization of newly proposed services through certificate of need 



1986] CERTIFICATE OF NEED 1083 

applies, however, only to a limited set of services which are almost 
exclusively provided in a hospital setting. States adding the quality-related 
function to certificate of need programs primarily focused on cost con- 
tainment can be expected to include in their coverage provisions additions 
of those specified new services, regardless of capital or operating cost, 
for which there is a demonstrable relationship between volume and patient 
outcome. Oregon's newly amended statute, which contains a $1,000,000 
capital threshold and coverage of new services that exceed the annual 
operating cost threshold or are identified with volume-related quality 
concerns, exemplifies this approach. '^^ Alternatively, a state that aban- 
doned certificate of need as a cost containment mechanism but wished 
to maintain limited entry controls for quality of care purposes might 
limit its coverage to new hospital services. California's hospital coverage 
provisions, which exempt all capital expenditures and service additions 
except for radiation therapy units, burn centers, emergency centers, 
psychiatric services, newborn intensive care nurseries, cardiac surgery 
units, and cardiac catheterization units, may reflect this approach. 

In recent years, a number of states have increased the role played 
by certificate of need review in assuring access to institutional health 
care by persons unable to pay, through preferential treatment of charitable 
facilities or by outright indigent care quotas. ^^^ This strategy has attracted 
attention in other states.-^" However, there is even greater interest at 
present among the states in programs that redistribute revenues from 
low indigent care facilities to those treating a disproportionate share of 
such patients. ^^"^ Typically, such programs authorize a tax on hospital 
sales or revenues that funds an indigent care account from which facilities 
with disproportionate indigent care loads may draw.^"" These programs 
may offer a more precise matching of the benefits or subsidies to a 
facility with its indigent care burden than certificate of need preferences 
or quotas. However, these programs may tend to concentrate indigent 
patients in a limited number of facilities more than certificate of need 
preferences or quotas do. The redistribution programs are not inconsistent 



programs, while licensing agencies have traditionally fulfilled the role of monitoring the 
ongoing operations of existing facilities and services. Certificate of need programs can do 
little in the way of monitoring facility operations, except through enforcement of licensure 
determinations in subsequent certificate of need proceedings. 

-"'See supra note 228. 

'^'See supra note 25. 

-''See, e.g., Subst. S.B. 4403, 48th Wash. Legis., 1984 Reg. Sess. § 22(2)(k), which 
adopted a certificate of need requirement that each applicant meet or exceed the regional 
average level of charity care (subsequently vetoed by the governor). 

-'"'Academy for State & Local Gov't, Access to Care for the Medically Indigent: 
A Resource Document for State and Local Ofhcials 54-71 (1985). 

^*°M. King, Alternative Funding Sources for Care of the Medically Indigent 3 (Nat'l 
Conf. of State Legislatures 1986). 



1084 INDIANA LAW REVIEW [Vol. 19:1025 

with certificate of need preferences or quotas. Given the high level of 
public concern with indigent care and the availability of more direct 
mechanisms for increasing indigent care access, it seems unlikely that 
states will make indigent patient access the dominant function of cer- 
tificate of need programs, but equally likely that it will continue to be 
one of several functions of such programs. 

Employment of certificate of need review as an adjunct to state 
programs regulating or reimbursing the operating expenses of health 
facilities is likely to continue as long as states continue to have such 
programs. However, the number of states with rate regulation programs 
shows no signs of increasing, and numerous states have changed their 
Medicaid reimbursement formulae in ways that reduce the incentives to 
overinvestment and correspondingly reduce the need for compensatory 
regulatory programs. ^^' 

C The Future of Federal Health Planning Law 

In the fall of 1986, Congress finally reached the decision to dis- 
continue NHPRDA funding. ^**^ Congress also passed and sent to the 
President legislation that would repeal NHPRDA. ^^^ The possibility of 
any continued federal funding for state certificate of need and capital 
expenditure review programs turns on the outcome of the debate over 
in-patient hospital reimbursement for capital expenditures under the 
Medicare program. Congress has given itself until October 1, 1987, to 
devise a mechanism for incorporating payment for such costs into the 
prospective payment system.^"* Even if it does so. Congress could choose 
to retain section 1122 either as a mandatory or as a state optional 
program. However, if Congress succeeds in enacting a new capital reim- 
bursement formula that rewards efficient operations and prudent in- 
vestment, that maintains an adequate capital plant to assure the long- 
term availability of hospital services to the increasing Medicare popu- 
lation, and that satisfies budget constraints, it is unlikely that fed- 
eral interest in supporting state regulatory health planning through sec- 
tion 1122 will continue. Congress might logically conclude that any incre- 
ment in cost-saving benefits to the Medicare program from state section 
1122 programs above and beyond the cost-containment incentives 
of the prospective payment system would be outweighed by the programs' 



^^'See supra notes 185-89 and accompanying text. 

-■^-Congress' decision took the form of a refusal to include funding for NHPRDA 
Programs in the 1987 fiscal year continuing resolution, terminating NHPRDA funding as 
of the end of the 1986 fiscal year (Oct. 1, 1986). See Congress Ends Federal Health Planning, 
Medicine & Health Perspectives, Oct. 6, 1986, at 1. 

"^See Congress' Health Leaders Agree to Health Legislation Package, Medicine & Health, 
Oct. 20, 1986, at 3. 

'«Tub. L. No. 98,369, § 2312(c), 98 Stat. 494 (1984). 



1986] CERTIFICATE OF NEED 1085 

undesirable enfranchising effect. Congress might also conclude that the 
benefits of state capital expenditure review programs (both in the area 
of cost-containment and in the quality of care and access arenas) accrue 
primarily to states which, on that account, ought to shoulder all or 
most of the cost of such programs. 

Another alternative deserves consideration. The section 1122 program 
could be retained, but put to a different use. Federally-funded health 
planning had its origins in planning for the disbursement of federal 
health facility construction funds through the Hill-Burton program. '*^'* 
Today the federal government no longer provides direct support for 
private health facility construction, even though many of the hospitals 
and other facilities built with Hill-Burton monies are in need of re- 
placement. ^*^^ Nor is it likely that grants or loans for hospital construction 
will be reinstituted in the forseeable future. Instead the federal government 
will support health facility construction primarily through tax exemptions 
for interest on certain bonds issued for health facility construction'*^^ 
and by Medicare reimbursement for capital costs. Both of these supports 
may be targeted for curtailment in the interest of deficit reduction. Yet 
it is through the provision of adequate support for health facility capital 
investments that the Medicare program is assured of the long-term 
availability of an adequate supply of health care facilities to meet the 
needs of the Medicare population. 

The Medicare program could employ the section 1122 review process 
to support selected health care facilities in each state and local community 
that are likely to be needed in the long run to assure the availability 
of services to Medicare beneficiaries. Health care facilities seeking to 
make major capital expenditures for replacement or new construction 
would apply for approval under the section 1122 process. ^'^'^ The review 
would proceed as it has in the past, except that the planning agencies 
would only determine the need for the proposed expenditure to serve 
the Medicare population, not the entire community need for the project. 
Facilities whose projects were identified as needed would be entitled to 
a Medicare capital allowance in addition to reimbursement for operating 
expenses associated with treatment of Medicare patients. Facilities not 
identified as needed would continue to be eligible to participate in 
Medicare and to receive per-case payment for operating expenses, but 
Medicare funds would not be given to replace or expand their capital 
plants. 

-""■See supra notes 33-37 and accompanying text. 

'**Ting & Valiante, Future Capital Needs of Community Hospitals, 1 Health Aff. 14 (1982). 

-•^l.R.C. § 103(a)(1) (1985). See generally Capital Projects, 2 Topics in Health Care 
Financing (Winter 1975). 

-"'Minor expenditures, including those associated with moveable equipment acquisitions, 
could be exempted from section 1122 review and reimbursed through a standard allowance 
incorporated into the per case payment. 



1086 INDIANA LAW REVIEW [Vol. 19:1025 

Under this approach, Medicare would selectively support major health 
facility construction, much as some state Medicaid programs currently 
contract with a limited group of hospitals or other providers for services 
to Medicaid beneficiaries, or as Hill-Burton once supported those facilities 
willing to provide uncompensated care and community service. From a 
predetermined total federal expenditure for Medicare capital reimburse- 
ment, each facility selected for capital payment under this system could 
receive more generous capital payment than it would receive under a 
system paying for capital expenses in every Medicare-participating facility. 

A simplified version of this process has been proposed. The Office 
of Management and Budget has suggested that Medicare capital reim- 
bursement to hospitals be limited to those facilities achieving eighty-five 
percent occupancy rates. ^^' The purposes of this approach are to channel 
Medicare capital reimbursement toward needed facilities, to avoid payment 
to underutilized, unnecessary facilities, and to permit more generous capital 
payment within budget constraints by spreading payment over fewer 
facilities. While the purposes are laudable, a target occupancy rate is a 
poor substitute for the kind of multi-factored determination of need 
that health planning programs can make. For example, an eighty-five percent 
target occupancy rate could penalize small rural hospitals that, although 
their occupancy rates are low, are needed for reasons of geographical 
access to services. A high occupancy hospital with a low Medicare patient 
load might be less deserving of capital support than a lower occupancy 
facility that treats many Medicare patients. Finally, rather than en- 
couraging closure of excess beds, a target occupancy rate could create 
an incentive to increase unnecessary admissions and extend hospital stays, 
contrary to the incentives in the per case system of payment for operating 
expenses. 

Using the section 1122 process to make the federal government a 
selective investor in health facility capital plants would provide a legit- 
imate participatory role for capital expenditure review in a competitive 
institutional health services market. It would also reinstitute health plan- 
ning as a major federal vehicle for management of health care delivery. 
Medicare is the nation's largest purchaser of institutional health services 
and few health care facilities do not participate in Medicare. Using health 
planning agencies operating through the 1122 process as Medicare's 
purchasing agents would place health planning programs in a central 
role in determining the allocation of health resources throughout the 
country. 

Whether or not federal funding continues, it appears that a substantial 
number of states will retain certificate of need programs, at least in the 

'"'Wash. Report on Medicine & Health, Dec. 23, 1985, at 3; see also 51 Fed. Reg. 19,983 
(1986) (HHS request for comments on methods for including adjustment to capital payment 
for low occupancy hospitals). 



1986] CERTIFICATE OF NEED 1087 

near future. It should be apparent that certificate of need regulation 
continues to satisfy a wide range of state policy roles. However, it also 
appears that in the absence of federal requirements, a significant number 
of states will abandon the program in favor of efforts to promote more 
competitive health service markets. This might well be a fortuitous 
development. As with any regulatory program that intervenes in the 
market to accomplish some social good, the necessity for certificate of 
need programs ought to be continuously evaluated, and the scope of 
the program tailored to meet specific, concrete, present purposes. It is 
difficult to do this when the states uniformly adopt the program. The 
repeal of the program in some jurisdictions provides a natural experiment 
to measure the impact of the presence or absence of certificate of need 
review on the direction and scope of health facility expenditures. 



1088 INDIANA LAW REVIEW [Vol. 19:1025 

APPENDIX 

SOURCES: Information contained in the Tables and in this Appendix 
has been compiled primarily from the author's review of state certificate 
of need and section 1122 statutes and regulations, supplemented by the 
author's written and telephonic communications with SHPDA officials, 
U.S. Department of Health and Human Services officials, and various 
secondary sources. 

EXPLANATORY NOTES: The symbol "X" appearing in the Tables in- 
dicates that a particular health care facility or project is subject to cer- 
tificate of need review in a given state. The symbol "N" appearing in 
the Tables indicates that additional information regarding a state's coverage 
of a particular facility or project may be found in the State-by-State Com- 
ments section of this Appendix. An asterisk (*) appearing in the "Capital 
and Other Projects" Table under the coverage categories relating to bed 
capacity indicates that the state covers the indicated bed-related change 
only if it exceeds ten beds or ten percent of bed capacity, whichever is 
less, in any two year period. A dollar amount adjacent to an "X" sym- 
bol in the ''Capital and Other Projects" Table indicates that the specified 
project or expenditure is covered only if its cost exceeds the dollar amount. 

ABBREVIATIONS USED IN THIS APPENDIX: 

AOC = annual operating cost; CCU = coronary care unit; CE = capital 
expenditure; CON = certificate of need; HHA = home health agency; 
ICF = intermediate care facility; LF = letter received from; ICU = in- 
tensive care unit; LT = letter sent to; MME = major medical equip- 
ment; NMR or MRI = magnetic resonance imaging; OAHCF = organized 
ambulatory health care facility; SHPDA = State Health Planning and 
Development Agency; SNF = skilled nursing facility; TCF = telephone 
call from; TCT = telephone call to; 10/10/2 = ten beds or ten percent, 
whichever is less, in any two-year period; 1122 = section 1122 program. 

COVERAGE NOT SHOWN IN THE TABLES: The Tables are intended 
to comprehensively display the facility and project coverage provisions 
of state certificate of need and section 1122 programs. A few entities 
and projects subject to review are not shown. In the ''Health Care 
Facilities, etc." Table, coverage of "persons" is not Usted, although vir- 
tually all states cover "persons." The "Capital and Other Projects" Table 
does not list the following transactions, covered under many state CON 
statutes: (1) Capital expenditure to acquire (either by purchase or under 
lease or comparable arrangement) an existing health care facihty if the 
person entering into a contractual arrangement for such acquisition does 
not notify the SHPDA at least thirty days prior to such contractual 



1986] CERTIFICATE OF NEED 1089 

arrangement or if the SHPDA finds that the services or bed capacity of 
the faciUty will be changed in being acquired. (2) Acquisition of major 
medical equipment not owned by or located in a health care facility if 
the person entering into a contractual arrangement to acquire the equip- 
ment does not notify the SHPDA at least thirty days before contractual 
arrangements are made to acquire the equipment. (3) Capital expenditures 
not otherwise subject to review for proposed changes in previously- 
approved projects, including cost overruns, and proposed changes not 
otherwise subject to review in previously-approved projects. 

DEFINITIONS OF TERMS IN TABLES: 

1. Definitions used in "Health Care Facilities, etc." Table: State 
CON/1122 statutes and regulations employ a variety of definitions and 
terms to identify the persons and entities subject to CON review. Usu- 
ally, but not invariably, state statutes first subject "health care facilities" 
to review and then in statute or regulations list and sometimes define the 
various types of facilities subsumed under that term. This Tat 'e was com- 
pleted using a standard set of health care facility definitions which does 
not duplicate any one state's coverage definitions exactly, but which is 
intended to place comparable types of facihties in distinct categories for 
comparison purposes. Readers seeking to ascertain whether a particular 
project would be subject to review in a given state are cautioned to con- 
sult the laws of that state. The following definitions apply to the Table: 
"Hospital" means an institution which primarily provides to inpatients, 
by or under the supervision of physicians, diagnostic services and 
therapeutic services for medical diagnosis, treatment and care of injured, 
disabled, or sick persons, or rehabilitation services for the rehabilitation 
of injured, disabled or sick persons. The term includes psychiatric and 
tuberculosis hospitals. Individual states may enumerate other categories 
of general and specialty hospitals falling within their definition of 
"hospital". "Skilled nursing facility" means an institution or a distinct 
part of an institution which primarily provides to inpatients skilled nurs- 
ing care and related services for patients who require medical or nursing 
care, or rehabiHtation services for the rehabilitation of injured, disabled, 
or sick persons. The term "intermediate care facility" means an institu- 
tion which provides, on a regular basis, health-related care and services 
to individuals who do not require the degree of care and treatment which 
a hospital or skilled nursing facility provides, but who because of their 
mental or physical condition require health-related care and services (above 
the level of room and board). The term "medically-oriented residential 
care facilities" refers to inpatient institutions providing room, board, and 
personal care services, not including continuous nursing services, to in- 
dividuals who do not require the degree of care and treatment which a 
hospital, skilled facility, or intermediate care facility provides but who 



1090 INDIANA LAW REVIEW [Vol. 19:1025 

by reason of illness, disease, or physical or mental infirmity are unable 
to effectively or properly care for themselves. The states have various 
names for these facilities. The term "inpatient rehabilitation facility" means 
an inpatient facility which is operated for the primary purpose of assisting 
in the rehabilitation of disabled persons through an integrated program 
of medical and other services which are provided under competent pro- 
fessional supervision. The term "home health agency" means a private 
or public agency or institution, not part of another health care facility, 
that provides "home health services" as that term is defined in Section 
1861(m) of the Social Security Act, or a similar set of services as pro- 
vided under state law. The term "hospice" means a public agency or 
private organization not part of another health care facility that pro- 
vides "hospice care" as that term is defined in Section 1861(dd) of the Soc- 
ial Security Act, or similar care as provided for under state law. The term 
"kidney dialysis treatment center (including freestanding hemodialysis 
units)" means a health care facility, not part of another health care facility, 
which provides dialysis services. "Health maintenance organization (sub- 
ject to exemption)" means a public or private organization that falls within 
the health maintenance organization definition in 42 U.S.C. § 300n(8) or 
a similar definition under state law, and whose capital expenditures and 
other projects are largely exempt from CON review under state law. "Am- 
bulatory surgery center" means a facility, not a part of another health 
care facility, which provide surgical treatment to patients not requiring 
hospitalization. The term does not include the offices of private physi- 
cians or dentists, whether for individual or group practice. "Organized 
ambulatory health care facilities/outpatient clinics" is a generic term en- 
compassing clinics, health centers, and independent facilities other than 
ambulatory surgery centers, not part of another health care facility, which 
are organized and operated to provide general outpatient medical care 
or specific types of medical care to outpatients. The term does not in- 
clude the offices of private physicians or dentists, whether for individual 
or group practice. States with broad, general provisions for coverage of 
OAHCFs but no breakdown or specification of the facilities included 
thereunder are listed in this category on the Table. A state whose law 
and regulations provide for both broad, general coverage of OAHCFs 
and express coverage of specified ambulatory facilities will be checked 
on the Table both in the "organized ambulatory health care facilities" 
box and in the boxes corresponding to the specific facilities covered. 
Some states do not have general coverage of OAHCFs but do cover 
some specified ambulatory facilities. They are on the Table accordingly. 
"Freestanding emergicenter" means a facility, not part of another health 
care facility, which is, or is licensed as, or presents itself to the pubHc 
as, a 24-hour facility to provide emergency or urgent medical care. "Am- 
bulatory obstetrical facilities/birthing centers" and "family planning/abor- 
tion centers" are facilities, not part of another health care facility, pro- 



1986] CERTIFICATE OF NEED 1091 

viding some or all such services. "Community health centers/clinics" means 
neighborhood health centers and community clinics, not part of another 
health care facility, and in any given state may include ''community health 
centers" faUing within the definition thereof in 42 U.S. C. § 254c, "migrant 
health centers" falHng within the definition thereof in 42 U.S.C. §254b, 
and "rural health clinics" falling within the definition thereof in 42 U.S.C. 
§ 254aa(2). "PubHc health center" means an official agency established 
by state or local government, not part of another health care facility, 
the primary function of which is to provide public health and medical 
services. "Community mental health centers" means outpatient facilities, 
not part of another health care facility, which fall within the definition 
of "community mental health centers" in 42 U.S.C. § 2691 (1973) or a 
similar definition under state law and includes facilities for treatment of 
developmental disabilities, mental retardation, alcohohsm, drug abuse, 
chemical dependency and mental illness. "Facilities for the provision of 
outpatient therapy services including speech pathology" means clinics, 
rehabilitation agencies, or public health agencies, not part of another health 
care facility, which provide outpatient physical therapy and speech 
pathology services as defined in 42 U.S.C. § 1395x(p). "Outpatient 
rehabilitation facility" means a facility, not part of another health care 
facility, which provides outpatient rehabilitative services and may include 
"comprehensive outpatient rehabilitation facilities" as the term is defined 
in 42 U.S.C. §§ 1395x(cc). 

2. Definitions of projects and capital expenditures in * 'Capital and Other 
Projects*' Table: State certificate of need and section 1122 statutes and 
regulations employ a variety of categories and terms to identify the ex- 
penditures, projects, and transactions subject to CON review. Usually, 
but not invariably, states subject some combination of capital expenditures, 
additions of new health services and beds, and acquisitions of major 
medical equipment to review. Most states employ expenditure or annual 
operating cost thresholds (i.e., dollar values of the amount of an expen- 
diture or major medical equipment acquisition or of the annual operating 
costs associated with a non-capital expenditure project below which an 
expenditure or project is not covered). The Table was completed using 
a standard set of expenditure, project, and transaction definitions which 
may not duplicate any one state's definitions exactly, but which is in- 
tended to place comparable types of expenditures, projects, and transac- 
tions in distinct categories for comparison purposes. Readers seeking to 
ascertain whether a particular project would be subject to review in a 
given state are cautioned to consult the laws of that state. 

Expenditure and project coverage is divided in the Table into two broad 
categories: coverage of capital expenditures and coverage of projects. The 
term "general purpose CE/expenditure threshold" refers to coverage of 
capital expenditures undertaken by or on behalf of health care facilities 



1092 INDIANA LAW REVIEW [Vol. 19:1025 

for any purpose. If the state employs an expenditure threshold, that 
threshold is shown. "CE for bed capacity increases and decreases/expen- 
diture threshold" refers to state coverage of applicable expenditures for 
both increases and decreases in bed capacity of a health care facility. If 
an expenditure threshold is applied to such coverage, the threshold is 
shown. "CE for bed capacity increases only/expenditure threshold" is 
self-explanatory. "CE for changes in bed categories/expenditure 
thresholds" refers to state coverage of capital expenditures for redistribu- 
tion of existing health care facility beds among license categories or other 
services specified under state law. If an expenditure threshold is applied 
to coverage of such projects, the threshold is shown. "CE for additions 
of health services/expenditure threshold" refers to state coverage of capital 
expenditures by or on behalf of health care facilities which are associated 
with additions of health services which were not offered by or on behalf 
of the facility within the previous twelve months. If state coverage is depen- 
dent on an expenditure threshold, the threshold is given; otherwise health 
service additions are covered under this category if they are associated 
with any capital expenditure. *'CE for terminations of health services/ex- 
penditures threshold" refers to coverage of capital expenditures which are 
associated with the termination of health services which were previously 
offered in or through the facility. If state coverage is dependent on an 
expenditure threshold, the threshold is given in otherwise health service 
terminations associated with any CE are covered. 

Under the listings for coverage of specified projects, "Bed capacity in- 
creases and decreases" refers to coverage of both increases and decreases 
in the total number of beds offered by or on behalf of a health care 
facility, regardless of whether the change is associated with a capital ex- 
penditure. "Bed category changes" refers to coverage of redistribution 
of beds among various license or other categories under state law, 
regardless of whether such redistribution is associated with a capital ex- 
penditure. "Bed relocations" refers to coverage of relocations of beds 
from one physical facility or site to another, regardless of whether such 
relocation is associated with a capital expenditure. "Additions of new 
health services/annual operating cost threshold" refers to coverage of the 
addition of a health service which was not offered by or on behalf of 
a health care facility within the previous twelve months, regardless of 
whether the addition is associated with a capital expenditure. If coverage 
of the health service addition is provided for only if the new health service 
will entail annual operating costs of at least an expenditure minimum for 
annual operating costs, then the Table indicates the state's annual operating 
cost dollar threshold. "Termination of a service" refers to a termination 
of a health service which was offered in or through a health care facility 
and which is not associated with a capital expenditure. "Acquisitions of 
major medical equipment/equipment threshold" refers to state coverage 
of the acquisition by any person of major medical equipment that will 



1986] CERTIFICATE OF NEED 1093 

be owned by or located in a health care facility, or equipment that will 
be used to provide services for hospital inpatients on other than a tem- 
porary basis in case of national disaster, major accident, or equipment 
failure. If the state employs an expenditure threshold for coverage of 
medical equipment acquisitions, the threshold is shown. "Construction, 
development, or other establishment of new health care facilities" refers 
to construction or commencing operation by any person of entirely new 
physical plants of health care facilities." "Acquisition of existing facilities" 
refers to the acquisition by any person of the physical plant of an ex- 
isting health care facility, or the acquisition of the stock or assets of a 
corporation or other entity owning an existing health care facility. If a 
state specifies coverage of other projects, the projects are listed in the 
state-by-state comments. 

STATE-BY-STATE COMMENTS TO TABLES'. 

ALABAMA: Inpatient rehabilitation facilities, outpatient rehabilitation 
facilities: State law provides for coverage of "rehabihtation centers." State 
regulations provide for coverage of "health facilities required by federal 
regulations" (which would include inpatient rehabilitation facilities) and 
"substance abuse rehabilitation facilities" (which may be inpatient or out- 
patient). Other entities, persons: Alabama covers facilities for the 
developmentally disabled. CE for other specified purpose: Alabama statute 
and regulations cover CE in excess of $245,000 for AOC. Coverage under 
this provision unclear. Additions of new health services: Alabama regula- 
tions contain a non-exclusive list of new services subject to review (e.g., 
(a) ambulance - air unit; (b) ambulance - ground unit; (c) birthing centers 
and services; (d) nursing home services (ICF and skilled considered as 
one service); (e) cardiac catheterization (adult or pediatric); (f) angiography 
laboratory; (g) cardiopulmonary laboratory; (h) ICU/CCU; (i) 
hemodialysis; G) hyberbaric chamber; (k) organ transplant; (1) organ bank; 
(m) open-heart surgery; (n) pulmonary function laboratory; (o) CT scan- 
ners (mobile or fixed); (p) nuclear medicine (includes NMR); (q) 
megavoltage radiation therapy; (r) neonatal intensive care (level II and 
III); (s) pediatric inpatient services; (t) extracorporeal lithotresis; (u) 
rehabihtation services (including physical therapy, speech and hearing); 
(v) psychiatric; (w) substance abuse; (x) specialty services which have been 
addressed in the appropriate state plan as being properly allocated on a 
regional basis). Other specified projects: Alabama regulations cover "plan- 
ning, predevelopmental, and developmental activities in excess of 
$300,000." 

ALASKA: Other entities: Alaska statute covers "federal hospitals." CE 
for bed supply increases and decreases: Statute covers "CE in excess of 
$1M for alteration of bed capacity." Table assumes this language pro- 



1094 INDIANA LAW REVIEW [Vol. 19:1025 

vides for coverage of bed increases and decreases with no 10/10/2 
exemption. 

ARIZONA: General: Arizona has no CON statute. Prior CON law was 
repealed 03/15/85. It does not have an 1122 program. 

ARKANSAS: General: Arkansas has a certificate of need program and 
an 1122 program, apparently with identical coverage. Hospice: coverage 
unclear. Other outpatient ambulatory care facilities: Arkansas also covers 
"chnical health centers, multidisciphnary clinics, specialty clinics." 

CALIFORNIA: General: California law provides various general exemp- 
tions from certificate of need coverage in addition to the categorical ex- 
emptions described below, including an exemption for facilities providing 
prepaid health care, facilities providing certain volumes of free care, etc. 
Cahfornia CON scheduled to sunset Jan. 1, 1987. Other outpatient am- 
bulatory care facilities: California also subjects to limited regulation "free 
clinics", "psychology clinics", "chronic dialysis clinics", and "employees' 
chnics." CE for other specified purposes/expenditure threshold: Cahfor- 
nia covers a capital expenditure in any amount for a specialty clinic 
(surgical, chronic dialysis, or rehabilitation clinic) for expanded outpa- 
tient capacity. California also covers capital expenditures in excess of 
$1,000,000 for other projects for a surgical chnic or rehabilitation clinic 
and capital expenditures in excess of $1,000,000 for services, equipment 
or modernization of a specialty clinic (e.g., surgical clinic, chronic dialysis 
clinic, rehabilitation clinic). Bed capacity increases: California covers bed 
supply increases, and exempts a bed supply increase less than ten percent 
of licensed bed capacity or ten beds whichever is less in a two-year period 
for certain classes of health facilities, if certain occupancy rate and ac- 
cessibility standards are met by the facihty. In addition, California ex- 
empts up to two additions of five SNF beds for a distinct part SNF of 
a Primary Health Service hospital if certain occupancy and cost condi- 
tions are met. Certain other bed supply increase project exemptions are 
available under California law. Bed category changes: California covers 
conversion of beds from general acute, general acute rehabilitative, skilled 
nursing, intermediate care-developmental disabilities, intermediate care- 
other, acute psychiatric, specialized care, chemical dependency recovery, 
bed categories to skilled nursing, psychiatric, intermediate care beds to 
any other category, except that California exempts conversion of a general 
acute care hospital's distinct part SNF or ICF beds licensed as of March 
1, 1983 to other categories provided that the conversion may not exceed 
during any three-year period five percent of the existing beds in the 
category to which the conversion is made. California exempts use of beds 
licensed in one category for another category of use if such changes do 
not exceed five percent of total bed capacity at any time, except that a 
facility may use an additional five percent of its beds in this manner if 



1986] CERTIFICATE OF NEED 1095 

seasonal fluctuations justify it. Health service additions: California covers 
establishment of specified new special services, e.g., radiation therapy 
department, burn center, emergency center, psychiatric service, intensive 
care newborn nursery, cardiac surgery, cardiac catheterization laboratory. 
California also covers establishment of certain special services by a surgical 
or rehabilitation clinic. Acquisition of major medical equipment: Califor- 
nia covers acquisitions of diagnostic or therapeutic equipment by primary 
care clinics, psychology clinics, and specialty care clinics in excess of 
$1,000,000. Construction, development or establishment of new health care 
facilities: Establishment of a new primary care clinic (e.g. community clinic, 
free clinic, employees' clinic), psychology cHnic, and chronic dialysis cHnic 
are not subject to review. Also exempt are conversion of an existing spec- 
ialty clinic to a primary care clinic or conversion of a primary care clinic 
from one licensure category to another. Other specified projects: Califor- 
nia covers conversion of an entire existing hospital, SNF, or ICF from 
one hcensure catagory to another. California covers conversion of a 
primary chnic (community, free, employees' clinic) to a specialty clinic 
(surgical, chronic dialysis, rehabilitation clinic). California covers conver- 
sion of a specialty chnic from one category to another. California covers 
a project by a health facility for expanded outpatient surgical capacity. 
Cahfornia covers relocation of a hospital, SNF, ICF, or specialty clinic - 
(surgical chnic, chronic dialysis chnic, rehabilitation chnic) to a different 
or adjacent site. 

COLORADO: General: Colorado's CON law underwent minor amend- 
ment in 1985. Kidney disease treatment centers, ambulatory surgery centers, 
freestanding emergicenters: The capital and other projects by or on behalf 
of these facilities which are subject to review are limited to capital expen- 
ditures regardless of purpose in excess of the capital expenditure threshold. 
Facilities for the provision of outpatient therapy services including speech 
pathology: No such projects have been proposed and it is unclear whether 
they would be subject to review. LF SHPDA 1/84. Other ambulatory 
care facilities: Colorado covers * 'facilities for the mentally retarded," 
'*habilitation centers for brain-damaged children," and "pilot project 
rehabilitative nursing facilities." General purpose CE/ expenditure 
threshold: Colorado's general purpose capital expenditure threshold covers 
expenditures in excess of $2,000,000 for "provision of clinically-related 
health care services" and excludes expenditures for a set of specified non- 
clinical services. Capital expenditures for additions of health services /ex- 
penditure threshold: Colorado covers capital expenditures in excess of 
$1,000,000 to "create or change" health services. CE for other specified 
purposes /expenditure threshold: Colorado covers the replacement of beds 
exceeding the capital expenditure threshold. Bed supply increases only, 
bed category changes and bed relocations: Colorado covers bed supply 
increases, category changes, and relocations in excess of twenty beds over 



1096 . INDIANA LAW REVIEW [Vol. 19:1025 

a two-year period. Other entities, persons, other specified projects: Col- 
orado covers expenditures for major medical equipment by or on behalf 
of any person in excess of $1,000,000 to provide "clinically related health 
care" which includes equipment not located in or providing services to 
inpatients of a hospital. 

CONNECTICUT: General: Connecticut amended its CON law in 1985. 
Inpatient rehabilitation facilities, ambulatory surgical facilities, organized 
ambulatory health care facilities: Coverage unclear. Other entities, per- 
sons: Connecticut covers '^coordination, assessment and monitoring agen- 
cies," student/faculty infirmaries, and "homemaker home health aide agen- 
cies." Bed capacity increases and decreases: Connecticut statute expressly 
covers only substantial decrease in total bed capacity. Bed supply increases 
are apparently included under statutory health service/function addition 
coverage. Additions of new health services: Connecticut covers additions 
of health services or functions, except additions of ambulatory services 
by HMOs, by all health care facilities or institutions (including state health 
care facilities or institutions) except home health care agencies, homemaker- 
home health aide agencies, and coordination, assessment, and monitoring 
agencies. Other specified projects: Connecticut covers transfer of owner- 
ship or control of a health care facility or institution (except home health 
care agencies and homemaker home health aide agencies) prior to initial 
licensure. Connecticut covers increases in coordination, assessment, and 
monitoring agency staffing by a specified percentage. Connecticut covers 
the termination of its Medicaid provider agreement by a nursing home. 
Other entities, persons, other specified projects: Connecticut covers ex- 
penditures by any person in excess of $400,000 to acquire "imaging equip- 
ment" which will not be owned by or located in a health care facility. 

DELAWARE: General: Delaware has certificate of need and 1122. Tables 
show CON coverage. Other entities: Delaware covers independent blood 
banks. Other specified projects: Delaware covers pre-development expen- 
ditures in excess of $50,000. 

DISTRICT OF COLUMBIA: General: The D.C. CON law underwent 
minor amendment in 1985. Health care facilities subject to review: The 
District of Columbia covers health care facilities only if they have an an- 
nual operating budget of at least $250,000. Other entities, persons: D.C. 
covers diagnostic health care facilities. CE for other specified purposes /ex- 
penditure threshold: D.C. covers capital expenditures intended to permit 
the increase of patient load or units of service by forty percent over pre- 
sent capacity and capital expenditures to permanently close a health care 
facility. Additions of new health services /annual operating cost threshold: 
D.C. regulations appear to provide for coverage of new health services 
both regardless of annual operating cost, and if they exceed an annual 
operating budget. Other entities, persons, other specified projects: D.C. 



1986] CERTIFICATE OF NEED 1097 

covers acquisition of MME with a fair market value in excess of $400,000 
by or on behalf of physicians, dentists, or other individual providers of 
individual group practice. 

FLORIDA: General: Florida CON law underwent minor amendment in 
1985. Portions of Florida CON law sunset in 1987. Home health agency: 
HHA coverage limited to HHAs certified or seeking certification as a 
Medicare home health services provider. Project coverage limited to 
establishment of a new HHA. Bed capacity increases and decreases: Florida 
covers increases in bed supply and any change in the number of psychiatric 
or rehabilitation beds. Bed category changes: Florida covers bed category 
conversions only between SNF and ICF beds, and only if the conversion 
exceeds 10/10/2, unless the facility is licensed for both SNF and ICF. 
Other specified projects: Florida covers conversion from one type of health 
care facility to another and transfer of a CON. 

GEORGIA: General: The Georgia CON law was amended in 1985. Georgia 
has CON and 1122. Facilities and projects identified as covered on Tables 
may be covered under either or both CON and 1122. Medically-oriented 
residential care facilities: Georgia covers only "personal care homes" not 
in existence on the effective date of the CON statute. Family plan- 
ning/abortion centers /clinics: Only abortion centers covered. Acquisition 
of existing facilities: Reviewable only under the state's 1122 program, ex- 
cept that acquisitions of publicly owned and operated health care facilities 
subject to CON review. Bed capacity increases only: Georgia exempts bed 
supply increases less than ten beds or ten percent of bed capacity, 
whichever is less, in any two-year period if the facility occupancy rate 
in the preceding year is more than eight-five percent. Other specified pro- 
jects: Georgia covers conversion or upgrading of a health care facility not 
previously subject to review under the CON law to a health care facility 
subject to review. 

HAWAII: Medically-oriented residential care facilities: Coverage unknown. 
Other outpatient ambulatory care facilities: Hawaii also covers centers for 
dental surgery; dental clinics; cosmetic surgery centers; any provider of 
medical or health services organized as a not-for-profit or business cor- 
poration other than a professional corporation; and any provider of 
medical or health services which describes itself to the public as a "center," 
"clinic" or by any name other than the name of one or more of the 
practitioners providing these services. CE for other specified purposes: 
Hawaii covers capital expenditures in excess of $600,000 for acquisition 
of existing health care facilities. Termination of a health service: Hawaii 
covers terminations but exempts service terminations by a health care facil- 
ity that is ceasing its entire operation. Acquisitions of major medical equip- 
ment: Hawaii has a $250,000 threshold for acquisitions of new medical 
equipment and a $400,000 threshold for replacement of medical equip- 



1098 INDIANA LAW REVIEW [Vol. 19:1025 

ment. Other specified projects: Hawaii covers change of location of a 
health service. Other entities, persons, acquisition of MME: Hawaii covers 
acquisitions of MME by offices of physicians, dentists, or other practi- 
tioners of the heahng arts. 

IDAHO: General: Idaho has an 1122 program, but no CON program. 
Table displays 1122 coverage. Other specified projects, CE for other 
specified purposes: Idaho covers development of a new facility, and a 
capital expenditure for development of a new facility, which will result 
in the addition of new licensed beds. 

ILLINOIS: General: Portions of the Illinois CON law are scheduled to 
sunset Jan. 1, 1986. Addition of new health services /annual operating 
cost threshold: Illinois covers additions of the following services if their 
annual operating costs exceed the threshold: blood bank; diagnostic im- 
aging; emergency services; laboratory; occupational therapy; outpatient 
ambulatory care; pharmacy; physical therapy; respiratory therapy; and 
surgery. Additions of the following services are covered regardless of cost: 
acute mental illness; alcoholism treatment; burn treatment; cardiac 
catheterization; computer systems; end stage renal disease; intensive care; 
medical-surgical; non-hospital based ambulatory surgery; obstetrical ser- 
vices; open heart surgery; pediatric services; perinatal-high risk; radiation 
therapy; rehabilitation services. Other specified projects: Illinois covers 
discontinuation of a health care facility. 

INDIANA: General: Indiana's CON law was amended in 1985. Indiana 
CON law sunsets June 30, 1987. Skilled nursing facilities and intermediate 
care facilities: Indiana exempts CE by or on behalf of health care facilities 
for SNF/ICF beds which are not certified to participate in Medicare or 
Medicaid. Kidney disease treatment centers (including freestanding 
hemodialysis units): Indiana does not cover freestanding hemodialysis units. 
CE for changes in bed category: Indiana covers changes in health care 
facility bed category from any category to certified long-term care 
SNF/ICF beds. Indiana covers changes in Medicaid-certified hospital or 
SNF/ICF beds to Medicaid-reimburseable ICF/mentally-retarded beds. 
Other specified projects: Indiana covers the appUcation of a SNF or ICF 
for certification to participate in Medicare or Medicaid. 

IOWA: General: Iowa has CON and 1122. Entities and projects iden- 
tified as covered in Tables may be covered under either 1122 or CON 
or both. Freestanding emergicenter; birthing center; public health center, 
outpatient physical therapy center: The state CON statute provides for 
coverage of "organized outpatient health facilities," (defined as "a facility, 
not part of a hospital, organized and operated to provide health care to 
noninstitutionalized and non-homebound persons on an outpatient basis; 
it does not include private offices or clinics of individual physicians, den- 
tists, or other practitioners, or groups of practitioners who are health care 



1986] CERTIFICATE OF NEED 1099 

providers"). State regulations have defined this to include, but not be 
limited to, "family planning cUnics, neighborhood health centers, com- 
munity mental health centers, drug abuse or alcoholism treatment centers, 
and rehabilitation facilities." According to the SHPDA, whether or not 
emergicenters, birthing centers, public health centers, and outpatient 
physical therapy centers would be covered would depend upon the pro- 
posed facilities' relationship to a hospital, if any; the services to be pro- 
vided by the facility and whether such services constitute "health care"; 
and the facilities' characteristic as a private office or clinic of a practi- 
tioner or a group of practitioners. LF SHPDA 2/84. Bed capacity in- 
creases and decreases: CON statute and regulations could be read not to 
cover. LF SHPDA 2/84 indicates state does review permanent changes 
in bed capacity whether the changes result in the addition or deletion of 
beds. 1122 coverage parallels CON coverage under "election not to review" 
regulation. Other specified projects: Iowa covers relocation of a health 
care facility, relocation of one or more health services from one physical 
facility to another. Other entities, persons, other specified projects: Iowa 
covers expenditure by or on behalf of individual health care provider or 
group of providers in excess of $400,000 for MME to be installed in a 
private office or clinic. 

KANSAS: General: The Kansas CON statute sunsetted July 1, 1985. Kan- 
sas has a statutory moratorium on new hospital construction and addi- 
tions or relocations of hospital beds through July 1, 1986. 

KENTUCKY: General: Kentucky has CON and 1122. Facilities and pro- 
jects identified in Tables may be covered under either or both programs. 
Public health centers: Kentucky covers capital expenditures in excess of 
the threshold by county and district health departments and establishment 
by such departments of health services for which there are separate licen- 
sure categories, e.g. primary care centers or home health agencies. CON 
not required to estabhsh traditional "public health" services. LF SHPDA 
2/84. Addition of a new health service/annual operating cost threshold: 
Kentucky covers health service additions exceeding an AOC threshold and 
also covers additions of health services subject to licensure or for which 
there is a component of the SHP without regard to annual operating costs. 
The services in the SHP are: acute care services; open heart surgery, car- 
diac catheterization, radiation therapy which utilizes mega-voltage equip- 
ment, ESRD services, CT scanners, NMR, long-term care services. Ac- 
quisitions of existing facilities: Acquisitions of hospitals, SNFs, ICFs, 
kidney disease treatment center including freestanding hemodialysis units, 
and ambulatory surgical facilities subject to 1122 review only if associated 
with capital expenditure in excess of $100,000. LF SHPDA 2/84. Other 
specified projects: Kentucky requires CON to alter the geographic service 
area which has been designated on a certificate of need or license, and 
to transfer a CON for establishment of a new facility or replacement of 
an existing facility. 



1100 INDIANA LAW REVIEW [Vol. 19:1025 

LOUISIANA: General: Louisiana has a Section 1122 program. Although 
it does not have a certificate of need law, it does have a statutory pro- 
gram of new home health agency Hcensure requiring a determination of 
need for the new home health agency by the designated planning agency. 
Home health agency: Louisiana's home health agency coverage is limited 
to establishment and licensure of new HHA. Other specified projects: Loui- 
siana covers relocation of a previously approved and licensed facility within 
the same service area. 

MAINE: General: Maine CON law was amended in 1985. Maine has CON 
and 1122. It elects not to review under 1122 projects not reviewed under 
CON. CE for other specified purpose: Maine covers a capital expenditure 
in excess of $350,000 for purchase or other acquisition of a health care 
facility. Bed capacity increases and decreases: Maine covers increases and 
decreases in licensed bed capacity by more than five beds or ten percent, 
whichever is less, in any two-year period. Bed category change: Maine 
covers increases or decreases in the number of beds licensed in particular 
levels of care by more than five beds or ten percent, whichever is less, in 
any two-year period. Bed relocations: Maine covers relocations of bed 
by more than five beds or ten percent of bed capacity, whichever is less, 
in any two-year period. Additions of new health services/annual operating 
cost threshold: Maine covers additions of health services with annual 
operating costs in excess of the threshold. It also covers the addition of 
any new health service (except an organized outpatient facility) without 
regard to cost. It also covers addition of the following services if the pro- 
posed addition duplicates a service presently offered in the proponent's 
service area: alcohol rehabilitation (inpatient or outpatient); medical-surgical 
(adult) (where converted from psychiatric beds); rehabilitation (inpatient 
or outpatient); and speech pathology. Other entities, other specified pro- 
jects: Maine regulations provide for coverage of the acquisition by any 
person of NMR scanning equipment that is to be used to provide services 
to persons other than hospital inpatients. 

MARYLAND: General: Maryland exempts certain projects to close all 
or part of a hospital. Maryland's CON law was amended in 1985. General 
purpose CE: Maryland exempts CE for site acquisitions, acquisitions of 
business or office equipment not directly related to patient care and CE 
to the extent they are directly related to acquisition and installation of 
MME. Maryland also exempts certain CE made as part of a health facil- 
ity merger, consolidation, or conversion to non-health related use. It covers 
CE for predevelopment activities. CE for other specified purpose: 
Maryland covers capital expenditures which result in any increase or 
decrease in the volume of one patient service where over a two-year period 
the change is twenty- five percent or more of that volume. Maryland covers 
CE that result in a substantial change in the bed capacity of a health 
care facility. Bed capacity increases and decreases: Maryland exempts cer- 



1 986] CER TIFICA TE OF NEED 1101 

tain bed capacity changes undertaken pursuant to a health facihty merger, 
consohdation, or conversion to non-health related use. Addition of new 
health service: Maryland exempts additions of new health services with 
annual operating revenue exceeding the threshold if such revenue is en- 
tirely associated with the use of medical equipment. Acquisition of MME: 
Maryland has a program of licensure of major medical equipment in ex- 
cess of $600,000 used to provide health services acquired, leased, operated, 
or received by any person. The program uses review criteria and stan- 
dards similar to those used under CON, but is separate from the state's 
CON program. Construction, development, or other establishment of new 
health care facilities: Maryland covers establishment of new health care 
facilities, relocation of an existing health care facility to a new site, and 
complete replacement of an existing facility on the same, contiguous, or 
adjacent site. Other specified projects: Maryland covers the addition of 
an HHA branch office by an existing HHA or home health service, 
establishment of an HHA or home health service in a new location by 
an existing HHA, or transfer of ownership of an HHA branch office 
or service. Maryland covers changes in the number of kidney dialysis sta- 
tions of a health care facility. Maryland covers any increase or decrease 
in magnitude of any single patient service over a two-year period, other than 
change in bed capacity, by which the facility plans to change the volume 
of the service by twenty-five percent or more. For determination of percen- 
tage of planned change, the volume of service shall be that unit which is nor- 
mally measured for the service, and shall be for the last prior annual 
recording period used by the facility. Certain services volume changes 
undertaken pursuant to facility merger, consolidation, or conversion to 
non-health related uses are exempted. 

MASSACHUSETTS: Freestanding emergicenters: "Clinic" definition in 
Mass. regulations appears to include emergicenters and bring them within 
CON. Other entities: Massachusetts covers institutions for care of unwed 
mothers and clinical laboratories. Bed capacity increases only: 
Massachusetts exempts one-time increases of four beds or a series of in- 
creases in bed capacity up to four beds, except in intensive care, cor- 
onary care, neo-natal intensive care, or renal dialysis beds and so long 
as the capital expenditure required for the increase or increases does not 
exceed $150,000. Addition of health services/annual operating cost 
threshold: Massachusetts covers the addition of major services (e.g., any 
service in the acute services, chronic rehabilitation, and mental health ser- 
vices categories, and establishment of a satellite clinic or unit of a facil- 
ity) without regard to annual operating cost. Other service additions are 
covered if they exceed an annual operating threshold of $250,000. Ac- 
quisitions of existing facilities: Massachusetts regulations indicate that ac- 
quisition of an existing health care facility by another health care facility 
is covered as a substantial change in services of the acquiring facility. 



1102 INDIANA LAW REVIEW [Vol. 19:1025 

In addition, transfers of ownership of a health care facility require a find- 
ing of need for the facility at the proposed location by the state depart- 
ment of health. Other specified projects: Conversion of an entire facility 
from one licensure category to another is covered. 

MICHIGAN: General: Michigan has CON and 1122. Facilities and pro- 
jects identified in Tables may be covered under either or both programs. 
Home health agencies: State CON statute provides that HHAs will be 
covered once HHAs are licensed in the state. Other entities: Michigan 
covers clinical laboratories. Bed category changes: Michigan covers bed 
category changes that result in an increase or decrease in beds in an 
obstetrical department, long-term care unit or psychiatric unit. 

MINNESOTA: General: Minnesota does not have a certificate of need 
law. State law places a moratorium on all new hospital construction and 
construction or modification by or on behalf of a hospital that increases 
bed capacity, relocates beds from one physical facility or to another, or 
otherwise results in an increase or redistribution of bed capacity, with 
certain exceptions through June 30, 1987. Minnesota has an 1122 pro- 
gram, and elects not to review or non-substantively reviews most projects. 

MISSISSIPPI: General: Mississippi CON law amended in 1985. Mississippi 
CON scheduled to sunset July 1, 1986. Bed capacity increases, CE for 
bed capacity increases, CE for bed category changes, CE for bed reloca- 
tions: Bed-related coverage after 1985 amendments unclear. The statute 
covers bed relocations of more than ten beds or ten percent over a two- 
year period specified by the state agency with a CE below $150,000, bed 
conversions ''of the total bed capacity of a designated licensed category 
or sub-category of any health care facility" with a similar 10/10/2 and 
a CE below $150,000, and alteration, refurbishing, or modernizing of a 
unit or department where such beds are located with a CE under $150,000. 
Not clear if the foregoing transactions would be covered when associated 
with a CE exceeding $150,000. Additionally, bed capacity additions not 
clearly covered, although legislative intent to cover them is apparent in 
statutory moratorium on CONs, which exempts certain bed additions. 
Other specified projects: Mississippi covers relocation of a health care 
facility, or portion thereof, or major medical equipment, or relocation 
of a health care service from one site to another. Mississippi covers ac- 
quisition of MME exceeding threshold by any person. 

MISSOURI: Health maintenance organizations: Missouri law and regula- 
tions do not provide an HMO exemption. CE for bed category change: 
Missouri exempts nursing facility conversion of beds from practical to 
professional levels of care if the facility meets the professional level licen- 
sure requirements. Additions of new health services: Missouri exempts ad- 
ditions of home health services. Other specified projects: Missouri covers 
pre-development expenditures exceeding $150,000. 



1986] CERTIFICATE OF NEED 1103 

MONTANA: General: Montana CON law sunsets July 1, 1987. The Mon- 
tana CON statute underwent minor amendment in 1985. Other entities: 
Montana covers infirmaries, e.g., facilities located in a university, col- 
lege, government institution, or industry for the treatment of the sick and 
injured on an inpatient or outpatient basis. Montana also covers adult 
day care centers. Other specified projects: Montana covers expansion of 
the geographic service area of a home health agency. Other entities, per- 
sons, other specified projects: Montana covers acquisition by any person 
of MME in excess of the threshold provided such an acquisition would 
require a CON if undertaken by or on behalf of a health care facility. 

NEBRASKA: General: Nebraska has 1122 and CON. It elects not to review 
under 1122 projects not reviewable under CON. Addition of new health 
services /annual operating cost threshold: Nebraska covers additions of new 
home health services regardless of annual operating cost and additions 
of other services in excess of the threshold. Acquisition of existing facil- 
ity: Various types of acquisitions of facilities and ownership interests in 
facilities are covered. 

NEVADA: General: Nevada statute amended 1985. Other entitites: Nevada 
covers any facility providing health services which is entitled to receive 
reimbursement from any public agency as a health facility. Other entities, 
other specified projects: Nevada covers any facility which acquires medical 
equipment with a cost exceeding the MME threshold. CE for other 
specified purpose: Nevada covers CE in excess of $100,000 for expansion 
or consolidation of a health service. Other specified projects: Nevada covers 
expansion or consolidation of health services exceeding $297,500 annual 
operating expenses. Nevada covers conversion of an existing office of a 
health practitioner to a health facility if the establishment of the offices 
would have exceeded the $100,000 CE or $297,500 annual operating cost 
threshold. 

NEW HAMPSHIRE: General: New Hampshire CON law was amended 
in 1985. Other entities: New Hampshire covers independent diagnostic 
laboratories as health care facilities. New Hampshire covers ''mental retar- 
dation facilities." Bed capacity increases, bed category changes: New 
Hampshire covers increases in bed capacity or changes in bed category 
exceeding ten beds or ten percent, whichever is less, in a five-year period. 
Addition of new services: New Hampshire covers addition of "special in- 
patient services," including but not limited to alcohol and drug dependen- 
cy, psychiatric services, and physical rehabilitation. Acquisition of existing 
facilities: New Hampshire covers transfers of ownership of health care 
facilities except where the transfer would be subject to the provisions of 
revaluation of assets as outlined in the Federal Deficit Reduction Act of 
1984. Other entities, persons, other specified projects: New Hampshire 
covers acquisitions of diagnostic or therapeutic equipment in excess of 
a $400,000 threshold by or on behalf of any health care provider. 



1104 INDIANA LAW REVIEW [Vol. 19:1025 

NEW JERSEY: General: New Jersey has both CON and 1122. Projects 
and facilities identified in Tables may be covered under either or both 
programs. Kidney disease treatment centers, ambulatory surgery centers, 
organized ambulatory health care facilities, other ambulatory care facilities: 
New Jersey covers public health centers, diagnostic centers, treatment 
centers, rehabilitation centers, outpatient clinics and dispensaries. The iden- 
tity of these facilities is not further defined in law or regulations. The 
Tables assume kidney disease treatment centers, ambulatory surgery centers, 
and organized ambulatory health care facilities are included within these 
terms. Other entities: New Jersey covers certain bio-analytical laboratories. 
CE for other specified purpose: New Jersey covers capital expenditures 
in excess of $150,000 for facility/service planning and any capital expen- 
diture which will result in a bed capacity decrease. Additions of new health 
services: New Jersey regulations contain a comprehensive list of new health 
services categories subject to review and components thereof which are 
not subject to review as new services. Construction, development, or other 
establishment of new health care facility: In addition to coverage of con- 
struction, development, or establishment of a new health care facility. 
New Jersey expressly covers replacement of an existing bed-related health 
care facility, establishment of a bed-related satellite location for an ex- 
isting health care facility, relocation and replacement of an existing non- 
bed-related health care facility into a new health service area or to an 
area that results in problems of access to populations historically served 
by the facility, and establishment of a non-bed satellite service of an ex- 
isting health care facility into a new health service area. Acquisition of 
existing facilities: Acquisition of facilities and of varying types and degrees 
of ownership interests in health care facilities are covered. Other specified 
projects: New Jersey covers transfer of a patient care service in whole 
or in part to another corporate entity; addition of regionalized services 
identified in Dept. of Health planning regulations; addition of renal dialysis 
stations; and addition of operating rooms. 

NEW MEXICO: General: New Mexico has 1122, not CON. 

NEW YORK: Home health agencies: Coverage limited to * 'public and 
voluntary" HHAs. Ambulatory surgery centers and organized ambulatory 
health care facilities: New York covers diagnostic centers, treatment centers, 
rehabilitation centers. ASC and various types of OAHCFS would appear 
to be covered under these categories, if they meet organizational and other 
criteria for distinguishing such centers from the private practice of 
medicine. Acquisition of major medical equipment: New York covers ad- 
dition or replacement of any equipment regardless of cost utilized in the 
provision of therapeutic radiology, open heart surgery, cardiac catheteriza- 
tion, kidney and heart transplant, acute or chronic renal dialysis, CT scan- 
ners, burn care, and extra corporeal Shockwave lithotripters that will 
significantly increase the capacity of providing such service. Other specified 



1986] CERTIFICATE OF NEED 1105 

projects: New York covers a change in the method of delivery of a licensed 
service regardless of cost. New York covers addition or deletion of ap- 
proval to operate part-time clinics. New York covers any proposal in- 
volving a total project cost exceeding $10,000 or an increase in operating 
costs by a medical facility that has been determined to be inappropriate 
or for which there has been a determination of no public need and which 
is identified as unneeded in the state medical facilities plan. 

NORTH CAROLINA: General: North Carolina's statute was amended 
in 1985. Hospices, other entities, CE for other specified purposes, other 
specified projects: North Carolina covers local health departments, but 
only to the extent of covering their CE in excess of the expenditure 
threshold. North Carolina covers construction, development, or estabhsh- 
ment of a hospice if the operating budget exceeds $100,000 or if there 
is a CE in excess of the expenditure minimum by or in behalf of the 
hospice. No other hospice or local health department projects are covered. 
CE for bed capacity increases and decreases: North Carolina covers CE 
in any amount for bed supply increases and CE in excess of the expen- 
diture minimum ($1,000,000) for bed supply decreases. CE for changes 
in bed category: North Carolina covers CE for bed category changes only 
if they involve a CE in excess of the expenditure minimum. Other specified 
projects: Conversion of non-health care facility beds to health care facil- 
ity beds is covered. Other entities, other specified projects: North Carolina 
covers acquisition by any person of "major medical equipment" that in- 
cludes magnetic resonance imaging or lithotripters, regardless of owner- 
ship or location. 

NORTH DAKOTA: General: North Dakota's statute was amended in 
1985. Home health agency: HHA coverage Hmited to expedited review 
of establishment of new HHA or expansion of geographic area of service 
of existing HHA. General purpose CE: Capital expenditures for site ac- 
quisition are exempt. CE for service additions: North Dakota statute 
defines "capital expenditure" in such a way as to incorporate the expen- 
diture threshold into the definition. Not clear if coverage of capital ex- 
penditures for service additions intended to include the threshold. Table 
assumes it does not. 

OHIO: General: The Ohio CON statute was amended in 1985. CE for 
changes in bed category: Ohio covers any redistribution of beds by ser- 
vice associated with a capital expenditure in any amount and amounting 
to nine beds or ten percent of bed capacity, whichever is less, in a two- 
year period. CE for other specified purpose: Ohio covers CE for decrease 
in bed capacity of more than nine beds or ten percent of bed capacity, 
whichever is less, within a two-year period. Bed category changes: Ohio 
covers redistribution of beds by service involving beds registered as 
psychiatric, physical rehabilitation, alcohol rehabilitation, or long-term care. 



1106 INDIANA LAW REVIEW [Vol. 19:1025 

Bed relocation: Ohio covers bed relocations from one physical facility or 
site to another excluding relocation within a health care facility or among 
buildings of a facility at the same location. Addition of a new health 
service: Ohio covers initiation of any program of heart, lung, liver, or 
pancreas transplant, without regard to cost. Other health services covered 
if they exceed annual operating cost threshold. Acquisitions ofMME: Ohio 
has $200,000 threshold for acquisition of technologically innovative medical 
equipment; $400,000 for all other major medical equipment. Other 
specified projects: Ohio covers change from one category of health facil- 
ity to another. 

OKLAHOMA: General: Oklahoma has CON and 1122. Tables show CON 
coverage. Not known if 1122 program coverage different. Portions of the 
Oklahoma CON law to sunset in 1989. Other entities: Oklahoma covers 
such institutions or services operated by the federal government in the 
state as may be authorized by the U.S. Congress. CE regardless of pur- 
pose/expenditure threshold: The expenditure threshold for SNF/ICF, and 
medically-oriented residential care facilities is $150,000; for hospitals and 
all other health care facilities it is $600,000. CE for bed supply increases 
and decreases, relocations and category changes: Oklahoma covers only 
SNF/ICF and medically-oriented residential care facilities under these forms 
of coverage. Bed capacity increases and decreases, category changes and 
relocations: These forms of coverage apply to health care facilities other 
than ICF, SNF, medically-oriented residential care facihties. Construction, 
development, or other establishment of new health care facility: Regula- 
tions cover. However, current statute could be read narrowly to cover 
only for SNF, ICF, medically-oriented residential care facility. 

OREGON: General: Oregon's statute was amended in 1985. Other en- 
tities: Oregon covers college infirmaries. General purpose CE/ expenditure 
minimum: Oregon covers expenditures for clinically-related services in ex- 
cess of the lesser of $1,000,000 or $250,000 plus .5% of the gross revenues 
for the last fiscal year. Site acquisitions are exempt. CE for other specified 
purposes: Oregon covers non-clinically related capital expenditures in ex- 
cess of the general purpose CE threshold. Additions of health services: 
Home health services, residential care or treatment of the elderly and 
residential or outpatient services for alcoholism, drug abuse, or mental 
or emotional disturbances are exempt. Oregon covers additions of all other 
health services which could significantly add to the cost of patient care 
or compromise quality of care. With several exceptions, Oregon regula- 
tions define new services with annual operating expenses exceeding $340,000 
as significantly adding to patient care costs. Other entities, other specified 
projects: Oregon covers acquisition of MME exceeding a $1 million 
threshold by any person. 

PENNSYLVANIA: CE for bed category changes: Pennsylvania exempts 
bed category changes within levels of care in a nursing home. 



1986] CERTIFICATE OF NEED 1107 

RHODE ISLAND: Other outpatient ambulatory care facilities: Rhode 
Island's coverage of organized ambulatory health care facilities includes 
central service facilities, treatment centers, diagnostic centers, outpatient 
chnics, and health centers. Other entities: Rhode Island covers clinical 
laboratories. Addition of a health service: Rhode Island statute provides 
for coverage of addition of any health service proposed to be offered 
to patients or the public by a health care facility which meets criteria 
defined in state agency rules and regulations. As of December 1985, ser- 
vice additions associated with a $75,000 annual operating cost and service 
expansions associated with a $150,000 increase in operating expenditures 
were covered. Other specified projects: Rhode Island covers major ex- 
pansion of an existing program which increases operating expenditures 
in a health care facility by $150,000 in one year. Other entities, persons, 
other specified projects: Rhode Island covers acquisition of new health 
care equipment proposed to be utilized by a health care provider (whether 
practicing alone or as a member of a partnership, corporation, organiza- 
tion, or association) costing in excess of $150,000. 

SOUTH CAROLINA: General: Project coverage shown is under South 
Carolina's CON program. Not known if 1122 coverage differs significantly. 
Other entities: South Carolina covers "outpatient facilities," not further 
specified or defined. South Carolina covers state health laboratories and 
nurse's training facilities. 

SOUTH DAKOTA: General purpose CE: South Dakota has a $183,690 
threshold for nursing facilities, $670,404 for all other health care facilities. 
CE for other specified purposes: South Dakota covers capital expenditures 
which decrease licensed bed capacity by ten beds or ten percent, whichever 
is less, in any two-year period. Bed category changes: South Dakota covers 
permanent changes in bed category in excess of five beds per calendar 
year. Additions of health services: South Dakota covers nursing home 
service additions with annual operating costs in excess of $91,845; other 
health facility service additions in excess of $279,336. Acquisitions of major 
medical equipment: South Dakota has a $400,000 threshold for MME in 
a hospital or physician's office; $150,000 in a nursing care facility. 

TENNESSEE: General: The Tennessee CON law was amended in 1985. 
Portions of the Tennessee CON statute sunset June 30, 1991. Bed capa- 
city increases and decreases: Nursing homes may increase or decrease licens- 
ed bed supply by ten beds or ten percent, whichever is less, in any two- 
year period. Bed category changes: Tennessee covers bed category changes 
between acute care and long-term care beds only. Additions of health ser- 
vices, terminations of health services: Tennessee covers additions and ter- 
minations of a specified set of major health care services, regardless of 
cost (e.g., (1) medical; (2) surgical; (3) obstetrical; (4) psychiatric/retar- 
dation/substance abuse treatment — adult, adolescent, children, and youth; 



1108 



INDIANA LAW REVIEW 



[Vol. 19:1025 



(5) special care units — ICU, CCU, burn, cardiac catheterization, neonatal 
nursery; (6) open heart surgery; (7) therapeutic radiology; (8) all outpa- 
tient services; (9) pediatric; (10) total body and head CT scanners; (11) 
home health services; (12) ambulatory primary care clinic services; (13) 
ambulatory surgery; (14) magnetic resonance imaging; (15) extracorporeal 
shock wave lithotripsy; (16) any service estabUshed and staffed as an 
organized unit with a projected annual operating budget in excess of 
$500,000; and (17) any service enumerated above provided to a facility 
or institution on a mobile basis). Other specified projects: Tennessee covers 
resumption of operation of any facilities or services previously discon- 
tinued (for reasons other than temporary closure for construction pur- 
poses) for one year or more. Tennessee covers change in site of a health 
care facility other than a primary care center or public health depart- 
ment. Other entities: Tennessee covers persons or combinations of per- 
sons engaged in a joint or cooperative enterprise designed to provide cen- 
tral facilities and/or services to two or more health care facilities. General 
purpose CE, Acquisition of MME: Tennessee exempts CE and acquisi- 
tion of MME not directly related to patient care. 

TEXAS: General: Texas does not have a CON or 1122 program. Current 
Texas law authorizes the Governor to establish a capital expenditure review 
program such as section 1122 if necessary to prevent "loss of federal 
funds." 

UTAH: General: Utah does not have a CON or 1122 program. 

VERMONT: Medically-oriented residential care facilities: Vermont covers 
community care homes having or seeking a CON to acquire a Ucensed 
capacity in excess of fifteen beds. Organized outpatient health care 
facilities: Vermont covers facilities or institutions which offer ambulatory 
care to two or more persons. Other entities: Vermont covers independent 
diagnostic laboratories. Bed increases, category changes, relocations: Ver- 
mont covers increases, category changes, relocations exceeding four beds or 
ten percent of capacity, whichever is less in a four-year period. 

VIRGINIA: General: The Virginia CON statute was amended in 1985. 
Virginia exempts nursing homes affiliated with nonprofit life care com- 
munities not participating in Medicaid. Inpatient rehabilitation facilities: 
Coverage unclear. Other entities: Virginia covers specialized centers or 
clinics developed for the purpose of providing radiation therapy, CT scan- 
ning, or other medical or surgical treatments requiring the utihzation of 
equipment not usually associated with the provision of primary health 
services. Addition of new health services: Home health service additions 
are exempt. Other persons, entities, other specified projects: Virginia covers 
acquisition by or on behalf of a physician's office of medical equipment 
exceeding $400,000 generally and customarily associated with provision 
of health services in an inpatient setting. 



1 986] CER TIFICA TE OF NEED 1 1 09 

WASHINGTON: CE for additions, terminations of health services: 
Washington covers CE for substantial change in services, defined as any 
capital expenditure for addition or termination of the following services: 
alcohol/substance abuse; burn unit; cardiac catheterization; chronic 
renal dialysis; kidney lithotripty; CT-computed tomography; NMR-nuclear 
magnetic resonance; PET-positron emission tomography; emergency ser- 
vices including regular outpatient emergency services staffed by physicians 
at a health care facility, and the provision of ambulance services, including 
licensed air ambulance services; inpatient psychiatric services; neonatal 
special care - level III; obstetrics - level I; obstetrics - level II; obstetrics 
- level III; open heart surgery; pediatrics - level I; pediatrics - level II; 
pediatrics - level III; radiation therapy-megavoltage, orthovoltage; 
rehabilitation - level I; rehabilitation - level II; rehabilitation - level III; 
change in the number of dialysis stations in a health care facility; and 
change from mobile to fixed base CT scanning. In addition, Washington 
covers as substantial changes in services the introduction of a new 
technology for diagnosis or treatment, a "change in the level of service," 
and the offering of any services at a new location not formerly part of 
the health care facility's campus. Acquisitions of existing facilities: 
Washington covers sale, purchase, or lease of part or all of any hospital. 

WEST VIRGINIA: General: West Virginia CON statute amended in 1985. 
West Virginia has CON and 1122. Tables show CON coverage. Not known 
if 1122 coverage is different. Organized ambulatory health care facilities: 
West Virginia covers '^ambulatory health care facilities," e.g., freestand- 
ing outpatient facilities not including physicians or other health profes- 
sionals' offices. Other entities: West Virginia covers inpatient "commun- 
ity mental health centers" {e.g., private facilities providing comprehen- 
sive services and continuity of care as emergency, outpatient, partial 
hospitalization, inpatient, and consultation and education for individuals 
with mental illness, mental retardation, or drug or alcohol addiction). CE 
for other specified purposes: West Virginia covers any capital expenditure 
associated with the partial or total closure of a health care facility. West 
Virginia also covers capital expenditures in excess of $1,000,000 for ac- 
quisitions of an existing health care facility. Other specified projects: West 
Virginia covers a substantial change in bed capacity if the change is 
associated with and within two years of a previous CE for which a CON 
was issued. West Virginia covers a substantial change, defined by regula- 
tions, in an institutional health service for which a CON is in effect. Other 
persons, entities, other specified projects: West Virginia covers acquisi- 
tion of major medical equipment exceeding $400,000 by any person. 

WISCONSIN: General: Wisconsin statute amended 1985. Wisconsin CON 
law sunsets July 1, 1989. General purpose CE; acquisition of major medical 
equipment: Wisconsin covers all-purpose hospital CEs and clinical medical 
equipment acquisitions exceeding $1,000,000 and the same transactions 



1110 



INDIANA LA W REVIEW 



[Vol. 19:1025 



for nursing home health care faciUties exceeding $600,000. However, the 
threshold for hospital CEs to renovate part or all of a hospital or to 
convert to a new use is $1,500,000. Bed capacity increases: Wisconsin 
covers bed capacity increases by hospitals and nursing homes, and addi- 
tions of psychiatric or chemical dependency beds by any person. Addi- 
tion of new health services: Wisconsin covers addition of organ transplan- 
tation program, burn center, neonatal ICU, cardiac program, and transport 
services. Acquisition of existing facilities: Wisconsin covers acquisitions 
of hospitals only. Other specified projects: Wisconsin covers construction 
or total replacement of a nursing home and construction or operation 
of an ambulatory surgical facility or home health agency. Other entities, 
other specified projects: Wisconsin covers obligations of an expenditure 
exceeding $1,000,000 by or on behalf of an independent practitioner, part- 
nership, unincorporated medical group, or service corporation for clinical 
medical equipment. 

WYOMING: General: The Wyoming CON law was amended in 1985. 
The Wyoming CON law sunsets July 1, 1989. Other entities: Wyoming 
covers "providers of alternative health care" (not otherwise defined). Ac- 
quisition of MME: Expenditure threshold for acquisition of MME by 
SNF/ICF is $150,000. Expenditure threshold for acquisition of MME by 
all other health care facilities is $400,000. Other specified projects: Wyom- 
ing covers acquisition of MME exceeding threshold by licensed practi- 
tioners' offices. 

TABLE 1: STATE PARTICIPATION IN CERTIFICATE OF NEED 
AND SECTION 1122 REVIEW PROGRAMS 







Year CON Statute 


Year Current 






Repealed or 


Section 1122 




Year First CON 


Scheduled to 


Agreement 


State 


Statute Adopted 
1977 


Sunset 


Entered Into 


Alabama 






Alaska 


1976 






Arizona 


1971 


1985 





Arkansas 


1975 




1973 


California 


1969 


1987 




Colorado 


1973 






Connecticut 


1969 






Delaware 


1978 




1973 


Dist. of Columbia 


1964 






Florida 


1972 


1987* 




Georgia 


1974 




1974 


Hawaii 


1974 







Idaho 

Illinois 

Indiana 



1980 

IO'7/l 


1983 


1983 


1980 


1985 


1973 



1986] 



CERTIFICATE OF NEED 



nil 



TABLE 1: Continued 







Year CON Statute 


Year Current 






Repealed 


or 


Section 1122 




Year First CON 


Scheduled 


to 


Agreement 


State 


Statute Adopted 
1977 


Sunset 




Entered Into 


Iowa 






1973 


Kansas 


1972 


1985 






Kentucky 


1972 






1974 



Louisiana 






1973 


Maine 


1978 




1973 


Maryland 


1968 






Massachusetts 


1971 






Michigan 


1972 




1973 


Minnesota 


1971 


1984 


1974 


Mississippi 


1979 


1986 




Missouri 


1979 






Montana 


1975 


1987 




Nebraska 


1979 




1973 


Nevada 


1971 






New Hampshire 


1979 






New Jersey 


1971 




1974 


New Mexico 


1978 


1983 


1973 


New York 


1964 






North Carolina 


1978 






North Dakota 


1971 






Ohio 


1975 






Oklahoma 


1971 


1989* 


1974 


Oregon 


1971 






Pennsylvania 


1979 






Rhode Island 


1968 






South Carolina 


1971 






South Dakota 


1972 






Tennessee 


1973 


1991* 




Texas 


1975 


1985 




Utah 


1979 


1984 




Vermont 


1979 






Virginia 


1973 






Washington 


1971 






West Virginia 


1977 




1974 


Wisconsin 


1977 


1989 




Wyoming 


1977 


1989 





*Only some portions of the statute are scheduled to sunset. 
SOURCES: Congressional Budget Office, Health Planning: Issues for 
Reauthorization 14-15 (1982); Author's survey of state statutes and communica- 
tions with state health planning and development agencies, 1985. 



1112 



INDIANA LA W REVIEW 



[Vol. 19:1025 



TABLE 2: HEALTH CARE FACILITIES, ETC., 

SUBJECT TO STATE CON/1122 REVIEW 

(See attached notes for explanatory information, definitions, and state-by-state comments. 

The symbol "N" in the table below indicates that additional information is provided in 

the state-by-state comments.) 

Ala Ak Ariz^ Ark^ Cal^ Colo Conn Del^ DC^ Fla^ 



Hospitals 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Skilled Nursing 
Facilities 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Intermediate Care 
Facilities 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Medically-Oriented 
Residential Care 
Facilities 






X 




X 


X 








Inpatient Rehabilitation 
Facilities 


XN 




X 


X 


X 


N 




X 




Home Health Agencies 


X 




X 






X 


X 


X 


XN 


Hospices 






N 




X 






X 


X 


Kidney Disease Treat- 
ment Centers (Including 
Freestanding 
Hemodialysis Units) 


X 


X 


X 




XN 


N 


X 


X 


X 


Health Maintenance 
Organization (Subject 
to Exemption) 


X 




X 


X 


X 




X 


X 


X 


Ambulatory Surgery 
Centers 


X 


X 


X 


X 


XN 


N 


X 


X 


X 


All Organized 
Ambulatory Health 
Care Facilities/ 
Outpatient Clinics 






X 






N 


X 


X 





Specified Ambulatory 
Health Care Facilities, 

i.e.: 



Freestanding 
Emergicenters 








X X 


Ambulatory 
Obstetrical 
Facilities/Birthing 
Centers 


Family Planning/ 
Abortion Centers/ 
Clinics 




X 






Community Health 
Centers/Clinics 




X X 


X 




Public Health Centers 


X 


X 






Community Mental 
Health Centers 


X 


X 


X 


X X 



Facilities for Pro- 
vision of Outpatient 
Therapy Services 
Including Speech 
Pathology 



X 



N 



Outpatient 
Rehabilitation Facility 


XN 




X 


X 


X 




X 




Other Outpatient 
Ambulatory Care 
Facilities 






N 


XN 


XN 


XN 






Other Entitites, 
Persons 


XN 


XN 






XN 


XN 


XN 


XN 



1986] 



CERTIFICATE OF NEED 



1113 





GaN 


Haw 


Id^ 


111 


Ind'^ 


la^ Ks'^ KyN 


La 


Me^ 


Hospitals 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Skilled Nursing 
Facilities 


X 


X 


X 


X 


XN 


X 


X 


X 


X 


Intermediate Care 
Facilities 


X 


X 


X 


X 


XN 


X 


X 


X 


X 


Medically-Oriented 
Residential Care 
Facilities 


XN 


N 




X 




X 


X 






Inpatient Rehabilitation 
Facilities 


X 


X 




X 


X 




X 


X 


X 


Home Health Agencies 


X 


X 










X 


XN 


X 


Hospices 




X 










X 






Kidney Disease Treat- 
ment Centers (Including 
Freestanding 
Hemodialysis Units) 


X 


X 


X 


X 


XN 


X 


X 


X 


X 


Health Maintenance 
Organizations (Subject 
to Exemption) 


X 


X 




X 




X 






X 


Ambulatory Surgery 
Centers 


X 


X 


X 


X 




X 


X 


X 


X 


Organized Ambulatory 
Health Care Facilities/ 
Outpatient Clinics 




X 








X 


X 







Specified Ambulatory 
Health Care Facilities, 

i.e.: 



Freestanding 
Emergicenters 




X 


N 


X 


Ambulatory 
Obstetrical 
Facilities/Birthing 
Centers 


X 


X 


N 


X 


Family Planning/ 
Abortion Centers/ 
Clinics 


XN 


X 


X 


X 


Community Health 
Centers/Clinics 




X 


X 


X 


Public Health Centers 




X 


N 


XN 


Community Mental 
Health Centers 




X 


X 


X 



Facilities for Pro- 
vision of Outpatient 
Therapy Services 
Including Speech 



Pathology 


X 


N 


X 




Outpatient 
Rehabilitation Facility 


X 


X 


X 




Other Outpatient 
Ambulatory Care 
Facility 


XN 








Other Entities 


XN 


XN 


XN 


X 



1114 



INDIANA LA W REVIEW 



[Vol. 19:1025 





Md^ 


Mass 


Mich^ Minn^ 


Miss'^ 


Mo 


Mont^ 


NebN 


NevN 


NH^ 


Hospitals 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Skilled Nursing 
Facilities 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Intermediate Care 
Facilities 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Medically-Oriented 
Residential Care 
Facilities 


X 


X 


X 






X 








Inpatient Rehabilitation 
Facilities 


X 


X 




X 


^^ 


X 


X 


X 


X 


Home Health Agencies 


X 




XN 


X 




X 


X 


X 


X 


Hospices 


X 




X 






X 




— 




Kidney Disease Treat- 
ment Centers (Including 
Freestanding 
Hemodialysis Units) 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Health Maintenance 
Organizations (Subject 
to Exemption) 


X 


X 


X 


X 


XN 


X 


X 




X 


Ambulatory Surgery 
Centers 


X 


X 


X 


X 


X 


X 


X 


X 


X 


All Organized 
Ambulatory Health 
Care Facilities/ 
Outpatient Clinics 




X 


X 






X 









Specified Ambulatory 
Health Care Facilities, 

i.e.: 



Freestanding 
Emergicenters 


XN 




X 




Ambulatory 
Obstetrical 
Facihties/Birthing 
Centers 


X 


X 


X 




Family Planning/ 
Abortion Centers/ 
Clinics 


X 


X 


X 




Community Health 
Centers/Clinics 


X 


X 


X 




Public Health Centers 


X 


X 


X 




Community Mental 
Health Centers 


X 


X 


X 


X 



Facilities for Pro- 
vision of Outpatient 
Therapy Services 
Including Speech 



Pathology 


X 


X 


X 






Outpatient 
Rehabilitation Facility 


X 


X 


X 






Other Outpatient 
Ambulatory Care 
Facility 


Other Entities 


XN 


XN 


XN 


XN 


XN 



1986] 



CERTIFICATE OF NEED 



1115 





NJN 


NM^ 


NY 


NCN 


ND^ 


Oh^ 


Ok^ 


OrN 


Pa 


RI 


Hospitals 


X 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Skilled Nursing 
Facilities 


X 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Intermediate Care 
Facilities 


X 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Medically-Oriented 
Residential Care 
Facilities 


X 




X 








X 




X 




Inpatient Rehabilitation 
Facilities 


X 




X 


X 


X 


X 


X 


X 


X 


X 


Home Health Agencies 


X 




XN 


X 


XN 


X 








X 


Hospices 






X 


XN 












X 


Kidney Disease Treat- 
ment Centers (Including 
Freestanding 
Hemodialysis Units) 


XN 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Health Maintenance 
Organizations (Subject 
to Exemption) 


X 






X 


X 


X 


X 


X 


X 


X 


Ambulatory Surgery 
Centers 


XN 


X 


XN 


X 


X 


X 


X 


X 


X 


X 


All Organized 
Ambulatory Health 
Care Facilities/ 
Outpatient Clinics 


XN 




XN 














X 



Specified Ambulatory 
Health Care Facilities, i.e.: 



Freestanding 
Emergicenters 




X 


X 


Ambulatory 
Obstetrical 
Facilities/Birthing 
Centers 




X 


X 


Family Planning/ 
Abortion Centers/ 
Clinics 


Communith Health 
Centers/Clinics 






X 


Public Health Centers X 


X 


X 




Community Mental 
Health Centers 




X 


X 



Facilities for Pro- 
vision of Outpatient 
Therapy Services 
Including Speech 
Pathology 



Outpatient 
Rehabilitation Facility 


X 








X 


Other Outpatient 
Ambulatory Care 
Facility 










XN 


Other Entities 


XN 


XN 


XN 


XN 


XN 



1116 



INDIANA LA W REVIEW 



[Vol. 19:1025 





SC 


SD 


TnN TxN 


Ut^ Vt 


VaN 


Wa 


wv^ 


WiN 


WyN 


Hospitals 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Skilled Nursing 
Facilities 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Intermediate Care 
Facilities 


X 


X 


X 


X 


X 


X 


X 


X 


X 


Medically-Oriented 
Residential Care 
Facilities 




X 




XN 










X 


Inpatient Rehabilitation 
Facilities 


X 


X 


X 






X 


X 


X 


X 


Home Health Agencies 


X 


X 


X 


X 




X 


X 


X 




Hospices 










X 


X 








Kidney Disease Treat- 
ment Centers (Including 
Freestanding 
Hemodialysis Units) 


X 


X 




X 


X 


X 


X 


X 


X 


Health Maintenance 
Organization (Subject 
to Exemption) 


X 


X 


X 


X 


X 


X 


X 






Ambulatory Surgery 
Centers 


X 


X 


X 


X 


X 


X 


X 


X 


X 


All Organized 
Ambulatory Heahh 
Care Facilities/ 
Outpatient Clinics 






X 


XN 






XN 







Specified Ambulatory 
Health Care Facilities, 

i.e.: 



Freestanding 
Emergicenters 




X 








Ambulatory 
Obstetrical 
Facilities/Birthing 
Centers 






• 






Family Planning/ 
Abortion Centers/ 
Clinics 




X 








Community Health 
Centers/Clinics 




X 








Public Health Centers 


X 


X 








Community Mental 
Heahh Centers 


X 




X 


X 





Facilities for Pro- 
vision of Outpatient 
Therapy Services 
Including Speech 
Pathology 



X 



Outpatient 
Rehabilitation Facility 
















Other Outpatient 
Ambulatory Care 
Facility 


Other Entities 


XN 


XN 


XN 


XN 


XN 


XN 


XN 



1986] 



CERTIFICATE OF NEED 



1117 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE 



ON BEHALF OF 
CON/ 1122 REVIEW 





Ala 


Ak Ariz^ 


Ark^ 


Cal^ 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


X 

$736,200 




X 

$736,200 




CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 




$1,000,000 


X 




CE for Bed Capacity Increases 
Only/Expenditure Threshold 


CE for Changes in Bed 

Category/Expenditure 

Threshold 






X 




CE for Bed Relocations/ 
Expenditure Threshold 






X 




CE for Additions of Health 

Services/Expenditure 

Threshold 




X 

$1,000,000 


X 




CE for Terminations of 
Health Services/ 
Expenditure Threshold 




X 

$1,000,000 


X 




CE for Other Specified 

Purpose/Expenditure 

Threshold 


X^ 
$245,000 






XN 

$1,000,000 




PROJECT 


COVERAGE 






Bed Capacity Increases 
and Decreases 


X 








Bed Capacity Increases Only 








XN 


Bed Category Changes 


X 






XN 


Bed Relocations 


X 








Additions of New Health 
Services/Annual Operating 
Costs Threshold 


XN 




X 

$306,705 


XN 


Terminations of a Service 


Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


X 

$245,000 




X 

$400,000 


XN 

$1,000,000 


Construction, Development 
or Other Establishment of 
New Health Care Facilities 


X 


X 

$1,000,000 




XN 


Acquisitions of Existing 
Facilities 


Other Specified Projects 


XN 






XN 



1118 



INDIANA LA W REVIEW 



[Vol. 19:1025 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE 



ON BEHALF OF 
CON/ 1122 REVIEW 





Colo 


Conn 


Del^ 


DCN 


FlaN 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


XN 

$2,000,000 


X 

$714,000 


X 

$150,000 


X 

$600,000 


X 

$736,200 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 








X 




CE for Bed Capacity Increases 
Only/Expenditure Threshold 


CE for Changes in Bed 

Category/Expenditure 

Threshold 








X* 




CE for Bed Relocations/ 
Expenditure Threshold 








X* 




CE for Additions of Health 

Services/Expenditure 

Threshold 


$1,000,000 




X 


X 




CE for Terminations of 
Health Services/ 
Expenditure Threshold 








X 


X 


CE for Other Specified 

Purpose/Expenditure 

Threshold 


XN 

$2,000,000 






XN 






PROJECT 


COVERAGE 






Bed Capacity Increases 
and Decreases 




N 






XN 


Bed Capacity Increases Only 


X'^ 




X* 






Bed Category Changes 


XN 




X* 




XN 


Bed Relocations 


XN 




X* 






Additions of New Health 
Services/Annual Operating 
Costs Threshold 




XN 


X 


XNxN 

$250,000 


X 

$306,750 


Terminations of a Service 




X 








Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


X 

$1,000,000 


X 

$400,000 


X 

$150,000 


X 

$400,000 


X 

$400,000 


Construction, Development 
or Other Estabhshment of 
New Health Care Facilities 


X 




X 


X 


X 


Acquisition of Existing 
Facilities 








X 




Other Specified Projects 


XN 


XN 


XN 


XN 


XN ' 



1986] 



CERTIFICATE OF NEED 



1119 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR ON BEHALF OF 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE CON/1122 REVIEW 





GaN 


Haw 


IdN 


111 


Ind^ 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


X 

$736,200 


X 

$600,000 


X 

$600,000 


X 

$736,200 


X 

$750,000 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 


CE For. Bed Capacity 
Increases Only/Expenditure 
Threshold 






X 




X 


CE for Changes in Bed 

Category/Expenditure 

Threshold 






X 




XN 


CE for Bed Relocations/ 
Expenditure Threshold 


CE for Additions of Health 

Services/Expenditure 

Threshold 






X 

$250,000 






CE for Terminations of 
Health Services/ 
Expenditure Threshold 


CE for Other Specified 

Purpose/Expenditure 

Threshold 




XN 

$600,000 


XN 








PROJECT 


COVERAGE 






Bed Capacity Increases 
and Decreases 




X 




X* 




Bed Capacity Increases Only 


XN 




X 






Bed Category Changes 




X 




X* 




Bed Relocations 




X 




X* 




Additions of New Health 
Services/Annual Operating 
Costs Threshold 


X 


X 


X 


XNxN 

$306,750 




Terminations of a Service 




XN 




X 




Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


X 

$429,012 


XN 

$250,000/ 
$400,000 




X 

$400,000 


X 

$750,000 


Construction, Development 
or Other Establishment of 
New Heahh Care Facilities 


X 










Acquisitions of Existing 
Facilities 


XN 










Other Specified Projects 


XN 


XN 


XN 


XN 


XN 



1120 



INDIANA LA W REVIEW 



[Vol. 19:1025 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR ON BEHALF OF 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE CON/1122 REVIEW 





laN 


KsN 


KyN 


La 


Me^ 


CAPITAL EXPENDITURE COVERARE 


General Purpose CE/ 
Expenditure Threshold 


X 

$600,000 




X 

$603,600 


X 

$600,000 


X 

$350,000 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 








X* 




CE for Bed Capacity Increases 
Only/Expenditure Threshold 


CE for Changes in Bed 

Category/Expenditure 

Threshold 








X 




CE for Bed Relocations/ 
Expenditure Threshold 


CE for Additions of Health 

Services/Expenditure 

Threshold 


X 

$250,000 






X 


X 


CE for Terminations of 
Health Services/ 
Expenditure Threshold 








X 


X 


CE for Other 
Specified Purpose/ 
Expenditure Threshold 










XN 

$350,000 


PROJECT COVERAGE 


Bed Capacity Increases 
and Decreases 


XN 




X 




XN 


Bed Capacity Increases Only 


Bed Category Changes 


X 




X 




XN 


Bed Relocations 


X 




X 




XN 


Additions of New Health 
Services/Annual Operating 
Costs Threshold 






XNxN 

$251,500 




XNxN 

$145,000 


Terminations of a Service 


X 




X 






Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


x^ 

$400,000 




X 

$402,000 




X 

$300,000 


Construction, Development 
or Other Establishment of 
New Health Care Facilities 


X 




X 




X 


Acquisitions of Existing 
Facilities 






XN 


X 




Other Specified Projects 


XN 




XN 


XN 


XN 



1986] 



CERTIFICATE OF NEED 



1121 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR ON BEHALF OF 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE CON/1122 REVIEW 





Md^ 


Mass 


Mich^ Minn^ Miss'^ 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


XN 

$730,000 


X 

$600,000 


X 

$150,000 


X 

$1,000,000 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 


CE for Bed Capacity Increases 
Only/Expenditure Threshold 








N 


CE for Changes in Bed 

Category/Expenditure 

Threshold 








XN 


CE for Bed Relocations/ 
Expenditure Threshold 








XN 


CE for Additions of Health 

Services/Expenditure 

Threshold 








X 


CE for Terminations of 
Health Services/ 
Expenditure Threshold 


CE for Other Specified 

Purpose/Expenditure 

Threshold 


XN 








PROJECT COVERAGE 


Bed Capacity Increases 
and Decreases 


X*N 








Bed Capacity Increases Only 




XN 


X 


N 


Bed Category Changes 






XN 




Bed Relocations 


Additions of New Health 
Services/Annual Operating 
Costs Threshold 


XN 

$305,000 


X^.XN 
$250,000 


X 


X 

$150,000 


Terminations of a Service 


X 








Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


N 


X 

$400,000 




X 

$750,000 


Construction, Development 
or Other Establishment of 
New Health Care Facilities 


XN 




X 


X 


Acquisitions of Existing 
Facilities 




X 






Other Specified Projects 


XN 


XN 




XN 



1122 



INDIANA LA W REVIEW 



[Vol. 19:1025 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR ON BEHALF OF 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE CON/1122 REVIEW 





Mo 


Mont^ 


Neb^ 


Nev'^ 


NH^ 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


X 

$736,000 


X 

$750,000 


X 

$512,100 


X 

$714,000 


X 

$1,000,000 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 






X* 






CE for Bed Capacity Increases 
Only/Expenditure Threshold 


X* 
$736,000 










CE for Changes in Bed 

Category/Expenditure 

Threshold 


$736,000 




X* 






CE for Bed Relocations/ 
Expenditure Threshold 


X* 
$736,000 




X* 






CE for Additions of Health 

Services/Expenditure 

Threshold 






X 


X 

$100,000 




CE for Terminations of 
Health Services/ 
Expenditure Threshold 






X 






CE for Other Specified 

Purpose/Expenditure 

Threshold 








XN 

$100,000 






PROJECT 


COVERAGE 






Bed Capacity Increases 
and Decreases 




X* 








Bed Capacity Increases Only 








X* 


XN 


Bed Category Changes 




X* 






XN 


Bed Relocations 




X* 








Additions of New Health 
Services/ Annual Operating 
Costs Threshold 


X^ 
$306,000 


X 

$100,000 


x^.x 

$256,050 


X 

$297,500 


XN 


Terminations of a Service 


Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


X 

$400,000 


X 

$500,000 


X 

$400,000 


X 

$400,000 


X 


Construction, Development 
or Other Establishment of 
New Health Care Facilities 


X 

$736,000 


X 


X 






Acquisitions of Existing 
Facilities 






XN 




XN 


Other Specified Projects 


XN 


XN 




XN 


XN 



1986] 



CERTIFICATE OF NEED 



1123 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR ON BEHALF OF 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE CON/1122 REVIEW 





NJN 


NM^ 


NY 


NC^ 


ND^ 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


X 

$600,000 


X 

$600,000 


X 

$300,000 


X 

$1,000,000 


XN 

$750,000 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 




X 




XN 

$1,000,000 




CE for Bed Capacity Increases 
Only/Expenditure Threshold 


CE for Changes in Bed 

Category/Expenditure 

Threshold 








XN 




CE for Bed Relocations/ 
Expenditure Threshold 








X 




CE for Additions of Health 

Services/Expenditure 

Threshold 




X 




X 


XN 


CE for Terminations of 
Health Services/ 
Expenditure Threshold 




X 




X 




CE for Other Specified 

Purpose/Expenditure 

Threshold 


XN 






XN 






PROJECT 


COVERAGE 








Bed Capacity Increases 
and Decreases 


X 




X 






Bed Capacity Increases Only 


Bed Category Changes 


X 




X 






Bed Relocations 


X 




X 






Additions of New Heahh 
Services/Annual Operating 
Costs Threshold 


XN 




X 


X 

$306,750 


X 

$300,000 


Terminations of a Service 


X 




X 






Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


X 

$400,000 




XN 


X 

$600,000 


X 

$500,000 


Construction, Development 
or Other Establishment of 
New Health Care Facilities 


XN 




X 


X 




Acquisitions of Existing 
Facilities 


XN 










Other Specified Projects 


XN 




XN 


XN 





1124 



INDIANA LA W REVIEW 



[Vol. 19:1025 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE 



ON BEHALF OF 
CON/ 1122 REVIEW 





Oh 


Ok^ 


Or 


Pa 


RI 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


X 

$714,000 


XN 

$600,000/ 
$150,000 


XN 

$1,000,000 


X 

$736,200 


X 

$150,000 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 




XN 








CE for Bed Capacity Increases 
Only/Expenditure Threshold 








X* 


X* 


CE for Changes in Bed 

Category/Expenditure 

Threshold 


XN 


XN 




X*N 


X* 


CE for Bed Relocations/ 
Expenditure Threshold 




XN 




X* 


X* 


CE for Additions of Health 

Services/Expenditure 

Threshold 








X 


X 


CE for Terminations of 
Health Services/ 
Expenditure Thresholds 


X 










CE for Other Specified 

Purpose/Expenditure 

Threshold 


XN 












PROJECT 


COVERAGE 






Bed Capacity Increases 
and Decreases 




XN 








Bed Capacity Increases Only 


X 




X* 


X* 




Bed Category Changes 


XN 


XN 








Bed Relocations 


XN 


XN 


X 






Additions of New Health 
Services/Annual Operating 
Costs Threshold 


XN^XN 
$297,500 


X 

$250,000 


XN 

$340,000 


X 

$306,750 


XN 

$75,000/ 
$150,000 


Terminations of a Service 


Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


XN 

$400,000/ 
$200,000 


X 

$400,000 


X 

$1,000,000 


X 

$400,000 


XN 

$150,000 


Construction, Development 
or Other Estabhshment of 
New Health Care Facilities 


X 


X 


X 


X 


X 


Acquisitions of Existing 
Facilities 




X 








Other Specified Projects 


XN 




XN 




XN 



1986] CERTIFICATE OF NEED 1125 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR ON BEHALF OF 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE CON/1122 REVIEW 



SC SD Tn^ Tx^ Ut 



N 



CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


X 

$600,000 


$670,404/ 
$183,690 


XN 

$1,000,000 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 


CE for Bed Capacity Increases 
Only/Expenditure Threshold 


CE for Changes in Bed 

Category/Expenditure 

Threshold 


CE for Bed Relocations/ 
Expenditure Threshold 


CE for Additions of Health 

Services/Expenditure 

Threshold 


X 


X 




CE for Terminations of 
Health Services/ 
Expenditure Thresholds 




X 




CE for Other Specified 

Purpose/Expenditure 

Threshold 




XN 






PROJECT 


COVERAGE 


Bed Capacity Increases 
and Decreases 






XN 


Bed Capacity Increases Only 


X 


X 




Bed Category Changes 


X 


XN 


XN 


Bed Relocations 






X 


Additions of New Health 
Services/ Annual Operating 
Costs Threshold 


X 

$250,000 


XN 

$279,336/ 
$91,845 


XN xN 

$500,000 


Terminations of a Service 


X 




XN 


Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


X 

$400,000 


XN 

$400,000/ 
$150,000 


X 

$1,000,000 


Construction, Development 
or Other Establishment of 
New Health Care Facilities 


X 




X 


Acquisitions of Existing 
Facilities 


X 






Other Specified Projects 






XN 



1126 



INDIANA LA W REVIEW 



[Vol. 19:1025 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR ON BEHALF OF 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE CON/1122 REVIEW 





Vt 


Va'^ 


Wa 


wv^ 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


X 

$150,000 


X 

$600,000 


X 

$1,071,000 


X 

$714,000 


CE For Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 








■X* 


CE for Bed Capacity Increases 
Only/Expenditure Threshold 




X 






CE for Changes in Bed 

Category/Expenditure 

Threshold 








X* 


CE for Bed Relocations/ 
Expenditure Threshold 




X* 




X* 


CE for Additions of Health 

Services/Expenditure 

Threshold 






XN 


X 


CE for Terminations of 
Health Services/ 
Expenditure Threshold 






XN 


X 


CE for Other Specified 

Purpose/Expenditure 

Threshold 








XN 




PROJECT 


COVERAGE 




Bed Capacity Increases 
and Decreases 


Bed Capacity Increases Only 


XN 




X 




Bed Category Changes 


XN 




X 




Bed Relocations 


XN 








Additions of New Health 
Services/Annual Operating 
Costs Threshold 


X 


XN 


X 

$536,000 


X 

$297,500 


Terminations of a Service 


Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


X 

$125,000 


X 

$400,000 


X 

$1,071,000 


X 

$400,000 


Construction, Development 
or Other Establishment of 
New Health Care Facilities 


X 




X 


X 


Acquisitions of Existing 
Facilities 






XN 




Other Specified Projects 




XN 




XN 



1986] CERTIFICATE OF NEED 1127 



TABLE 3: CAPITAL AND OTHER PROJECTS BY OR ON BEHALF OF 
HEALTH CARE FACILITIES, ETC. SUBJECT TO STATE CON/1122 REVIEW 





WiN 


WyN 


CAPITAL EXPENDITURE COVERAGE 


General Purpose CE/ 
Expenditure Threshold 


$1,000,000/ 
$600,000 


X 

$714,000 


CE for Bed Capacity 
Increases and Decreases/ 
Expenditure Threshold 




X* 


CE for Bed Capacity Increases 
Only/Expenditure Threshold 


CE for Changes in Bed 

Category/Expenditure 

Threshold 


CE for Bed Relocations/ 
Expenditure Threshold 


CE for Additions of Health 

Services/Expenditure 

Threshold 


CE for Terminations of 
Health Services/ 
Expenditure Threshold 




X 


CE for Other Specified 

Purpose/Expenditure 

Threshold 




PROJECT 


COVERAGE 


Bed Capacity Increases 
and Decreases 


Bed Capacity Increases Only 


XN 




Bed Category Changes 


Bed Relocations 


Additions of New Health 
Services/Annual Operating 
Costs Threshold 


XN 


X 

$150,000 


Terminations of a Service 


Acquisitions of Major 
Medical Equipment/ 
Equipment Expenditure 
Threshold 


$1,000,000/ 
$600,000 


XN 

$400,000/ 
$150,000 


Construction, Development 
or Other Estabhshment of 
New Health Care Facilities 




X 


Acquisitions of Existing 
Facilities 


XN 




Other Specified Projects 


XN 


XN 



Reform Revisited: A Review of the Indiana Medical 
Malpractice Act Ten Years Later 

James D. Kemper* 

Myra C. Selby** 

Bonnie K. Simmons*** 



I. Introduction 

In the mid- 1 970' s, both the private and public sectors nationwide 
became alarmed at the significant costs associated with malpractice li- 
ability in the health professions.' Indiana, one of the first states to seek 
a legislative solution to the perceived problem of increasing costs, enacted 
the Indiana Medical Malpractice Act^ (Act) in 1975. However, a nation- 
wide reassessment of the malpractice controversy has been triggered in 
the mid- 1 980' s by the recurrence of a marked increase in malpractice claims 
against physicians and hospitals and by reports of drastic increases 
in the cost of liability insurance. The direction of current solutions to 
the malpractice controversy is decidedly different from earlier reforms. 

In the 1980's, the focus of legislative solutions is not on wholesale 
tort law reform. Rather, the activity is directed toward reassessing the 
reforms made in the 1970's with a goal of making additional reforms 
to respond to the economic realities of the 1980's. The conflicting forces 
of plaintiffs seeking larger recoveries and defendants attempting to limit 
recovery make medical malpractice litigation an obvious area for con- 
tinued efforts for legislative reform. 

It is important that legislators and lobbyists reflect on the history 
of the reforms of the 1970's before considering what changes are ap- 
propriate in the 1980's. Although evaluations of the success of earlier 
medical malpractice reforms must be subjective, an objective assessment 
of the impact of the reforms can be made. This Article will review the 
reform in medical malpractice litigation in Indiana by considering the 



*Partner, Ice, Miller, Donadio & Ryan, Indianapolis. B.S., Indiana University, 1969; 
J,D., Indiana University, 1971. 

**Associate, Ice, Miller, Donadio & Ryan, Indianapolis. B.A., Kalamazoo College, 
1977; J.D., University of Michigan, 1980. 

***Associate, Ice, Miller, Donadio & Ryan, Indianapolis. B.S., Indiana University, 
1978; J.D., Indiana University, 1985. 

^See, e.g., Nat'l Center for Health Statistics, Dep't of Health, Education, 
& Welfare, Medical Malpractice Closed Claim Study 1976 (1978); Nat'l Center for 
Health Statistics, Dep't of Health, Education & Welfare, Medical Malpractice 
Closed Claim Study 1970 (1973). 

^IND. Code §§ 16-9.5-1-1 to -10-5 (1982). 

1129 



1130 INDIANA LAW REVIEW [Vol. 19:1129 

original purpose of the Act, the functioning of the medical review panel 
established by the Indiana statute, constitutional challenges to the Indiana 
statute, and the effect of changes in federal law on state malpractice 
reforms. 

II. The Purposes and Goals of the Indiana Act 

The Indiana Medical Malpractice Act was passed in response to an 
outcry over drastic increases in malpractice insurance premiums for health 
professionals.^ The legislature believed that these increased costs, along 
with the unavailability of insurance for some health professionals, caused 
health care providers to discontinue services, thereby reducing the health 
care services available to the public."^ The Act was intended to protect 
the public from decreased services by protecting health care providers 
from the cancellation of insurance coverage.^ 

While there has been no agreement among commentators as to the 
cause of the increased premiums,^ to date at least thirty states have 
enacted legislation attempting to resolve this perceived crisis."^ In an effort 
to balance the interest of the private plaintiff with the public's interest 
in preserving the health care industry, the legislative solution in Indiana 
was twofold. The Act provides for (a) limiting the amount of damages 
and attorney's fees that a plaintiff can recover and (b) a process of 
screening malpractice claims by a medical review panel. ^ 

The effectiveness of the Act and how well the solution has worked 



^LaCava, A Legislative Response: The Indiana Experience, 3 Health Span 14, 14 
(1986). 

''Rohrabaugh v. Wagoner, 274 Ind. 661, 667, 413 N.E.2d 891, 894 (1980); Johnson 
V. St. Vincent Hosp., 273 Ind. 374, 387, 404 N.E.2d 585, 594 (1980). 

'Id. 

^Some authors suggest the rise in cost was due to a widespread reaction to one 
company's poor investments. See Neubauer & Henke, Medical Malpractice Legislation: 
Laws Based on a False Premise, Trial, Jan. 1985, at 64, 65. Others reason that an 
increase in the size and frequency of claims led to the rise in premiums. See Sloan, State 
Responses to the Malpractice Insurance "Crisis" of the 1970s: An Empirical Assessment, 
9 J. OF Health Pol. Pol'y & L. 629 (1985). 

^It is difficult to determine the exact number of states enacting such legislation 
because several states are in the process of revising, enacting, or revoking their legislation. 
A state by state statutory review is beyond the scope of this article. However, it is clear 
that Indiana is not alone in attempting to remedy the medical malpractice crisis. See 
generally Klein, A Practical Assessment of Arizona's Medical Malpractice Screening System, 
1984 Ariz. St. L.J. 335, 343. For examples of comparative legislation in other states, 
see Ariz. Rev. Stat. Ann. §§ 12-561 to -569 (1982 & Supp. 1985); Md. Cts. & Jud. 
Proc. Code Ann. §§ 3-2A-01 to -09 (1984 & Supp. 1985); Mass. Gen. Laws Ann., ch. 
231, § 60B (West 1985 & Supp. 1986). 

»lND. Code §§ 16-9.5-1-1 to -10-5 (1982). 



1 986] MEDICAL MALPRA CTICE ACT 1131 

have been subject to considerable debate.^ Panels, in theory, handle 
claims more quickly with lower costs than trial litigation.'^ Moreover, 
they encourage settlement of meritorious claims while discouraging base- 
less claims. '^ Critics, however, point out that panel review adds another 
layer of proceedings, is likely to involve substantial legal expenses, and 
may encourage the filing of claims by providing an informal, initially 
less expensive proceeding. '^ While the use of a panel has not been proven 
to encourage settlement, to resolve cases more quickly, or to reduce the 
size of awards or number of lawsuits filed, '^ a panel may serve other 
purposes. It can be a tool for early trial preparation, and because the 
opinion of the panel is nonconclusive evidence at a subsequent trial, '^ 
use of the panel may encourage thorough preparation of evidence early 
in litigation. 

The impact of the Indiana Act on medical malpractice litigation has 
been more dramatic than merely a change in procedure, however. The 
changes appear to reflect an attitudinal change toward the purpose of 
tort law. It may no longer be the sole purpose of tort resolution in the 
medical malpractice area simply to compensate the victim for damages 
and deter harmful behavior. There now seems to be a legislatively- 
recognized goal of promoting the economy and protecting the health 
care industry. Compensation for harm resulting from deviation from the 
standard of care required of a doctor now seems to be tempered by an 
economically motivated leveler. 

It is beyond the scope of this Article to speculate whether this 
legislative action simply replaces historical societal limitations. In the 
past, close, lifelong doctor-patient relationships functioned to restrain 
patients from filing medical malpractice claims. In today's more im- 
personal society, such lawsuits are no longer taboo. Also, the ability of 
a community to process information about the competence of a doctor 
no longer seems sufficient to "weed out" or control less competent 
doctors. To insure that all victims of medical malpractice can recover 
in today's more Htigious atmosphere, the Act limits the amount of 
damages and attorney's fees recoverable by the plaintiff and provides 
for panel review of malpractice claims before lawsuits are filed. *^ 



"^See LaCava, supra note 3, 
'°5ee Sloan, supra note 6. 
"'5ee LaCava, supra note 3, at 16. 
^^See Sloan, supra note 6, at 636. 

'^C/". Daughtrey & Smith, Judges' Views of Medical Malpractice Review Panels, Va. 
B.A.J. , Spring 1985, at 14; Klein, supra note 7. 
"•IND. Code § 16-9.5-9-9 (1982). 
''See id. §§ 16-9.5-1-1 to -10-5. 



1132 



INDIANA LAW REVIEW 



[Vol. 19:1129 



III. Functioning of the Act 

A. How Medical Panels Work — The Statutory Scheme 

Essentially, the Indiana Act calls for a specific timetable. Before 
the plaintiff may file any action in court, he must first file a proposed 
complaint with the Indiana Department of Insurance. ^^ Upon receipt of 
the proposed complaint, the Department of Insurance will, within ten 
days, forward a copy to each health care provider named as a defendant. ^^ 
After twenty days from the filing of the proposed complaint with the 
Department of Insurance, either party may serve on the Commissioner 
of Insurance by registered or certified mail a request for the formation 
of a medical review panel. '^ 

Within fifteen days of filing this request, the parties should select 
a chairperson by agreement.*^ If they cannot agree on the selection, the 
Act states that, 

either party may request the clerk of the supreme court to draw 
at random a list of five (5) names of attorneys quahfied to 
practice and presently on the rolls of the supreme court and 
maintaining offices in the county of venue designated in the 
proposed complaint or in a contiguous county. ^^ 

The party making such a request is required to pay a fee.^^ Beginning 
with the plaintiff, each side then has five days to strike a name from 
the list. If a party does not strike a name, the opposing side may request 
in writing that the clerk strike for the party, and the clerk must strike. ^^ 
Striking continues until one name remains. Within five days after the 
last name remains, the clerk must notify that person and the parties of 
the name of the selected chairperson.^^ The chairperson then must either 
send a written acknowledgment of his appointment to the clerk within 
fifteen days, or if he does not want to serve, he must show that service 
would constitute an unreasonable burden or undue hardship. ^"^ 

After the chairperson is selected, the parties must select the other 
panel members. ^^ Within fifteen days after the chairperson is selected, 



'Hd. §§ 16-9.5-9-1, -2. 

''Id. 

''Id. 

''Id. § 16-9.5-9-3(a). 

''Id. 

'Ud. 

''Id. 

''Id. § 16-9.5-9-3(a), (c). 

''Id. § 16-9.5-9-3(b)(lH2). 



1986] MEDICAL MALPRACTICE ACT 1133 

each side chooses one health care provider to serve on the panel. Within 
fifteen days of their selection, these two providers then select a third 
provider for the panel. ^^ If the two providers do not choose a third 
panelist, the chairperson selects the third provider.^^ 

Challenges without cause may be made to any selection within ten 
days after selection of that panel member. ^^ If two such challenges are 
made, the chairperson within ten days proposes a special hst of three 
quahfied paneHsts.^^ Each side then has ten days to strike one of the 
three, with the party whose appointment was challenged striking last.^^ 
When the final member is named, the chairperson should, within five 
days, notify the Commissioner of Insurance and the parties of the names 
and addresses of panel members and the date on which the last member 
was selected.^' The panel is then required to render its expert opinion 
within 180 days after the selection of the last member. ^^ 

The entire panel review process should take nine months. ^^ However, 
the reality is much different from the mechanism set out in the Act. 

B. How Medical Panels Work — Reality 

The nine-month statutory timetable is rarely, if ever, met. One reason 
is that the large number of complaints filed has caused delays. The 
number of complaints filed has skyrocketed since the Act was passed. 
In 1975, the year of enactment, only one complaint was filed, but 773 
complaints were filed with the Commissioner in 1985.^^ As of December 
31, 1985, 4,225 complaints had been filed; of those, only 1,171 were 
closed. ^^ An average complaint took 23.4 months to go through the 
process as of May 31, 1983.^^ These delays are not simply the fault of 
'*the system;" delays can also be caused by the actions of the parties 
and of the chairperson, as well as by outside circumstances. 

The parties themselves cause delays when the parties do not follow 
the statutory procedures for panel review. For example, delays arise 



^'Id. § 16-9.5-9-3(b)(2). 

^'Id. 

''Id. § 16-9.5-9-3(b)(3). 

'^Id. 

'°Id. 

''Id. § 16-9.5-9-3(b)(4). 

''Id. § 16-9.5-9-3.5. 

''See id. § 16-9.5-9-3. 

"^See Patients Compensation Div., Ind. Dep't of Ins., Year End Report and 
Actuarial Study (1985) [hereinafter Year End Report]. 

"Id. 

'^Cha V. Warnick, 476 N.E.2d 109, 112 (Ind. 1985), cert, denied, 106 S. Ct. 249 
(1985); see also Williams, Indiana Medical Malpractice Act— The Developing Law, 27 
Res Gestae 494, 497 (1984). 



1134 INDIANA LAW REVIEW [Vol. 19:1129 

when the complaint is improperly filed by the plaintiff.^^ In addition, 
the parties rarely request the formation of the panel as quickly as the 
Act allows.^^ Further delays occur because the parties rarely invoke the 
procedure under the authority of the clerk of the supreme court to select 
a chairperson.^^ Moreover, the nominations of the health care providers 
are often not made in fifteen days/° And finally, delays by the parties 
in submitting evidence also contribute to the time lag/^ 

The chairperson of the panel also has a significant impact on the 
flow of the case regardless of the actions of the parties. Novice chair- 
persons may take a considerable amount of time to become familiar 
with the Act and may fail to be aware of statutory deadlines or to 
apply those deadlines strictly."^^ 

Delays can also occur after the panel is convened. For example, 
there can be delays in receiving evidence. Although all evidence submitted 
to the panel must be in written form, the Act provides that after 
submission of all evidence, either party may convene the panel in order 
to question panel members at a time and place agreeable to the panelists. "^^ 
Because the panelists may have other responsibilities, significant delays 
can occur in finding a time and place agreeable to them."^ 

Further delays may be created when either of the parties or the 
Insurance Commissioner calls into play the provisions of Chapter 10 of 
the Act. Either party may file a motion in a court having jurisdiction 
over the subject matter to determine questions of *'any affirmative defense 
or issue of law or fact that may be preliminarily determined under 
Indiana Rules of Procedure" or to compel discovery."*^ The panel pro- 
ceedings are then stayed until the court rules on the motion."^^ Court 
involvement at this point is Hmited to the matters set out in the statute. "^^ 
Once the court rules on the motion, its jurisdiction ends, and the panel 
resumes its consideration of the case."^^ The court's jurisdiction is not 
properly invoked again until a complaint is filed, after the panel issues 
an opinion. ^^ 

^'A total of 76 claims filed from 1975 through 1985 involved problems with the 
initial complaint. Year End Report, supra note 34. 

^^Pinkus, The Role of the Panel Chairman, 1984 Ind. Continuing Legal Educ. 
Forum on Presenting a Case Before Medical Review Board IV-1, IV-7. 

'"Id. 

'°Id. 

''Id. 

'Ud. 

nNT>. Code § 16-9.5-9-5 (1982). 

*'^See supra notes 37 to 43 and accompanying text. 

^'Ind. Code § 16-9.5-10-1 (1982). 

''Id. § 16-9.5-10-4. 

''Id. § 16-9.5-10-2. 

''Id. §§ 16-9.5-10-1 to -4. 

"See Johnson v. Methodist Hosp. of Gary, 547 F. Supp. 780, 782 (N.D. Ind. 1982). 



1986] MEDICAL MALPRACTICE ACT 1135 

Some of these delays can be discouraged by the use of judicially- 
imposed sanctions, for example, fines against the delaying parties or 
judicial reprimands. Although the Act does not contain specific sanctions 
for a party's failure to comply with its provisions, the Act does state: 

A party, attorney or panelist who fails to act as required by 
this chapter without good cause shown is subject to mandate 
or appropriate sanctions upon application to the court designated 
in the proposed complaint as having jurisdiction.^^ 

Under Chapter 10 of the Act, a party may make a motion for sanctions, 
but the procedure for the court's ruling on such a motion can create 
its own problems. A judicial decision on a motion made under Chapter 
10 is to be rendered within thirty days after the matter is heard. ^' If 
there is no hearing, the decision must be rendered within thirty days 
after the last written response to the motion is filed. ^^ However, the 
Act does not provide explicit sanctions for the failure of a judge to 
render a decision within the prescribed time. At least one Indiana court 
has concluded that this time limitation and its purpose are similar to 
those provided for other civil actions under Indiana Trial Rule 53.1(A)." 
The court of appeals has held that the appropriate sanction for a judge 
who fails to rule on a Chapter 10 motion within the prescribed time 
period is disquahfication under trial rule 53.1.^"* Perhaps other analogies 
as to appropriate sanctions could be persuasively made. 

C Statute of Limitations 

In addition to the procedural structure of the Act, another important 
provision is the time limitation for bringing a medical malpractice action. 
The Act provides: 

No claim, whether in contract or tort, may be brought against 
a health care provider based upon professional services or health 
care rendered or that should have been rendered unless filed 
within two (2) years from the date of the alleged act, omission, 
or neglect, except that a minor under the full age of six (6) 
years shall have until his eighth birthday in which to file.^^ 

This period is triggered by the occurrence of the act, omission or neglect, 
not by the discovery that the cause of the injury was a health care 



=°IND. Code § 16-9.5-9-3. 5(b) (1982). 
''IND. Code § 16-9.5-10-3. 

"Hepp V. Pierce, 460 N.E.2d 186, 189 (Ind. Ct. App. 1984). 

''Id. 

«IND. Code § 16-9.5-3-1 (1982). 



1136 INDIANA LAW REVIEW [Vol. 19:1129 

provider's act, omission or neglect. ^^ However, where the entire conduct 
of the doctor constitutes fraudulent concealment, the doctrine of equitable 
estoppel may prevent a defendant doctor from taking advantage of his 
deceit by barring the doctor from asserting the statute of Hmitations as 
a defense. ^^ Fraudulent concealment includes both affirmative acts to 
conceal information and passive failure to disclose information required 
by the duties of the doctor-patient relationship.^^ Where the concealment 
is passive, the concealment is considered to end when the doctor-patient 
relationship ends; at that time the statute of limitations begins to run.^^ 

The statute of limitations may also be tolled under a continuing 
wrong theory. As described in Frady v. Hedgcock,^ '*[w]hen an entire 
course of conduct combines to produce an injury, the conduct may 
constitute a continuing wrong so as to delay the running of the statute 
of limitations. . . . Under this theory, the statutory period commences 
at the end of the continuing wrongful act."^^ In Frady, a wrongful 
death action was brought under the Act against a physician whose patient 
had died of renal failure, thought to be caused by the allegedly excessive 
medication prescribed by the physician. The physician last saw the patient 
for treatment more than one month before her death. A complaint was 
filed more than two years after the date of her last visit, but less than 
two years after her death. The court of appeals found that a material 
issue of fact existed as to whether the doctor's treatment was a continuing 
wrong as late as the date of death, so as to toll the limitation period 
until the date of death. ^^ The court also made clear that the statute of 
limitations of the Act could apply to a wrongful death action if mal- 
practice was the basis of the action. The statutory time period for 
wrongful death actions would be inappHcable in this case.^^ Therefore, 
wrongful death actions based upon medical malpractice must be filed 
within two years of the act, omission, or neglect, not within two years 
of the date of death. ^ 

A recent decision by the Indiana Court of Appeals has an uncertain 
impact on interpretation of the statute of hmitations provision. In Barnes 
V. A. H. Robins Co.,^^ the court of appeals adopted a '^discovery" rule 



^^Colbert v. Waitt, 445 N.E.2d 1000, 1002 (Ind. Ct. App. 1982). 

''Id. at 1002-03. 

'^Id. at 1003. 

'^Id.; Weinstock v. Ott, 444 N.E.2d 1227, 1236 (Ind. Ct. App. 1983). 

^"497 N.E.2d 620 (Ind. Ct. App. 1986). 

''Id. at 622. 

"/</. at 622-23. 

'Ud. at 622. 

''Id. 

"476 N.E.2d 84 (Ind. Ct. App. 1985). 



1986] MEDICAL MALPRACTICE ACT 1137 

and found that the statute of Hmitations commenced when the plaintiff 
knew or should have discovered that an injury was suffered and was 
caused by a product or act of another, in this case, an intrauterine 
device.^^ The court limited this rule to situations where "[the] injury to 
a plaintiff [was] caused by a disease which may have been contracted 
as a result of protracted exposure to a foreign substance. "^"^ In Walters 
V. Owens-Corning Fiberglass Corp. ,^^ the United States Court of Appeals 
for the Seventh Circuit held that exposure to asbestos over a twenty- 
five year period constituted "protracted exposure to a foreign substance" 
and allowed the tolling of the statute of limitations until the time of 
discovery, based on Barnes. ^'^ Future malpractice plaintiffs may use these 
decisions to argue for broader appHcation of such a rule where the 
statute of limitations has otherwise expired and may succeed in having 
the discovery rule apply to occurrences of medical malpractice. 

D. Scope of the Act 

The Indiana statute is extremely restrictive. It does not apply to all 
defendant-doctors, and it does not cover all occurrences of malpractice. 
This strictness causes confusion and statute of limitations problems when 
the plaintiff is trying to decide if his action is subject to panel review 
under the Act or if he should proceed directly in court. 

1. Qualified Health Care Providers. — The Act applies only to health 
care providers quahfied therein.^" If the health care provider is not included 
in the coverage of the Act, the Act is inapplicable and the patient 
must pursue remedies outside the Act.^' A qualified health care provider 
is one who files proof of financial responsibility and pays the surcharge 
provided for in the Act.^^ If the patient files his complaint in a timely 
fashion with the Department of Insurance, but the defendant is not a 
quahfied provider under the Act, the filing is apparently ineffective for 
torts statute of limitation purposes. Although the Act provides for tolling 
the statute of Hmitations upon filing of a proposed complaint until ninety 
days after the panel opinion is issued,'^ this provision is inapplicable if 
the provider is not quahfied. The result is that the statute of Hmitations 
will continue to run, and if the time is near, as it inevitably is, it may 
be too late to file a complaint in court. 



^Id. at 87-88. 

"•'Id. at 87. 

^«781 F.2d 570 (7th Cir. 1986). 

'•''Id. at 572. 

™lND. Code § 16-9.5-1-5 (1982). 

''Id. 

'^Id. § 16-9.5-2-1. 

'Hd. § 16-9.5-9-1. 



1138 INDIANA LAW REVIEW [Vol. 19:1129 

Certainly the reverse is true. Where the defendant health care provider 
is qualified, the action must proceed under the Act.^"^ The plaintiff's 
proposed complaint must be filed with the Department of Insurance. If 
the complaint is mistakenly filed in court instead, it may be subject to 
summary judgment. ^^ If the statutory time limit expires after the filing 
in court but before dismissal of the action, the plaintiff cannot start 
over and file the complaint with the Department of Insurance. ^^ In other 
words, if the plaintiff files a complaint within the prescribed time limit 
but in the wrong forum, it may be too late to correct the mistake. This 
has been held true in one case despite evidence that the plaintiff had 
been told incorrectly by the Department of Insurance that the health 
care provider was not qualified, leading the plaintiff to file the action 
in the wrong forum. '^'^ 

The Department of Insurance works within a limited budget and 
with limited resources. ^^ Beyond the expected human errors that can 
occur in recordkeeping, the Act contains provisions that complicate 
matters even more. The Act provides for a 180-day grace period from 
the termination of insurance coverage and a showing that coverage is 
being renewed. ^^ Because of this grace period, it may be difficult for 
a plaintiff to determine if a defendant is qualified under the Act. Because 
of these complications as well as the unfortunate result to the plaintiff 
if he files a complaint in the wrong forum, plaintiffs are commonly 
advised to file both with the court and the Department. ^° 

2. Situations Covered by the Act. — The Act contains very broad 
definitions, which make many types of conduct subject to its provisions. 
* 'Malpractice" is defined as "any tort or breach of contract based on 
health care or professional services rendered, or which should have been 
rendered, by a health care provider, to a patient. "^^ "Health care" is 
broadly defined as "any act or treatment performed or furnished, or 
which should have been performed or furnished, by any health care 
provider for, to, or on behalf of a patient during the patient's medical 
care, treatment, or confinement. "^^ 

Although, clearly, typical acts of malpractice are covered by the 



''Id. §§ 16-9.5-1-5, -9-2. 

''See Whitaker v. St. Joseph's Hosp., 415 N.E.2d 737, 742-45 (Ind. Ct. App. 1981). 

'"Id. 

"Id. 

^^Clegg, Insurance Commissioner's Role, 1984 Ind. Continuing Legal Educ. Forum 
ON Presenting a Case Before Medical Review Board II-l, II-7. 

^'IND. Code § 16-9.5-4-l(e) (1982). 

^^See Clegg, supra note 78, at II-7; Murphy, Pitfalls in Medical Malpractice Panel 
Practice, 29 Res Gestae 178, 178 (1985). 

«'lND. CofDE § 16-9.5-l-l(h) (1982). 

^Ud. § 16-9.5-1-1(1). 



1986] MEDICAL MALPRACTICE ACT 1139 

Act, a curious line of cases has found less typical occurrences also 
covered. ^^ In Ogle v. St. John's Hickey Memorial Hospital, ^"^ the rape 
of one patient by another, allegedly caused by negligence on the part 
of the hospital, was determined to be a tort action subject to the Act.^^ 
In Methodist Hospital of Indiana v. Rioux,^^ the Act was found to 
apply to a slip-and-fall action of a patient against a hospital. ^^ The 
Rioux decision met with disapproval in Winona Memorial Foundation 
V. Lomax,^^ a later, similar case. The Lomax court found that the Act 
did not apply where the fall occurred during a time when the patient 
was not receiving treatment or care, nor was attended by any hospital 
employees. ^^ The Lomax court felt that literal application of the Act to 
these circumstances would be absurd, contradictory, and not within the 
intent of the legislature.^^ These conflicting interpretations are unresolved. 
Certainly factors of each decision should be weighed by plaintiffs in 
trying to decide where to file and by defendants in deciding whether to 
challenge a court action in order to obtain panel review. 

Another example of the less typical occurrences found to be covered 
by the Act arose in Detterline v. Bonaventura.^^ The court of appeals 
found that in an action for wrongful commitment to a mental hospital, 
the claim must be submitted to a medical review panel under the Act.^^ 
This decision required a broad reading of the statutory definition of 
''patient" because the plaintiff had never been examined or seen by the 
defendant doctor. The patient's wife had arranged for the doctors to 
sign the commitment papers; her action on the patient's behalf created 
a sufficient relationship to qualify the plaintiff as a patient. ^^ 

5. Multiple Defendants. — The Act also creates potential problems 
when multiple defendants are involved. Compliance with the Act is 
difficult when some of the defendants are qualified health care providers 
and some are not. The defendants falling under the Act should be named 
in a complaint filed with the Department of Insurance, but those not 



''See Ogle v. St. John's Hickey Memorial Hosp., 473 N.E.2d 1055 (Ind. Ct. App. 
1985); Detterline v. Bonaventura, 465 N.E.2d 215 (Ind. Ct. App. 1984); W^inona Memorial 
Found. V. Lomax, 465 N.E.2d 731 (Ind. Ct. App. 1984); Methodist Hosp. of Ind. v. 
Rioux, 438 N.E.2d 315 (Ind. Ct. App. 1982). 

«M73 N.E.2d 1055 (Ind. Ct. App. 1985). 

''Id. 

M38 N.E.2d 315 (Ind. Ct. App. 1982). 

''Id. 

M65 N.E.2d 731 (Ind. Ct. App. 1984). 

'Hd. at 741-42. 

^Id. at 734-39. 

^'465 N.E.2d 215 (Ind. Ct. App. 1984). 

^^Id. Sit 216. 

''Id. at 219. 



1140 INDIANA LAW REVIEW [Vol. 19:1129 

covered by the Act will be sued in a court. ^'^ In this way, the plaintiff 
can file against all possible defendants before the statute of Hmitations 
runs out.^^ The defendants in the court proceeding will probably want 
to obtain a stay until a panel opinion has been issued. ^^ This allows 
defendants not only additional time, but also the benefit of learning 
about the case through its development before the panel. ^"^ 

4. Impact of Recent Amendments. — Recent amendments both to 
the Act and to the Indiana comparative fault statute affect both the 
amount of damages a plaintiff can recover and a defendant's liability 
under the Act. Effective September 1, 1985, plaintiffs with claims of 
$15,000 or less may choose not to proceed before a panel.^^ However, 
if the plaintiff chooses to go straight to court, he cannot recover more 
than $15,000.^^ This new provision allows for a quicker, less costly 
settlement where the amount involved is small. If the plaintiff discovers 
after the action has begun that the bodily injury is more serious than 
previously believed and that $15,000 is insufficient compensation, the 
plaintiff may move that the action be dismissed without prejudice, and 
upon dismissal, the plaintiff may proceed as usual under the Act.^°° In 
such a case, the statute of limitations is extended by 180 days.^^^ A 1985 
amendment to Indiana's comparative fault statute provides that the 
comparative fault statute does not apply to an action brought under the 
Medical Malpractice Act.'^^ Thus a malpractice plaintiff cannot invoke 
the provisions of the comparative fault statute, and a malpractice defend- 
ant may be able to utilize defenses such as contributory negligence. ^^^ 

E, How to Participate in the Panel: Cautions and Encouragements 

In litigating a malpractice case under the Act, parties can take alter- 
native stances based on their feelings about the panel. They may choose to 
participate as little as possible, or they may choose to use the panel 
proceedings as an opportunity to prepare for trial. The first alternative 
cannot be carried too far, however, without creating the threat of 
sanctions.'^ 



^'^See supra notes 70 to 80 and accompanying text. 

^^Shula, How to Present Defendant's Case to the Medical Review Panel, 1984 Ind. 
Continuing Legal Educ. Forum on Presenting a Case Before Medical Review Board 
III-l, III-2. 

•""Id. at III-2. 

^'Id. 

'«Ind. Code § 16-9.5-9-2. 1(a) (Supp. 1985). 

^''Id. 

"^Id. § 16-9.5-9-2. 1(b). 
'<"M § 16-9.5-3-l(b). 
•°^/af. § 34-4-33-1. 
'""'See id. 
^°*See supra notes 50-54 and accompanying text. 



1986] MEDICAL MALPRACTICE ACT 1141 

The Act also provides that the panel consider the issues as charged 
in the complaint when determining its opinion. '^^ Although the panel 
members will concentrate on submissions and medical records, not merely 
the complaint, ^^^ any complaint filed in court after panel review should 
duplicate the proposed complaint considered by the panel. '^"^ If new 
theories are submitted to a court after the panel opinion is rendered, 
the defendant has a basis to argue for reconvening the panel and 
submitting the new claims to the panel. ^^^ Furthermore, failure to submit 
all issues and evidence to the panel is likely to insure an unfavorable 
decision from the panel. Because the panel opinion is admissible at trial 
as nonconclusive expert evidence, ^^^ a party who submits little or no 
data to the panel risks an unfavorable panel opinion that has a significant 
effect on the fact-finder at trial. Courts from other jurisdictions have 
held that a nonparticipating party cannot reveal to the jury that no 
evidence was presented to the panel. ^^° The delay and expense incurred 
at the panel level should be balanced with these results. The degree of 
nonparticipation may be limited by these considerations. 

However, the disadvantage of plunging into full preparation at the 
panel stage is the risk of revealing too much to opposing parties. The 
use of affidavits from experts may lead to early deposition of these 
people, for example. Balancing this threat, however, is the availability 
of the three panel members to testify as witnesses at trial and of up 
to three opinions for submission at trial.^^' (The Act appears to allow 
multiple opinions from the panel. )"^ The purposes of the Act, then, are 
probably better served by full participation. 

Because the panel is not bound by formalities, the parties can 
encourage the progress of the proceedings. Because the chairperson is 
the only attorney on the panel, "^ legal issues and submissions should 
be restricted to that person, who can present them as appropriate to 



'o^lND. Code § 16-9.5-9-7 (1982). 
'"^See Shula, supra note 95, at III-ll. 
'°Vc?. at III-12. 

•°^IND. Code § 16-9.5-9-9 (1982). 

'""See, e.g.. Phoenix Gen. Hosp. v. Superior Court, 138 Ariz. 504, 506, 675 P.2d 
1323, 1325 (1984) (en banc); Herrera v. Doctor's Hosp., 360 So. 2d 1092, 1096 (Fla. 
Dist. Ct. App.), aff'd, 367 So. 2d 204 (Fla. 1978). 

•"Ind. Code § 16-9.5-9-9 (1982); see also Hobbs v. Tierney, 495 N.E.2d 217, 222 
(Ind. Ct. App. 1986) (discussion of panel member's competency as an expert witness to 
testify in malpractice actions). 

''^See Kranda v. Houser-Norborg Medical Corp., 419 N.E.2d 1024, 1034 (Ind. Ct. 
App.) reh'g denied, 424 N.E.2d 1064 (Ind. Ct. App. 1981), appeal dismissed, 459 U.S. 
802 (1982). 

"^Ind. Code § 16-9.5-9-3 (1982). The other panel members are health care providers, 
although they may evidently be physician-attorneys. 



1142 INDIANA LAW REVIEW [Vol. 19:1129 

the Other members. Direct discussion about legal issues with the medical 
members of the panel can lead to unnecessary confusion and risks 
misunderstanding. Also, the parties may find it appropriate to monitor 
the chairperson's compliance with statutory deadlines, particularly when 
dealing with an inexperienced chairperson. In addition, parties can control 
the speed of the formation of the panel through the selection of the 
chairperson and the other members by prompt contact with the clerk 
of the court and, subsequently, with the chairperson. 

Parties should also recognize that the Department of Insurance acts 
only as a recordkeeping body.*'"* The Commissioner has no control or 
interest in creation of the panel, compelling discovery, distribution of 
evidence to panel members, or determination of sanctions on opposing 
parties. *^^ The Department should not be expected to distribute infor- 
mation, and parties should not involve that body unnecessarily. 

Parties must submit evidence to the panel in written form only.^^^ 
Commonly, the chairperson will set up a staggered submission schedule 
beginning with the plaintiff.''^ In addition to medical records, parties 
may wish to include medical literature, treatises, and letters from ex- 
perts.'*^ The parties may also want to provide the chairperson with briefs 
on legal issues which the chairperson is then required to explain to the 
other panel members. ^^^ 

Although no trial or formal hearing occurs, either party can convene 
the panel at a time and place agreeable to all the panel members and 
question panel members about any matter relevant to the issues. '^° Aside 
from the potential for delays in finding a suitable time and place, ^^^ 
this provision can be advantageous to the parties. The practical appU- 
cation of this provision is expansive. Some parties make formal records 
of the meeting hoping to use statements made by panel members to 
impeach the members at trial if the panel opinion is adverse. ^^^ Meetings 
can also be used to discover potential biases and to determine areas of 
uncertainty. A party may find it appropriate at panel proceedings to 
guide a chairperson so that arguments are not presented and only the 
legitimate inquiry allowed by the Act occurs. 

The opinion of the panel is no more than an opinion. '^^ It is 



^^*See supra note 80. 

"^IND. Code § 16-9.5-9-4 (1982). 
'"See Shula, supra note 95, at III-9. 
"«lND. Code § 16-9.5-9-4 (1982). 

'^°M § 16-9.5-9-5. 

'^'See supra notes 43 to 44 and accompanying text. 

'^^Murphy, supra note 80, at 179-80; Shula, supra note 95, at III-8, n.l. 

'"IND. Code §§ 16-9.5-9-7, -9 (1982). 



1986] MEDICAL MALPRACTICE ACT 1143 

considered expert testimony, not a judgment or determination of either 
legal issues or damages. ^^"^ The panel has the following four statutory 
options for its opinion: 

(a) The evidence supports the conclusion that the defendant 
or defendants failed to comply with the appropriate standard 
of care as charged in the complaint. 

(b) The evidence does not support the conclusion that the 
defendant or defendants failed to meet the applicable standard 
of care as charged in the complaint. 

(c) That there is a material issue of fact, not requiring expert 
opinion, bearing on liability for consideration by the court or 
jury. 

(d) The conduct complained of was or was not a factor of 
the resultant damages. If so, whether the plaintiff suffered: 

(1) any disability and the extent of duration of the dis- 
ability, and 

(2) any permanent impairment and the percentage of the 
impairment. '^^ 

A party who still wishes to go to trial after issuance of the panel 
opinion must file his complaint in court ninety days following the receipt 
of the opinion. ^^^ Even with a favorable panel opinion, a plaintiff may 
wish to file a complaint in court to avoid statute of limitations problems 
if a settlement is delayed. A defendant of course must simply wait for 
the plaintiff's next steps; an opinion favorable to the defendant is no 
guarantee that the plaintiff will stop pursuing his claim. 

IV. Constitutionality 

The Indiana Act withstood early constitutional challenges shortly 
after its enactment. '^"^ Several years later, in Warnick v. Cha,^^^ plaintiffs 
were again unsuccessful in challenging the constitutionality of certain 
provisions of the Act. The plaintiffs in Warnick alleged that the provisions 
of the Act that require submission of a claim to a medical review panel 



'^Id. 

'^nd. § 16-9.5-9-7. 

'^Hd. § 16-9.5-9-1. 

'^^See Johnson v. St. Vincent Hosp., 273 Ind. 374, 404 N.E.2d 585 (1980). 

•28No. SD 83-163 (Jasper Super. Ct. Nov. 2, 1983). 



1144 INDIANA LAW REVIEW [Vol. 19:1129 

before filing a lawsuit in court ^^^ violated state and federal constitutional 
rights to trial by jury and access to courts as well as the equal protection 
and due process clauses of the fourteenth amendment. '^ 

Warnick originated with the filing of a complaint for a declaratory 
judgment seeking to have the Act declared unconstitutional.^^' The plain- 
tiff had previously filed a medical malpractice action against the same 
defendant that resulted in a default judgment against the defendant. '^^ 
The Indiana Court of Appeals vacated the default judgment and re- 
manded the case for further proceedings.'" The Indiana Supreme Court 
denied transfer. '^"^ 

In the subsequent declaratory judgment action, the trial court held 
the Act unconstitutional on several bases. The court found that the delay 
caused by mandatory submission of a malpractice claim to a medical 
review panel violated the right of free access to courts as guaranteed 
by the constitution of the state of Indiana and the United States Con- 
stitution. The court also held that the mandatory submission provisions 
violated the right to trial by jury as provided by the constitution of the 
state of Indiana, '^^ as well as the equal protection and due process clauses 
of the fourteenth amendment to the Constitution of the United States. '^^ 

On direct appeal, the Indiana Supreme Court reversed the trial court 
and upheld the constitutionaHty of the Act.'^^ The court discussed Johnson 
V. St. Vincent Hospital,^^^ the earlier case, stating that it had recognized 
in Johnson the potential for delays created by the Act but found the 
delay constitutionally permissible.'^^ The court stated, *'In other words, 
the mere fact that there is a delay which may be as long as 23.4 months 
from the time of filing until the time the panel opinion is rendered is 
not enough to hold Indiana's Malpractice Act unconstitutional. "'"^^ The 
court recognized that delays to the claimant were an acceptable trade- 
off in light of the benefits to be derived. Despite the delays, the Act 
was a reasonable means to achieve the stated compelling state interest 
in insuring the continuation of medical services within the state and in 
dealing with the malpractice insurance emergency that threatened the 



'2'lND. Code §§ 16-9.5-1-1 to -9-10 (1982). 
'^''Warnick, No. SD 83-163, at 1. 

''^Id. at 1-2. 

•"Cha V. Warnick, 455 N.E.2d 1165 (Ind. Ct. App. 1983), trans, denied. 

'''See Cha, 476 N.E.2d at 109. 

'''Warnick, No. SD 83-163, at 7-10. 

'''Id. at 10. 

"'Cha, 476 N.E.2d at 109. 

'^«273 Ind. 374, 404 N.E.2d 585 (1980). 

"^Cha, 476 N.E.2d at 112. 

'"^Id. 



1986] MEDICAL MALPRACTICE ACT 1145 

availability of these services. Therefore, the Act was not unconstitu- 
tional. ^"^^ The lynchpin of the court's analysis of the constitutionality 
issue was that the plaintiffs failed to show that a medical malpractice 
insurance emergency no longer existed in the state. Thus, the Johnson 
analysis that the Act was a reasonable means to respond to that emergency 
still applied. '^2 

Warnick seems decisively to foreclose any attack on the constitu- 
tionahty of the Act based on delays resulting from the medical review 
panel process. However, other aspects of the panel procedure may be 
subject to constitutional challenge. Warnick seems to suggest, though, 
that any such challenge, in order to be successful, would have to rest 
on evidence that invalidates or undermines the legislative judgment un- 
derlying the Act.'^^ 

Interestingly, other provisions of the Act were not challenged in 
Warnick. For example, the provision limiting a plaintiff's recovery to 
a certain amount was not challenged by the Warnick plaintiffs. Indiana 
remains one of a relatively small number of states that limit the amount 
of damage awards to plaintiffs in medical malpractice cases. '"^"^ 

V. Beyond the Panel 

It may never be possible to determine conclusively whether the 
statutory measures serve the goals for which they were intended. Despite 
the limitation on recovery and despite the effect of panels in discouraging 
lawsuits and encouraging settlements, some costs remain unaffected. Both 
parties can suffer large degrees of non-monetary cost, including the 
psychological and emotional strain of adversarial actions. The Act makes 
the goal of compensating victims for damages secondary to that of 
assuring that insurance companies can reliably and predictably insure 
doctors. The long-term effect is that health care providers are encouraged 
to maintain insurance because of increased protection. This continued 
availability of insurance in turn increases the likelihood that plaintiffs 
will actually receive damages, albeit limited damages, rather than pursuing 
collection from bankrupt, uninsured defendants. 

The goal of tort law of deterring malpractice is unaffected by this 
statute, however. Although the threat of large monetary costs is removed 
from health care providers qualified under the Act, many penalties remain 
untouched. The accusation of malpractice before a panel or a court 
exacts costs in the form of social stigma, loss of prestige, embarrassment. 



""M at 112-113. 

''^Id. at 113. 

'«5ee Cha, 476 N.E.2d at 113. 

'"^See Medical Malpractice: The States Respond, 9 Health Law Vigil 11, 18 (1986). 



1146 INDIANA LAW REVIEW [Vol. 19:1129 

anxiety, and time. These costs cannot be easily legislated away. Indeed, 
the only alternative may be to cap the number of malpractice lawsuits 
at a specific level — a change not likely to occur without drastic change 
in the current attitude about justice. 

The true deterrents to negligent behavior by a physician are probably 
the non-monetary costs of an accusation of medical malpractice, not 
the possibility of increased financial costs. '"^^ The accusation alone may 
be a sufficiently negative sanction to change a doctor's methods of 
practice. One result of the perceived medical malpractice crisis has been 
the practice of defensive medicine, the increased use of costly procedures 
and tests to foreclose accusations of malpractice. ^"^^ 

VI. Impact of Federal Law 

Medical treatment decisions are not made in a vacuum. Increasingly, 
medical practice is affected by changes in the economics of practice. 
Prior to the advent of Medicare, ^"^"^ doctors and hospitals relied upon 
patients and private insurance for reimbursement. In 1965, Medicare 
came into being to pay for medical expenses for the elderly. ^"^^ The goals 
of the program, to improve health care for the elderly by paying for 
specified services, have come into conflict with the restrictive attitude 
toward federal spending in the 1980's. Increases in the cost of medical 
care, whether from inflation or technological advances, and the perceived 
need for the federal government to contain those costs have led to 
significant changes in federal reimbursements under Medicare. 

The Health Care Financing Administration (HCFA) reimburses hos- 
pitals for services covered by Medicare. ^^^ At the direction of Congress, 
HCFA has now developed prospective rating formulas designed to de- 
termine the amount of Medicare reimbursement according to the di- 
agnosis-related group (DRG) category applicable to a patient. *^^ Because 
reimbursement is no longer based on the cost of services rendered, 
hospitals are encouraged to keep their costs to a minimum. ^^^ 

In addition to DRGs, quality control Peer Review Organizations 
(PRO'S) have been estabhshed.^^^ These organizations are made up of 

'^'Bell, Legislative Intrusion into the Common Law of Medical Malpractice: Thoughts 
About the Deterrent Effect of the Tort Liability, 35 Syracuse L. Rev. 939 (1984). 
''^Id. 
''HI U.S.C. §§ 1395, 1395a to 1395xx (1982). 

''^Id. § 1395 WW. 

'''See 97 Stat. 65 (1983); 42 C.F.R. § 412 (1985). 

'''See Note, Rethinking Medical Malpractice Law in Light of Medicare Cost-Cutting, 
98 Harv. L. Rev. 1004, 1006 (1985). 

"^See Gosfield, Hospital Utilization Control by PROs: A Guide Through the Maze, 
2 Healthspan 3 (1985), for a general history of legislation concerning review of utilization 
of hospital services. 



1986] MEDICAL MALPRACTICE ACT 1147 

physicians and contract with the Department of Health and Human 
Services to review health care provided by hospitals and to validate 
reimbursements. ^^^ These reviews perform watchdog duties to insure that 
hospitals do not abuse the Medicare system. ^^"^ The motivation for this 
legislation was also cost efficiency. '^^ PRO review does provide some 
protection from liability; the law shields physicians and other health 
care providers from civil Uability "on account of any action taken . . . 
in compliance with or reliance upon professionally developed norms of 
care and treatment apphed by an organization under contract . . . ."^^^ 
The degree to which this immunity will protect a doctor is uncertain, 
however.^" The primary goal of the legislation is not to change mal- 
practice Uability, but to decrease costs. '^^ 

The philosophy underlying these measures directly conflicts with that 
of defensive medicine. Defensive medicine is an effort to protect against 
the accusation of malpractice by using every indicated procedure to 
diagnose and treat illness. '^^ This practice is fundamentally opposed to 
the concept of minimizing service costs. In the world of reducing costs 
for services, defensive medical procedures may be the first to fall.'^*^ 
This change is already occurring in some public hospitals.'^' 

The recent emphasis on cost-cutting in medical care may also affect 
the tort principle of standard of care. In Indiana, the standard of care 
is determined by a "modified locality rule."^^^ The competence of medical 
care is evaluated in the context of the medical care rendered by physicians 
in the same or a similar locality. ^^^ The standard therefore is self- 
determined by the profession. In conjunction with advances in medical 
technology, heightened patient expectations, and the spread of defensive 
medicine, the standard of care has become increasingly higher. '^^ This 
higher standard of care compounds the problem of increased costs. 
Physicians perform more tests to ward off malpractice suits, which, in 



'"42 U.S.C. § 1320(c) (1982). 

'^"Gosfield, supra note 152, at 6-7. 

'"5ee Kapp, Legal and Ethical Implications of Health Care Reimbursement by Di- 
agnosis Related Groups, 1984 Law, Med. and Health Care 245, 245. 

'^^42 U.S.C. § 1320(c)-6(c) (1982). 

'"Gosfield, supra note 152, at 8. 

'^*See Kapp, supra note 155, at 245. 

'^Troject, The Medical Malpractice Threat: A Study of Defensive Medicine, 1971 
Duke L.J. 939, 942-943. 

'^See Rosenblatt, Rationing "Normal" Health Care: The Hidden Legal Issues, 59 
Texas L. Rev. 1401 (1981). 

'^'M at 1402. 

'"Kranda v. Houser-Norborg Medical Corp., 419 N.E.2d 1024, 1040 (Ind. Ct. App. 
1981). 

'"Joy V. Chau, 177 Ind. App. 29, 36, 377 N.E.2d 670, 675 (1978). 

'"See Note, supra note 151, at 1009. 



1148 INDIANA LAW REVIEW [Vol. 19:1129 

turn, increase the standard of care. This, in turn, increases the likeUhood 
of allegations of malpractice if tests are not performed, thereby rein- 
forcing the need to perform more tests. The new Medicare prospective 
reimbursement system breaks this circle. ^^^ 

Now, the medical profession is confronted with a cost containment 
philosophy that has repercussions on the standard of care in the com- 
munity. Although the community of doctors may consider tests or 
procedures appropriate, the cost-cutting pressures exerted by the federal 
government may influence a doctor's decisions regarding treatment. The 
federal changes are dictated by economic considerations. These consid- 
erations conflict with the historical medical ethic to spare no expense 
to treat a patient, which had been reinforced by tort law. While federal 
law demands that the benefit of additional tests be weighed against the 
costs, the prevaihng attitude in tort cases minimizes this balancing. The 
effect of this economic balancing on tort law standards has yet to be 
determined. ^^^ 

The conflicting philosophies of cost-containment and tort law arise 
from different perspectives. Cost-containment looks at the medical care 
system as a whole and institutes changes on a system-wide basis. '^^ The 
decision-making process in a tort suit looks at a specific case and addresses 
problems on an individual basis. '^^ As one commentator noted: 

[I]t is generally difficult to distinguish between medically indicated 
costcutting undertaken without regard for medical efficacy. The 
distinction becomes even more elusive when the criteria used to 
make it depend on whether one views the problem from the 
perspective of a legislature seeking to cut costs in general or 
that of a jury deciding whether malpractice was committed in 
a specific case.*^^ 

The conflict inherent in these different viewpoints will lead to conflicts 
in the responses generated by both the medical profession and the judicial 
system. ^^° 

Hospitals will become more susceptible to malpractice claims as cost- 
cutting measures influence care given to patients. ^"^^ Where federal cost- 
cutting pressures are exerted on physicians, the hospital may be more 
likely to be allocated part of the liability. Of particular concern to society 



^^^See supra notes 147-158 and accompanying text. 
'^See Note, supra note 151, at 1009. 



^^''See Rosenblatt, supra note 160, at 1422. 
'''Id. 

^'^See Note, supra note 151, at 1013 (citations omitted). 
'™For discussion as to resolution of this conflict, see id. at 1017-19. 
'''For a good discussion of the impact of cost cutting measures on those eligible for 
Medicare and Medicaid, see Rosenblatt, supra note 160, at 1401. 



1986] MEDICAL MALPRACTICE ACT 1149 

will be the federal government's pressure on hospitals to monitor phy- 
sicians and control decision-making regarding treatment. Whether this 
will subject hospitals to broader liability for patient care is yet to be 
determined. 

It is also possible that patients who believe they have been harmed 
as a result of cost-cutting measures such as prospective payment will 
include insurers as defendants in malpractice suits. In a recent California 
case involving a prospective payment mechanism, a patient who was 
discharged from a hospital sooner than her physician initially recom- 
mended and who suffered a leg amputation due to complications that 
would have been detected had she stayed in the hospital named the 
third-party payer as a defendant in a negligence suit.'^^ Although the 
appellate court found the insurer not liable in this case,'^^ the holding 
does not preclude insurer liabiHty in other circumstances. 

VII. Conclusion 

The Indiana legislature's reaction in 1975 to the rise in medical 
malpractice insurance costs resulted in a trade-off of time and amounts 
recovered for preserving the protection of insurance.'^"* Although the Act 
contemplates a relatively short period for review of malpractice claims, 
implementation of the Act has caused significant delays. ^^^ However, 
neither the procedural roadblock the Act creates for plaintiffs nor the 
reality of delays has been sufficient to support a constitutional challenge 
to the Act.'^^ Further, much of the delay can be controlled by assertion 
of the statutory provisions. However, the statutory solution offers not 
only opportunities to prepare for litigation, but also traps for those who 
are not familiar with the intricacies of the Act, including who is covered 
by the Act, what kind of actions are considered malpractice, and how 
the statute of limitations applies. 

Although Indiana's legislative solution to the medical malpractice 
problem represents a change in attitudes about victim recoveries, it does 
not affect the deterrent goal of tort law. The deterrent goal is, however, 
affected by changes in federal law.'^^ The federal government's en- 
couragement of cost-containment in health care discourages practices 
that shield doctors and hospitals from accusations of medical mal- 
practice. ^^^ Viewed in the context of the federal changes, Indiana mal- 



"^Wickline v. State, 183 Cal. App. 3d 1175, 228 Cal. Rptr. 661 (1986). 

"■*See supra notes 4-14 and accompanying text. 

'^^See supra notes 34-54 and 136-142 and accompanying text. 

"^See supra notes 136-142 and accompanying text. 

^^''See supra notes 154-171 and accompanying text. 

178 r^ 



1150 INDIANA LAW REVIEW [Vol. 19:1129 

practice reform takes on greater import. Although the Indiana Act's 
provisions for panel review and limitation of damages do not change 
the deterrents of negligent behavior, '^^ the federal law does. 

Yet, both state and federal law reflect similar changes in attitude, 
which taken together have a greater impact than if they stood alone. 
The state law represents a choice of affordable insurance and at least 
partial compensation for victims as opposed to full compensation re- 
coverable from only a few deep pockets. The federal law represents a 
choice of economy at the risk of omissions in health care — care that might 
be provided if costs were not a barrier. 

Although the parties involved would acknowledge the importance of 
providing the best quality health care, or full compensation where care 
is not the best, the changes represent an implicit acknowledgment of 
certain realities. Both federal and state legislatures have recognized the 
impact of the economics of medical care. Ultimately, it is this economic 
reality which any future steps toward reform must consider. 



"^See supra notes 154-161 and accompanying text. 



Making Hard Choices Under the Medicare Prospective 

Payment System: One Administrative Model for 

Allocating Medical Resources Under a Government Health 

Insurance Program 

Eleanor D. Kinney* 

I. Introduction 

Since 1980, the federal government, states, and private purchasers 
of health care services have determined that the amount of resources 
devoted to purchasing health care services is too great. Consequently, 
the 1980' s have witnessed unprecedented efforts by these purchasers to 
cut spending for health care services and to adopt payment strategies 
to purchase health care services more efficiently. For private purchasers, 
i.e., business, private insurance companies, and Blue Cross and Blue 
Shield plans, these strategies include chiefly preferred provider 
organizations^ and prepaid health plans such as health maintenance 
organizations.^ Similarly, states and the federal government have adopted 
comparable strategies for their pubHc health insurance programs.^ These 
strategies limit public expenditures for health care services chiefly through 
rate regulation.^ 

The underlying theory of nearly all of these public and private 
strategies is to put the providers of health care services, e.g., hospitals 

♦Assistant Professor of Law and Director of The Program for Law, Medicine & the 
Health Care Industry, Indiana University School of Law - Indianapolis; B.A., Duke University, 
1969; J.D., Duke University, 1973; M.P.H., University of North Carolina, 1979. 

'A PPO is as an arrangement between selected providers and at least one group 
purchaser whereby the services of the providers are purchased for a specified group of 
individuals at a negotiated rate. See Am. Hosp. Ass'n, State Regulation of Preferred 
Provider Organizations: A Survey of State Statutes (1984). 

^In a prepaid health plan, the consumer or someone on his behalf pays a fixed 
amount to the provider, and in return, the provider furnishes any volume of covered 
heahh care services irrespective of their cost. A health maintenance organization is an 
example of a prepaid health plan. A prepaid health plan is distinguished from conventional 
health insurance in that the provider rather than the heaUh insurance company is at risk 
for the cost of services to beneficiaries over and above the premiums. 

The Social Security Act authorizes state Medicaid programs to purchase health care 
services for certain groups of patients from specified providers on a prepaid basis. 42 
U.S.C. § 1396 (1982 & Supp. 1985). To use this strategy, state Medicaid programs must ensure 
that the providers have a plan to manage the care of individual patients properly. Id. 
§ 1396a(a). 

^In rate regulation schemes, which are directed chiefly at institutional providers, the 
payer regulates the amount paid for a unit of services, i.e., the price per case as under 
the Medicare prospective payment system, or even the entire amount the program will 
pay an institution annually as under revenue caps or budget review strategies. 

1151 



1152 INDIANA LAW REVIEW [Vol. 19:1151 

and physicians, at risk financially for the cost of services that exceed 
defined norms. This approach involves putting a limit on what the 
purchaser will pay for services in a given case or group of cases, with 
the result that if the provider's costs of the care exceed the limit, the 
provider must absorb the excess costs. The objective of these strategies 
is the same: to encourage providers to become more conscious of the 
costs of treating patients and to use less resources and thus incur fewer 
costs in the treatment of patients. 

However, these strategies fundamentally change the nature of the 
decision-making of health care providers with respect to the medical 
treatment of individual patients. Simply, providers must consider the 
cost of the treatment as well as its efficacy. Specifically, providers can 
no longer adhere to what Dr. Avedis Donabedian has called an absolutist 
standard of health care quality in which providers specify care based 
on what they consider best for patients, even if benefits are quite 
incremental, without regard to costs. ^ Also, the specter of financial 
liability for excessive services on the part of the provider directly is a 
troublesome ingredient of the decision making process as it pits the 
provider's self-interest squarely against the patient's need for an above 
average amount of health care services in a given instance. This raises 
the possibility that the quality of medical treatment may be compromised. 
This possibility, which must be addressed in the design and implemen- 
tation of any purchasing strategy that places the provider at risk fi- 
nancially, presents a host of important ethical and, in the case of public 
programs, political issues, some of which will be explored in this Article 
and this symposium.^ 

This Article delineates the central issues presented when government 
adopts a strategy to purchase health care services more efficiently and 
to reduce the resources it devotes to health care. It reviews how the 
American health care system reached the point where purchasers of 
health care services have almost uniformly decided to curtail the resources 
they commit to purchasing health care services and the resulting percep- 
tion among providers, patients, and the public that hard choices about 
the allocation of limited resources are now required. 

But, the chief objective of this Article is to analyze how the Medicare 



'Donabedian, Quality, Cost, and Clinical Decisions, 468 Annals 196, 200 (1983). 

•^This dilemma and its philosophical implications have been analyzed by several 
scholars. See Cassel, Doctors and Allocation Decisions: A New Role in the New Medicare, 
10 J. Health Pol. Pol'y & L. 549 (1985); Kapp, Legal and Ethical Implications of 
Health Care Reimbursement by Diagnosis Related Groups, 12 L. Med. & Healthcare 
245 (1984); Mariner, Diagnosis Related Groups: Evading Social Responsibility!, 12 L. Med. 
& Healthcare 243 (1984); Morriem, The MD and the DRG, Hastings Center Rep., 
June 1985, at 19; Veatch, DRG's and the Ethical Reallocation of Resources, Hastings 
Center Rep., June 1986, at 32. 



1986] MEDICARE PROSPECTIVE PAYMENT 1153 

prospective payment system makes fair decisions about the allocation 
of hospital services to Medicare beneficiaries. In this reform of the 
payment methodology for hospital services,^ Congress endeavored to 
purchase health care services more efficiently for the nation's elderly 
and disabled and consequently put hospitals at risk financially for costs 
of treatment that exceed defined norms. In designing the administrative 
structure for the prospective payment system, Congress specifically ad- 
dressed the three critical problems facing public health insurance programs 
that endeavor to curtail expenditures by putting providers at risk fi- 
nancially: (1) how to make fair decisions at the societal level as to what 
resources in the control of government should be devoted to the health 
care of the program's beneficiaries, (2) how to ensure that providers, 
who are at risk for especially costly services, make fair decisions about 
what resources should be used to care for beneficiaries, and (3) how to 
protect adequately beneficiaries' interests in obtaining health care services 
under the Medicare program. 

II. The Central Issues 

How much of society's resources should be devoted to health care 
and how those resources should be distributed among members of society 
— particularly the more disadvantaged — are fundamental questions of 
distributive justice beyond the scope of this Article.^ But these questions 
are not just abstract philosophical questions of remote importance. They 
are concrete questions that continually and directly face American health 
policy. In particular, these questions confront federal and also state 
policy makers daily as they address the health care needs of their citizens 
and as they design and implement public health insurance programs. 
Thus it is useful to explore some of the central issues involved with the 
general question of how much of society's resources should be devoted 
to health care and how those resources should be distributed among 
society's members before reviewing the history of how this nation has 
endeavored to resolve these issues generally and in the context of the 
Medicare program. 

First and foremost is the issue of whether health care is such an 
important societal good that it should be accorded special treatment vis- 
a-vis other societal goods competing for society's resources. Second, who 



^Social Security Amendments of 1983, Pub. L. No. 98-21, tit. VI, § 601(c)(1), 97 
Stat. 65 (codified as amended at 42 U.S.C. § 1395ww (Supp. 1985)). 

''See, e.g., N. Daniels, Just Health Care, 1-74 (1985); Daniels, Rights to Health 
Care and Distributive Justice: Programmatic Worries, 4 J. Med. & Phil. 174 (1979); 
Fried, Rights and Health Care - Beyond Equity and Efficiency, 293 New Eng. J. Med. 
241 (1975); Miller & Miller, Why Saying No to Patients in the United States Is So Hard: 
Cost Containment, Justice and Provider Economy, 314 New Eng. J. Med. 1380 (1986). 



1154 INDIANA LAW REVIEW [Vol. 19:1151 

is making the decisions about the amount and allocation of these health 
care resources at the societal level and also at the individual level? Third, 
what consumer interests in health and health care services should be 
protected while making those choices? 

Decisions about the amount and allocation of medical resources are 
made in two contexts, the societal context and the individual context. 
The societal context involves decisions about the amount of society's 
resources that should be allocated to health care services vis-a-vis other 
unrelated needs, as well as decisions as to what groups these medical 
resources should be targeted in order to assure preservation or enhance- 
ment of the lives of society's members in the aggregate, i.e., ''statistical 
lives. "^ The individual context is fundamentally different; it involves 
whether and how society's resources should be dedicated to meet the 
specific health care needs of identifiable individuals. 

With respect to whether health is of such value that it should be 
treated specially, the philosopher Norman Daniels has characterized the 
key aspects of this issue in developing a philosophical theory of health 
care: 

In short, a theory of health care needs must come to grips with 
two widely held judgments: that there is something especially 
important about health care and that some kinds of health care 
are more important than others. ^° 

Whether it is even philosophically appropriate to give health care special 
status is a troubling question of distributive justice. But it is fair to say 
that this society has made a collective judgment that health care has 
special value and that some measures, e.g., public health insurance 
programs, over and above market forces should be invoked to ensure 
that this good is widely distributed. The federal and state governments 
have concurred in this assumption, albeit with waning enthusiasm in 



^See Blumstein, Constitutional Perspectives on Governmental Decisions Affecting 
Human Life and Health, 40 L. & Contemp. Probs. 231 (1976) [hereinafter Blumstein, 
Constitutional Perspectives]; Havighurst & Blumstein, Coping with Quality/Cost Trade- 
offs in Medical Care: The Role of PSRO's, 70 Nw. U.L. Rev. 6, 22-23 (1975) [hereinafter 
Havighurst & Blumstein, Coping with Quality /Cost Trade-Offs]; see also Fried, The Value 
of Life, 82 Harv. L. Rev. 1415 (1969). 

A "statistical Ufe" is basically a measure representing one unit of human existence, 
whereas an identifiable life is recognized as a life of a specific human being. Havighurst 
and Blumstein more aptly articulated the difference between "statistical" and "identifiable" 
lives in colorful and precise examples of these concepts: an identifiable hfe is an "in- 
tercontinental balloonist lost at sea" whereas statistical hves are those which "predictably 
will be lost as a result of a societal undertaking such as maintenance of an automobile- 
based economy or construction of a bridge or tunnel." Havighurst & Blumstein, Coping 
with Quality /Cost Trade-Offs, supra at 21-22. 

'"Daniels, Health-Care Needs and Distributive Justice, 10 Phil. & Pub. Aff. 146 
(1981); see also N. Daniels, supra note 8, at 1-17. 



1986] MEDICARE PROSPECTIVE PAYMENT 1155 

recent years. However, important evidence suggests that the American 
pubHc does not beUeve that this nation and its government should Hmit 
their financial and ideological commitment to ensuring high quality, 
accessible health care services for those in need.^^ Nevertheless, the degree 
to which this nation and its governments should treat health care as 
special and invoke special measures to assure wide distribution of health 
care services as well as the nature of these special measures have been 
the central themes of health policy since 1965. 

Daniels' second observation raises the more important inquiry from 
a practical perspective and perhaps the key ethical dilemma for the 
American health care system today. Clearly, all health care services are 
not the same and have varying degrees of worth, especially when com- 
pared with other societal needs. This dilemma is perhaps best exemplified 
by some of the trade-offs that the federal government has made with 
respect to resources devoted to health care needs of infants. For example, 
since 1981, the federal government has reduced funding for prenatal 
health and nutrition programs for millions of mothers and children'^ 
while at the same time has subsidized costly organ transplants of ques- 
tionable long term benefit for selected babies through waivers of Medicaid 
program requirements on a seemingly ad hoc basis. '^ This dilemma 
raises the second issue involved with making hard choices — who should 
make these decisions both in the societal and individual contexts. 

The decision-makers are a disparate group. In the societal context, 
the federal and state governments are the primary decision-makers. In 
the individual context, the decision-makers fall into two categories: those 
who provide services and those who pay for services. The providers 
include, chiefly, physicians and hospitals. The payers are insurance com- 
panies. Blue Cross and Blue Shield plans, business, and other entities 
that pay for the health services provided to specified groups of individuals. 
Payers include individual patients, also an important group given that 
twenty-eight percent of the nation's personal health care expenditures 
are made by individuals.'"^ Payers also include the federal and state 
governments in their capacity as administrators of the Medicare, Med- 
icaid, and other public health insurance programs. 



"Blendon & Altman, Public Attitudes About Health-Care Costs: A Lesson in National 
Schizophrenia, 311 New Eng. J. Med. 613 (1984); see also Ferguson & Rogers, The Myth 
of America's Turn to the Right, Atl. Monthly, May 1986, at 43. 

'^Mundingher, Health Services Funding Cuts and the Declining Health of the Poor, 
313 New Eng. J. Med. 44 (1985). 

^^See, e.g., Wessell, Medical Quandary Transplants Increase, and So Do Disputes 
over Who Pays Bills, Wall St. J., Apr. 12, 1984, at 1; Friedman & Richards, Life and 
Death in a Policy Vacuum, Hospitals, May 16, 1984, at 79; Rust, Transplant Success Stirs 
Debate on Coverage, Am. Med. News, Oct. 21, 1983, at 1. 

'"Levit, Lazenby, Waldo & Davidoff, 1984 National Health Expenditures, 7 Health 
Care Financing Rev. 1 (1985) [hereinafter National Health Expenditures, 1984]. 



1156 INDIANA LAW REVIEW [Vol. 19:1151 

The respective roles of these decision-makers have been the focus of 
considerable attention in the health policy debate in recent years. The 
question is whether decisions about the content and allocation of health 
care resources are best made explicitly on an aggregate level by gov- 
ernment as the representative of its citizens, or impHcitly and unsyste- 
matically on an individual level either through the market and within 
the context of the provider-patient relationship whenever possible. ^^ The 
liberal position assigns the federal government the predominant role in 
making decisions on a societal level about what national resources should 
go to health care services versus competing needs and also, through 
selection of federally-dominated national health insurance benefits, what 
health care services should be available to patients at the individual level. 
The conservative view maintains that health care services should be 
delivered on a private basis whenever possible and that allocation deci- 
sions on the societal level as well as the individual level should be made 
collectively through the operation of the market with government interven- 
ing only as a last resort to correct manifest injustice. 

The final issue is what are the interests and, indeed, rights of the 
individuals who need health care services and are affected by these 
decisions. Moreover, what kind of protection does a decision-making 
process afford an individual patient who may be adversely affected by 
a decision, whether he be one gravely ill individual who is denied 
expensive, life-prolonging treatment or a member of a group who benefits 
from a government health service program? 

Much ink has been spilled over whether individuals have a right to 
health care in a moral or legal sense, and if so, what this right means 
in terms of the responsibility of government, other payers, and providers 
to furnish health care services. ^^ The President's Commission for the 
Study of Ethical Problems in Medicine and Biomedical and Behavior 
Research declined to declare that health care is either a legal or moral 
right, but rather chose to frame its analysis of securing access to health 



'The question of who should make these choices, the market or government, has 
been debated and analyzed extensively in a published dialogue between Professors James 
Blumstein and Rand Rosenblatt. See Blumstein, Distinguishing Government's Responsibility 
in Rationing Public and Private Medical Resources, 60 Tex. L. Rev. 899 (1982); Blumstein, 
Rationing Medical Resources: A Constitutional, Legal and Policy Analysis, 59 Tex. L. 
Rev. 1345 (1981) [hereinafter Blumstein, Rationing Medical Resources]', Rosenblatt, Ra- 
tioning "Normal" Health Care: The Hidden Legal Issues, 59 Tex. L. Rev. 1401 (1981); 
Rosenblatt, Rationing "Normal" Health Care Through Market Mechanisms: A Response 
to Professor Blumstein, 60 Tex. L. Rev. 919 (1982); see also Mehlman, Rationing Expen- 
sive Lifesaving Treatments, 1985 Wis. L. Rev. 239. 

'^See, e.g., K. Davis & C. Schoen, Health and the War on Poverty: A Ten 
Year Appraisal 2-7 (1978); Buchanan, The Right to a Decent Minimum of Health Care, 
13 Phil. & Pub. Aff. 55 (1984); Siegler, A Right to Health Care: Ambiguity, Professional 
Responsibility, and Patient Liberty, 4 J. Med. & Phil. 148 (1979). 



1986] MEDICARE PROSPECTIVE PAYMENT 1157 

'*in terms of the special nature of health care and of society's moral 
obligation to achieve equity, without taking a position on whether the 
term 'obligation' should be read as entailing a moral right. '"^ Indeed, 
it is hardly useful to talk about the interests of consumers in health 
care as a right because, as a practical matter, interests are protected and 
enforceable as rights only when there is an associated remedy accorded 
by law. 

From a legal perspective, it is clear that one does not have an 
enforceable, legal "right" to health care. The Supreme Court has ruled 
that the federal Constitution does not recognize any such '*right" to 
medical care.'^ The federal Constitution does protect the entitlement 
interest of beneficiaries in the federal and state Medicare and Medicaid 
programs, but only to the extent outlined in the enabling legislation for 
these programs. ^^ However, as with any entitlement program, the nature 
of the entitlement interest can be limited by subsequent legislative amend- 
ment and the nature of the constitutional protection accorded is that 
of procedural due process. ^^ 

Certainly, citizens do not have so powerful an interest or right that 
they can obtain high quality services of any type on demand. However, 
it is widely held, as a corollary of the tenet that health care is special, 
that individuals have some interest in obtaining health care services 
although that interest is subject to legal protection only in the context 
of an entitlement created by, and then only to the extent authorized by, 
the government in its design and lawful implementation of the entitlement 
program. Thus, decision-makers have considerable power in making 



''I President's Commission for the Study of Ethical and Biomedical and Be- 
havioral Research, Securing Access to Health Care: The Ethical Implications of 
Differences in the Availability of Health Services 32 (1983) [hereinafter President's 
Commission, Securing Access to Health Care]. 

>«See Harris v. McRae, 448 U.S. 297 (1980); Mahrer v. Roe, 432 U.S. 464 (1977) 
(involving state obligations to provide certain benefits under their Medicaid programs). 
The possible exception is a right of prisoners to necessary medical care on grounds that 
denial of such care is cruel and unusual punishment proscribed by the eighth amendment. 
Estelle V. Gamble, 429 U.S. 97 (1976). See President's Commission, Securing Access 
TO Health Care, supra note 17, at 33; Blumstein, Constitutional Perspectives, supra note 
9, at 257-70; Blumstein, Rationing Medical Resources, supra note 15, at 1377-81. 

It is worth noting that at least one state supreme court has interpreted its state 
constitution as according a right to certain health care services which the state had to 
provide. Callahan v. Carey, N.Y.L.J., Dec 11, 1979, at 10, col. 5 (Sup. Ct. N.Y. County 
1979); see also Malone, Homelessness in a Modern Urban Setting, 10 Fordham Urb. L. 
J. 749 (1982). 

'^See, e.g., O'Bannan v. Town Court Nursing Center, 447 U.S. 773 (1980); Gray 
Panthers v. Schweiker, 652 F.2d 146 (D.C. Cir. 1980). 

^°See Blumstein, Rationing Medical Resources, supra note 15, at 1369-72; see also 
Note, Due Process in the Allocation of Scarce Lifesaving Medical Resources, 84 Yale 
L.J. 1734 (1975). 



1158 INDIANA LAW REVIEW [Vol. 19:1151 

decisions about the composition and allocation of health care services 
to individuals. 

Finally, it should be noted that there is constant tension between 
making allocation decisions at the societal level and at the individual 
level that inevitably confuses decision-makers and that results in con- 
siderable irrationality in the distribution of medical resources. This tension 
exists between the need and effort to allocate scarce medical resources 
in the societal context and the observance of the strongly-held societal 
value of assuring preservation of "identifiable" lives in the individual 
context. This tension has been aptly described: 

Decisions which seem economically necessary and ethically ap- 
propriate at the first [macro-prospective] level force choices at 
the second [micro-immediate] which seem ethically unacceptable 
(and vice-versa — aggregating up from the micro-immediate level 
in response to ethical imperatives seems to result in a requirement 
at the macro-prospective level which is economically unaccept- 
able).2i 

This tension is aggravated when reductions in resources mandate allo- 
cation policies that deny services to a specific individual with a life- 
threatening need. American society values individual life so deeply that 
it may not be able to tolerate poHtically or morally the denial of medical 
care to identifiable individuals in need when government policies and 
economic realities would curtail such costly health care services at the 
societal level. Government as representative of its citizens and admin- 
istrator of public health insurance programs is often confronted with 
this tension and the hard choices it generates. Congress endeavored to 
address this tension and the resulting hard choices in its design of the 
administrative structure for the Medicare prospective payment system 
for hospitals. 

III. Reaching the Point of Hard Choices 
A. Some History 

In 1965, the Congress of the United States established the Medicare 
and Medicaid programs to address the problem of restricted access to 
health care services for the elderly and poor because of the prohibitive 
cost of many health care services for these disadvantaged groups. ^^ This 



2'Zechauser, Coverage for Catastrophic Illness, 21 Pub. Pol'y 149, 163 n.24 (1973) 
(quoting Carl Stevens); see Blumstein, Constitutional Perspectives, supra note 9, at 254 
n.l34. 

^^Social Security Amendments of 1965, Pub. L. No. 89-97, tit. I §§ 101-111, 121- 
122, 79 Stat. 291-360 (codified as amended at 42 U.S.C. §§ 1395, 1396 (1982 & Supp. 
1985)); see also S. Rep. No. 404, 89th Cong., 1st Sess., reprinted in 1965 U.S. Code 
Cong. & Admin. News 1943. 



1986] MEDICARE PROSPECTIVE PAYMENT 1159 

congressional action confirmed that modern medicine — with its sophis- 
ticated scientific and technological base— had come of age.^^ Never had 
medicine enjoyed greater prestige. Virtually overnight, penicillin and the 
Salk vaccine had wiped out diseases that had plagued mankind since 
recorded history. The discovery of DNA and other startling advances in 
biomedical research in the early 1950's ushered in a new era promising 
even greater medical breakthroughs and fostering the public perception 
that the cure for all illness was within reach. 

Surely this phenomenon of modern medicine was truly a "good 
thing" that should be made available to all Americans. After World 
War II and in a fashion unprecedented for treatment of a predominantly 
private activity, Congress committed federal resources to a whole range 
of health related endeavors. In 1946, Congress established the Hill- 
Burton program to finance the construction of hospitals and health care 
facilities, with the requirement that assisted facilities provide a reasonable 
volume of health care services to the poor and be open to all people 
in the institution's service area.^'^ Congress also established the National 
Institutes of Health to coordinate the enormous federal expenditure for 
basic biomedical research. ^^ The 1950's and 1960's also saw substantial 
federal support of academic medical centers for medical and allied health 
education and biomedical research training. ^^ But, the culmination of 
this federal commitment to ensuring high quality and accessible health 
care services was establishment of the Medicare and Medicaid programs 
in 1965. 

Medicare, a federal social insurance program administered by the 
Department of Health and Human Services, provides hospital insurance 
for hospital and extended care services as well as supplementary medical 
insurance for physician and associated services to the aged, disabled, 
and certain individuals with end stage renal disease. ^^ Medicaid, a welfare 
program administered by the states pursuant to federal guidelines, pro- 



"See p. Starr, The Social Transformation of American Medicine, 335-78 (1982). 

^Hospital Survey and Construction Act, Pub. L. No. 79-725, 60 Stat. 1040 (1946) 
(codified as amended at 42 U.S.C. §§ 291-291o (1982 & Supp. 1985)). See generally 
Blumstein, Court Action Agency Reaction: The Hill-Burton Act as a Case Study, 69 Iowa 
L. Rev. 1227 (1982); Rose, Federal Regulation of Services to the Poor Under the Hill- 
Burton Act: Realities and Pitfalls, 70 Nw. U.L. Rev. 168 (1975); Rosenblatt, Health Care 
Reform and Administrative Law: A Structural Approach, 88 Yale L.J. 243 (1978). 

^'Pub. L. No. 95-622, tit. II, § 241(a)(1), 92 Stat. 3424 (1978) (codified as amended 
at 42 U.S.C. § 281 et seq. (1982 & Supp. 1985)); see also Fredrickson, Health and the 
Search for Knowledge, in Doing Better and Feeling Worse: Health in the United 
States 159 (J. Knowles ed. 1977). 

^See generally Ebert, Medical Education in the United States, in Doing Better and 
Feeling Worse: Health in the United States 171 (J. Knowles ed. 1977). 

2^In 1972, Congress added the disabled and individuals with end stage renal disease 
to those eligible for Medicare. Social Security Amendments of 1972, Pub. L. No. 92-603, 
tit. II, § 2991, 86 Stat. 1329 (codified as amended at 42 U.S.C. § 1395 (1982 & Supp. 
1985)). 



1160 INDIANA LAW REVIEW [Vol. 19:1151 

vides hospital, physician, and nursing home services to persons eUgible 
for categorical assistance programs under the Social Security Act^* and 
who, but for income, otherwise meet the ehgibility criteria for these 
categorical assistance programs. ^^ The Medicare program is financed 
through trust funds comprised chiefly of proceeds from a payroll tax 
and insurance premiums and, to a minimal extent in the case of the 
supplementary medical insurance. Congressional appropriations from gen- 
eral revenues; Medicaid is financed out of federal appropriations that 
match state appropriations for this program. ^^ These government health 
insurance programs now serve over 50 million people. ^^ These two pro- 
grams have had a tremendous impact on the improvement of health 
status among the elderly and poor, demonstrated by sharp decreases, 
over thirty percent, in mortality rates for diseases that afflicted the aged 
and poor disproportionately, e.g., diabetes, heart disease, stroke, and 
pneumonia, as well as substantial reductions in infant mortality rates. ^^ 
However, at no time did these two programs cover all persons in need 
and, currently, at least fifteen percent of all Americans have no health 
insurance coverage." 

Medicare and Medicaid represented an enormous expression of con- 
fidence in a modern, scientifically-based, health care system. In designing 
these programs. Congress was guided almost exclusively by concerns and 
interests of the architects of this new health care system — physicians 
and hospitals. ^^ The hospital industry and the medical profession dictated 



^^There are two categorical assistance programs under the Social Security Act: Aid 
to Families with Dependent Children, for poor mothers and children, 42 U.S.C. §§ 601- 
615 (1982 & Supp. 1985), and Supplemental Security Income Program for the indigent 
aged, disabled, and blind, id. §§ 1381-1394. 

''Id. § 1396a(a)(10)(c); see also K. Davis & C. Schgen, supra note 16, at 52- 
56. States must provide Medicaid benefits to those on categorical assistance programs; 
however, they have the option of adopting a medically needy program. 42 U.S.C. 
§§ 1396a(a)(10)(c), 1396d(a) (1982 & Supp. 1985). Over half of the states have a medically 
needy program despite marked cut-backs in federal matching funds for state Medicaid 
programs. 

'"See 42 U.S.C. §§ 13951, 1395t (1982 & Supp. 1985) (Medicare trust fund provisions); 
id. § 1396b (Medicaid state appropriations provisions). 

^^ National Health Expenditures, 1984, supra note 14. 

^'What Medicaid and Medicare Did — and Did Not — Achieve, Hospitals, Aug. 1, 
1985, at 41-42 (interview with Karen Davis); see also Davis & Reynolds, The Impact of 
Medicare and Medicaid on Access to Medical Care, in The Role of National Health 
Insurance in the Health Service Sector 391 (R. Rosett ed. 1976). 

"Mundingher, supra note 12, at 44; see Davis & Rowland, Uninsured and Under- 
served: Inequities in Health Care in the U.S., in 3 President's Commission, Securing Access 
TO Health Care, supra note 17, at 55. 

^'^See generally J. Feder, Medicare: The Politics of Federal Hospital Insurance 
(1977); T. Marmor, The Politics of Medicare (1973); Cohen, Reflections on the En- 
actment of Medicare and Medicaid, 7 Health Care Fin. Rev. 3 (Supp. 1985). 



1 986] MEDICARE PROSPECTIVE PA YMENT 1161 

the benefit packages and payment methodologies for these program and 
even retained control over who among their ranks would participate in 
these programs. ^^ Further, the Medicare and Medicaid statutes assured 
that the structure of and key relationships within the health care system 
would be unaffected by these programs, with such measures as the 
guarantee of beneficiaries' freedom of choice to select their physicians 
and other health care providers. ^^ Indeed, not interfering with the practice 
of medicine in any health care institutions was stated as a central policy 
in the Medicare program in the first section of the Medicare statute: 

Nothing in this title shall be construed to authorize any Federal 
officer or employee to exercise any supervision or control over 
the practice of medicine or the manner in which medical services 
are provided, or the selection, tenure, or compensation of any 
officer or employee of any institution, agency, or person pro- 
viding health services; or to exercise any supervision or control 
over the administration or operation or any such institution, 
agency or person. ^^ 

Perhaps most important, the Medicare and Medicaid programs gave 
physicians and hospitals almost complete autonomy in setting the level 
of payment for services provided to their beneficiaries, chiefly because 
of considerable political opposition to the programs from providers. 
According to Wilber Cohen, the Secretary of the Department of Health, 
Education and Welfare when the Medicare and Medicaid programs were 
adopted, at the time, ''[t]he ideological and political issues were so 
dominating that they precluded consideration of issues such as reimburse- 
ment alternatives and efficiency options."^* 

Initially, both Medicare and Medicaid paid hospitals the costs, as 
calculated by hospitals, of providing services to beneficiaries with the 
only prescription that the costs be * 'reasonable. "^^ Medicare paid phy- 



'Tor example, accreditation by the Joint Commission on Accreditation of Hospitals, 
the private accrediting body appointed by the hospital industry and the medical profession, 
would be sufficient to demonstrate a hospital's ehgibility to participate in the Medicare 
program. 42 U.S.C. § 1395bb (1982 & Supp. 1985). See generally Jost, The Joint Commis- 
sion on Accreditation of Hospitals: Private Regulation of Health Care and the Public In- 
terest, 24 B.C.L. Rev. 835 (1983). 

''See 42 U.S.C. §§ 1395a, 1396a(a)(23) (1982 & Supp. 1985). 

''Id. § 1395a. 

^*Cohen, supra note 34, at 5. 

^'Social Security Amendments of 1965, Pub. L. No. 89-97, § 102(a), 79 Stat. 286 
(codified as amended at 42 U.S.C. §§ 1395(0(b), 1395x(v) (1982 & Supp. 1985)) (Medicare); 
id. at § 121(a) (codified as amended at 42 U.S.C. § 1396(a)(10) (1982 & Supp. 1985)) 
(Medicaid). Congress suggested that reimbursement methodologies of private insurance 
companies should guide the Medicare program in development of Medicare's reimbursement 
methodology: 



1162 INDIANA LAW REVIEW [Vol. 19:1151 

sicians eighty percent of the reasonable, customary, or prevailing charge 
for covered services and allowed physicians to bill patients directly for 
their full charge under the traditional fee-for-services arrangement with 
patients then receiving payment from Medicare/^ In contrast, Medicaid 
has always been stricter in its reimbursement for physicians, requiring 
them to accept assignment of Medicaid benefits from their patients and 
allowing states to set payment rates quite low/' 

The Medicare and Medicaid programs changed the complexion of 
the American health care system fundamentally by transforming the cost 
and quality of accessible health care from basically a private matter to 
a matter of public concern. With Medicare and Medicaid, the federal 
government and also the states assumed a major responsibility for assuring 
access to health care services for disadvantaged groups, a significant 
departure from past policy of viewing the provision of medical care to 
these groups as primarily a local and voluntary effort. In addition, with 
these programs, the federal government and also the states assumed 
responsibility for the problem of what to do about the increasing cost 
of health care services. 



The bill provides that the payment to hospitals and other providers of services 
shall be equal to the reasonable cost of services and that the methods to be 
used and the items to be included in determining the cost shall be developed 
in regulations of the Secretary in accordance with the provisions of the bill. 
S. Rep. No. 404, 89th Code Cong., 1st Sess., reprinted in 1965 U.S. Cong. & Admin. 
News 1943, 1976. 

Initially, state Medicaid programs had to observe Medicare cost reimbursement prin- 
ciples for paying hospitals. Social Security Amendments of 1965, Pub. L. No. 89-97, 
§ 121(a), 79 Stat. 286. Over time. Congress gave states greater flexibihty in structuring 
Medicaid hospital payment methods and allowed paying hospitals less than Medicare. Social 
Security Amendments of 1972, Pub. L. No. 92-603, § 232(a), 86 Stat. 1329; Omnibus Recon- 
ciliation Act of 1981, Pub. L. No. 97-35, §§ 2171-2178, 195 Stat. 357. Also, in the Omnibus 
Reconciliation Act of 1981, Congress authorized states to curtail beneficiaries' choice of 
hospital providers under certain circumstances. Id. § 2175. 

^Social Security Amendments of 1965, Pub. L. No. 89-97, § 102(a), 79 Stat. 286 
(codified as amended at 42 U.S.C. § 1395/(a) (1982 & Supp. 1985)). In recent years, 
physician reimbursement has come under increasing regulation, and now there are greater 
incentives for physicians to accept assignment of Medicare benefits from their patients as 
payment in full as well as freezes and other limits on the amount of payment for physicians' 
services. See Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 2306, 98 Stat. 494 
(codified as amended at 42 U.S.C. § 1395u(b) (Supp. 1985)). See American Medical Ass'n 
V. Heckler, 606 F. Supp. 1422 (S.D. Ind. 1985), in which the American Medical Association 
and Indiana doctors unsuccessfully challenged this freeze on constitutional and other 
grounds. 

^'42 U.S.C. § 1396a(45), 1396k (1982 & Supp. 1985). As a result of these restrictive 
policies and practices, few physicians take Medicaid patients. These patients then must 
rely chiefly on hospital outpatient clinics and other facilities that cater specifically to the 
indigent for physicians' services. See Mitchell & Cromwell, Access to Private Physicians 
for Public Patients: Participation in Medicaid and Medicare, in 3 President's Commission, 
Securing Access to Health Care, supra note 17, at 105. 



1986] MEDICARE PROSPECTIVE PAYMENT 1163 

The Medicare and Medicaid programs generated enormous demand 
for health care services and with this increased demand came sharp and 
continuing increases in the cost of health care services/^ The seriousness 
of the cost problem surfaced shortly after the inauguration of the 
Medicare and Medicaid programs^^ and has dominated the health policy 
debate ever since. Of greatest concern were a rate of inflation in health 
care costs far exceeding that of the general economy, uncontrolled rise 
in federal and state budgetary expenditures in public health insurance 
programs to the exclusion of other public commitments, and the fact 
that health care commanded an ever greater proportion of the nation's 
resources as well."^ 

The federal government and the states became concerned about 
escalating costs of the Medicare and Medicaid programs and explored 
numerous cost containment strategies. Congress authorized waivers of 
Medicare and Medicaid program requirements to test cost-saving meth- 
odologies for paying for hospital services under these programs, and the 
Department of Health, Education and Welfare inaugurated experiments 
in several states to test the cost-effectiveness of prospective payment 
methodologies.^^ Several states adopted programs to regulate rates of 
hospitals and other health care institutions, and many of these state 
programs include Blue Cross, other private payers, and even Medicare.''^ 
Also, in the late 1960's and early 1970's, about one-third of the states 



"^Gornick, Greenberg, Eggers & Dobson, Twenty Years of Medicare and Medicaid: 
Covered Populations, Use of Benefits, and Program Expenditures, 7 Health Care Fin. 
Rev. 13, 35-45 (Supp. 1985). 

'^^Proposed Medicare Reimbursement Formula: Hearings Before the Senate Comm. 
on Finance, 89th Cong., 2d Sess. (1966); Staff of Senate Comm. on Finance, Medicare 
AND Medicaid: Problems, Issues, and Alternatives, 91st Cong., 1st Sess. 53, 140-43 
(Comm. Print 1970). 

'^Between 1967 and 1983, the rate of increase in hospital costs was 17.2% and did 
not abate until 1984, the first year of the prospective payment system. Gornick, supra 
note 42, at 35-45. The Medicare program consumed an increasingly large portion of the 
federal budget during these periods. Further, the health care system commanded a larger 
portion of the nation's resources. In 1965, the percentage of the gross national product 
devoted to health care was about 6*^0 and in 1984 that percentage was 10.8%. National 
Health Expenditures, 1984, supra note 14, at 1. 

^'Social Security Amendments of 1967, Pub. L. No. 90-248, § 402, 81 Stat. 821; 
Social Security Amendments of 1972, Pub. L. No. 92-603, § 222(a), 86 Stat. 1329; see 
also Dep't of Health & Human Services, Health Care Financing Admin., Health 
Care Financing Grants and Contracts Report, The National Hospital Rate-Setting 
Study: A Comparative Review of Nine Prospective Rate-Setting Programs (1980). 

"^See Esposito, Hupfer, Mason & Rogler, Abstracts of State Legislated Hospital 
Cost-Containment Programs, 4 Health Care Fin. Rev. 129 (1982). 

As of 1986, ten states have adopted mandatory rate regulation programs involving 
payers besides Medicaid: New York, New Jersey, Maryland, Massachusetts, Washington, 
Wisconsin, Connecticut, Maine, and West Virginia. Some states have Medicare waivers to 
operate all payer systems. States can obtain waivers to set up their own all payer rate 



1164 INDIANA LAW REVIEW [Vol. 19:1151 

adopted capital expenditure review programs to regulate costly capital 
investment in health care facilities and services on the theory that excess 
capital investment was a major cause of the escalation of all health care 
costs. ''^ 

In the Social Security Amendments of 1972, Congress adopted several 
regulatory strategies to address the problem of cost inflation in the 
Medicare and Medicaid programs. Borrowing from state approaches to 
rate regulation, Congress authorized HEW to impose a Umit on the 
routine costs that Medicare paid hospitals. "^^ These amendments also 
supported state capital expenditure review programs by authorizing the 
Medicare program to withhold reimbursement for capital costs for any 
projects disapproved under a state certificate-of-need program."^^ In ad- 
dition, these amendments established a professional peer review program 
to review the utilization of hospital services provided beneficiaries of 
the Medicare and Medicaid programs. ^^ Regarding Medicaid, Congress 
accorded states greater flexibihty to structure and reduce payments to 
health care institutions for the care of Medicaid beneficiaries.^^ 

In 1974, Congress enacted the National Health Planning Resources 
and Development Act of 1974.^^ This statute required all states to establish 
health planning and certificate-of-need programs to control capital ex- 
penditure by health care facilities and assure rational distribution of 
health care services. Federally-mandated health planning and certificate- 
of-need programs represented a comprehensive federal effort to compel 
states to regulate the distribution of health care services on a local and 
state- wide level." 

Nevertheless, throughout the 1960's and 1970's, the federal govern- 
ment and also the states to varying degrees remained committed to the 
ideal of a strong government role in ensuring access to health care 
services for the aged, disabled, and poor through public health insurance 
programs. Indeed, the federal government under both Repubhcan and 



setting programs and opt out of the Medicare prospective payment system. See Am. Hosp, 
Ass'n, Legal Developments Report No. 1: How States Can Opt Out of the Federal 
Medicare DRG System: A Summary of Legal Issues (1983). 

"'B. Lefkowitz, Health Planning: Lessons for the Future 13 (1983). 

^^Social Security Amendments of 1972, Pub. L. No. 92-603, § 223, 86 Stat. 1329 
(codified as amended at 42 U.S.C. §1395x(v)(l)(A) (1982 & Supp. 1985)). 

'Ud. § 221(a) (codified as amended at 42 U.S.C. § 1320a-l (1982 & Supp. 1985)). 

^°Id. § 249F(b). This program has been terminated and another peer review program 
established in its place. See infra notes 135-42 and accompanying text. 

^'Social Security Amendments of 1972, Pub. L. No. 92-603, § 232(a), 86 Stat. 1329 
(codified at 42 U.S.C. § 1396(a) (1982 & Supp. 1985)). 

"National Health Planning and Resources Development Act of 1974, Pub. L. No. 
93-641, 88 Stat. 2225 (codified as amended at 42 U.S.C. § 300K (1982 & Supp. 1985)). 

"This program also established guidelines for the appropriate levels of certain health 
care services. See id. § 3 (codified as amended at 42 U.S.C. § 300k-t (1982)). 



1986] MEDICARE PROSPECTIVE PAYMENT 1165 

Democratic administrations was prepared to expand this commitment 
and provide health insurance coverage to all Americans through a national 
health insurance plan.^"^ The only barrier to this goal was the serious 
problem of hospital cost containment and the concomitant fear that 
national health insurance would be prohibitively expensive. ^^ 

But also during this period, a consensus developed among federal 
and state policy makers, scholars, and other observers that the health 
care system was wasteful in its use of resources and experienced an 
inordinately high rate of inflation without a corresponding improvement 
in the health status of the population. ^^ This phenomenon was particularly 
troubling given the other types of government services that could have 
been provided with the same funds. ^"^ Three factors were seen as causes 
for this waste and inflation. First were payment methodologies that paid 
providers basically the costs they incurred on their charges for providing 
services. ^^ This contained incentives for overutilization of services and 
the resulting conception and expectation of high quality medical care as 
being any care that might benefit, regardless of cost.^^ The second factor 
was increases in costly medical technology. ^^ The third factor was the 



^'^See House Subcomm. on Health of the Comm. on Ways and Means, National 
Health Insurance Resource Book, 94th Cong., 2d Sess. (1976); K. Davis, National 
Health Insurance: Benefits, Costs, and Consequences (1975); National Health In- 
surance: What Now, What Later, What Never (M. Pauly ed. 1980). 

"The Carter Administration, to prepare the way for enactment of its National Health 
Plan, introduced two unsuccessful hospital cost containment bills in Congress. These bills 
proposed establishing a national rate regulation program for all payers on the theory that 
this regulation would keep hospital costs under control when the national health insurance 
program with its increased demand for services was implemented. See Wing & Silton, 
Constitutional Authority for Extending Federal Control over the Delivery of Health Care, 
57 N.C.L. Rev. 1423 (1979). 

^^See Doing Better and Feeling Worse: Health in the United States (J. Knowles 
ed. 1977); Hospital Cost Containment: Selected Notes for Future Policy (M. Zubkoff, 
L. Raskin & R. Hanft eds. 1978). 

"For example, in 1976, Medicare program analysts estimated that with the $4 billion 
for new technology for Medicare patients in 1976, the federal government could have 
brought all aged persons above the poverty line or provided rent to raise two miUion 
elderly from substandard to standard housing, brought all the elderly above the lowest 
accepted food budget, or provided eyeglasses and hearing aids to all in need. See Warner, 
Effects of Hospital Cost Containment on the Development and Use of Medical Technology, 
56 Milbank Memorial Fund Q. /Health and Society 187, 188 (1978). 

^^See Biles, Schramm & Atkinson, Hospital Cost Inflation Under State Rate-Setting 
Programs, 303 New Eng. J. Med. 664 (1980); Steinwald & Sloan, Regulatory Approaches 
to Hospital Cost Containment: A Synthesis of the Empirical Evidence, in A New Approach 
to the Economics of Health Care 2736 (M. Olson ed. 1981). 

''Donabedian, supra note 5, at 200; Light, Is Competition Bad?, 309 New Eng. J. 
Med. 1315 (1984); see also Havighurst & Blumstein, Coping with Quality /Cost Trade- 
offs, supra note 9, at 12-13. 

^See Dep't of Health, Education & Welfare, Medical Technology: The Culprit 
Behind Health Care Costs? (Proceedings on the 1977 Sun Valley Forum on National 



1166 INDIANA LAW REVIEW [Vol. 19:1151 

Structure and financing of most health insurance plans, including public 
programs.^' Specifically, health insurance with low or no coinsurance 
insulated the consumers from any financial consequences of their decision 
to use health care services, resulting in indiscriminate and wasteful use 
of services. 

Toward the end of the 1970's, recognition of these problems with 
the American health care system precipitated a loss of confidence in the 
direction of federal health policy causing many to question the underlying 
assumptions that had supported federal health policy for over a decade." 
Specifically challenged was the idea that the federal government should 
be involved in providing health insurance for all Americans in view of 
the costly track record of the Medicare and Medicaid programs." Also 
questioned was whether regulation of capital investment and institutional 
payment rates were effective in assuring rational distribution of health 
care services as well as containment of health care costs. ^"^ It was suggested 
that the new direction for federal health policy was to promote com- 
petition between providers, to reform the structure and financing of 
public and private health insurance programs to have consumers directly 
affected by their decisions to use health care services, and to reduce the 
regulatory control of federal and state governments over providers and 
health insurers. ^^ 

B. The Redirection of Federal Health Policy 

The election of Ronald Reagan in 1980 marked the turning point 
in national health policy and the rejection of the liberal health pohcy 



Health, 1977); L. Russell, Technology in Hospitals: Medical Advances and Their Diffusion 
(1979); see also Office of Technology Assessment, Medical Technology Under Proposals 
to Increase Competition in Health Care (1982). 

^'See P. JosKow, Controlling Hospital Costs: The Role of Government Reg- 
ulation 20-31, 36-43 (1981); The Role of Health Insurance in the Health Services 
Sector (R. Rosett ed. 1976); Feldstein, The Welfare Loss of Excess Health Insurance, 
81 J. Pol. Econ. 251 (1973). 

^^See, e.g., I. Illich, Medical Nemesis (1976); Starr, The Politics of Therapeutic 
Nihilism, in Working Papers for a New Society 48 (1976). 

"5ee National Health Insurance: What Now, What Later, What Never, supra 
note 54; see also Blumstein & Zukoff, Public Choices in Health: Problems, Politics and 
Perspectives on Formulating National Health Policy, 4 J. Health Pol. Pol'y & L. 382 
(1979). 

*''C. Havighurst, Deregulating the Health Care Industry 25-52 (1982); P. 
JosKOw, supra note 61, at 169-78. 

*^A. Enthoven, Health Plan: The Only Practical Solution to the Soaring 
Cost of Medical Care (1980); see also Competition and Regulation in Health Care 
Markets, 59 Milbank Memorlal Fund Q. /Health and Society 107 (1981); A Special 
Symposium: Market Oriented Approaches to Achieving Health Policy Goals, 34 Vand. 
L. Rev. 849 (1981). 



1986] MEDICARE PROSPECTIVE PAYMENT 1167 

of the previous fifteen years. Ronald Reagan had a fundamentally con- 
servative conception of government's responsibility toward its citizens 
and was committed to disengaging the federal government from all aspects 
of American life and reducing federal taxes dramatically. Thus, instead 
of expanding the federal role in assuring access to quality health care 
services to underserved groups, which had clearly been the focus of the 
Carter Administration's health policy, ^^ the Reagan Administration sought 
to reduce the federal role and commitment to assure quality health care 
services for Americans in need and to address the problem of cost 
inflation in public health insurance programs. The Reagan Administration 
aggressively redirected federal health policy along the lines suggested by 
the more articulate critics of the liberal health policy such as Alan 
Enthoven and Clark Havighurst and even enlisted the involvement of 
these critics in the formulation of a new conservative health policy. 

The summer of 1981 was an eventful season for American health 
policy. The newly-elected and politically powerful Reagan Administration 
under the technical leadership of the energetic Budget Director David 
Stockman worked feverishly to develop proposals to dismantle the liberal 
welfare state and to inaugurate the conservative revolution promised by 
the election of Ronald Reagan. The specific objective of these proposals 
was to reduce the amount of the nation's resources commanded by the 
federal government and to reduce the proportion of federal resources 
devoted to social programs. The Administration submitted legislative 
proposals affecting all aspects of American life, which Congress con- 
sidered in developing the federal budget for fiscal year 1982. With respect 
to health, the Administration proposed transferring financial and ad- 
ministrative responsibility for nearly all categorical health programs to 
the states in block grants^^ and to impose a limit on the amount of 
federal expenditures for the Medicaid program while giving states greater 
administrative flexibility to achieve savings. ^^ 

But before adopting these proposals for the federal budget, Congress 
enacted the Economic Recovery Act of 1981, which contained the Reagan 
Administration's proposals for sharply reducing federal income taxes, 
thus reducing the proportion of the nation's resources commanded for 
government ends.^^ This legislation was to result in an estimated revenue 



"Dep't of Health & Human Services, Office of the Ass't Secretary for Plan- 
ning & Evaluation, Background Papers, Vol. 1 (1980); Dep't of Health & Human Ser- 
vices, Office of the Ass't Secretary for Planning & Evaluation, Decision Papers 
for the Secretary, Vol. 2 (1980). 

*^CoNG. Budget Office, An Analysis of President Reagan's Budget Revisions for 
Fiscal Year 1982, Staff Working Papers, A-53 (1981). 

^»M at A-56. 

^^Economic Recovery Act of 1981, Pub. L. No. 97-34, 95 Stat. 172. 



1168 INDIANA LAW REVIEW [Vol. 19:1151 

loss of $37.7 billion for fiscal year 1982^° despite the fact that the deficit 
in the federal budget at the time, fiscal year 1981, was $59.6 billion.^' 
It should be noted that the actual budget deficit for fiscal year 1982 
was $110.6 biUion.^^ The Reagan Administration, committed to expanding 
the nation's defense capability through massive expenditures on national 
defense, sought to address the budget deficit through draconian decreases 
in social and health programs and, raising the specter of the increasing 
deficit, the Administration sought public support to dismantle the Amer- 
ican social welfare state. ^^ 

The major piece of legislation to accomplish this task was the 
Omnibus Budget Reconciliation Act of 1981,^"^ which Congress enacted 
immediately after the Economic Recovery Act of 1981. In this legislation. 
Congress adopted many of the health policy proposals and budget re- 
duction strategies of the immensely popular Reagan Administration, 
including block grants for categorical social and health programs and 
sharp reduction in funding for regulatory programs such as federally- 
mandated health planning and certificate of need programs and the peer 
review organization program for the Medicare and Medicaid programs.'^ 
The Omnibus Budget Reconciliation Act also reduced federal funding for 
Medicaid and gave states greater flexibility to structure payment methods 
and modes of deUvering health care services to Medicaid beneficiaries.^^ 



'°H.R. CoNF. Rep. No. 215, 97th Cong., 1st Sess. 292, reprinted in 1981 U.S. Code 
Cong. & Admin. News 380. 

''Executive Office of the President, Office of Management & Budget, FY 1982 
Budget Revisions 11 (1981). 

'^Executive Office of the President, Office of Management & Budget, Budget 
of the United States Government, FY 1984 M-11 (1983). 

^^See generally D. Stockman, The Triumph of Politics: Why the Reagan Rev- 
olution Failed (1986); Jacob, Reaganomics: The Revolution in American Political Econ- 
omy, 48 Law & Contemp. Probs. 7(1985); see also Ethridge, Reagan, Congress, and 
Health Spending, 2 Health Aff. 14 (1983); Michaelson, Reagan Administration Health 
Legislation: The Emergence of a Hidden Agenda, 20 Harv. J. on Legis. 575 (1983). 

'^Omnibus Budget Reconciliation Act of 1981, Pub. L. No. 97-35, 95 Stat. 357. 

''Id. §§ 1901-1910, 1911, 1921-1922, 1926, 2191-2194 (codified as amended at 42 U.S.C. 
§§ 201-300 (1982 & Supp. 1985)). 

With respect to categorical health services programs of the Public Health Service, 
the Omnibus Budget Reconciliation Act of 1981 terminated federal programmatic re- 
sponsibility for nearly all of these programs and placed funding for these programs into 
block grants to be administered by states. Id. §§ 300w to 300w-8. Funding for these block 
grants was reduced by twenty-five percent in 1981 and has been reduced subsequently. See 
The Reagan Experiment: An Examination of Economic and Soclal Policies Under the 
Reagan Administration 280-82 (J. Palmer & I. Sawhill eds. 1982). The Reagan Administra- 
tion, in its new federahsm initiative, proposed even greater transfers of federal 
responsibility for social programs to states. See President's Federalism Initiative, Govern- 
mental Affairs, United States Senate, 97th Cong., 2d Sess., Feb. 4, Mar. 11, 16, 18 
(1982). 

'^Omnibus Budget Reconciliation Act of 1981, Pub. L. No. 97-35, §§ 2161-2184, 95 
Stat. 357 (codified as amended at 42 U.S.C. § 1396 (1982 & Supp. 1985)). See generally R. 



1986] MEDICARE PROSPECTIVE PAYMENT 1169 

What the Reagan Administration and Congress accompHshed with 
this first wave of legislation in the summer of 1981 was to reduce the 
proportion of federal resources devoted to health care at the societal 
level. Indications are that these decisions have hurt the poor and those 
without health insurance. About fifteen percent of the population report 
having no health insurance — a significant barrier to access to health 
services given the high cost of even minimal medical care.^^ This figure 
is a twenty- five percent increase since 1977 and is due to several factors 
such as increased unemployment, an increase in the number of individuals 
living in poverty, and a tightening of criteria for Medicaid and other 
pubhc programs that finance health care for the poor.^^ There is also 
evidence that the health status of mothers and infants and persons with 
chronic disease, groups likely to be poor and the beneficiaries of public 
programs, has been significantly compromised since 1980.^^ 

After the summer of 1981, the Reagan Administration turned its 
attention to developing strategies to make Medicare and private insurance 
programs more efficient purchasers of health care services. The Admin- 
istration's chief policy initiative and critically important from a rhetorical 
perspective was to encourage increased competition in the health care 
system through the reform of health insurance and, particularly, federal 
financing of private health insurance through the federal income tax 
exemption for health insurance premiums. ^° 

However, the most important of these structural reforms was adoption 
of the prospective payment system for the Medicare program. Pressed 
by the need to reduce federal budget expenditures and alleviate the 
alarming growth of the federal budget deficit, which in fiscal year 1983 



BOVBJERG & J. HOLAHAN, MEDICAID EN THE ReAGAN ErAI FEDERAL POLICY AND StATE CHOICES 

(1982); The Reagan Experiment, supra note 75. Congress did not adopt the Reagan 
Medicaid proposals because of pressure from governors who were concerned about possible 
increased Medicaid program costs for states. See Wing, The Impact of Reagan-Era Politics 
on the Federal Medicaid Program, 33 Cath. U.L. Rev. 1 (1983). 

^^See supra note 33 and accompanying text. 

^^Mundingher, supra note 12, at 45. 

'^See id. 

^"See H.R. Doc. No. 24, 98th Cong., 1st Sess. (1983); Proposals to Stimulate 
Competition in the Financing and Delivery of Health Care, 1981: Hearings Before the 
Subcomm. on Health of the Comm. on Ways and Means of the House of Representatives, 
97th Cong., 1st Sess. (1981). Congress never enacted the Reagan Administration's com- 
petition proposal and this policy initiative, although referred to constantly in the rhetoric 
of the Administration, never was developed beyond an initial legislative proposal. See 
Medicare Reimbursement to Competitive Medical Plans, Hearing Before the Special Comm. 
on Aging, 97th Cong., 1st Sess. (1981); Congressional Budget Office, Containing 
Medicare Care Costs Through Market Forces (1982); Enthoven, The Competition 
Strategy: Status and Prospects, 304 N. Eng. J. Med. 109 (1981); Feder, Holahan, Bovbjerg 
& Hadley, The Shift in Social Policy: Health, in The Reagan Experiment 271 (J. Palmer 
and I. Sawhill eds. 1982). 



1 1 70 INDIANA LA W REVIEW [Vol. 19:1151 

was estimated to be $107.2 billion,^' Congress and the Reagan Admin- 
istration sought to address the largest component of the federal health 
budget where reforms were possible and which had been left relatively 
untouched in the initial budget cutting efforts of 1981: Medicare ex- 
penditures for hospital services. In the Tax Equity and Fiscal Respon- 
sibility Act of 1982, Congress laid the groundwork for prospective 
payment by establishing limits on the costs that Medicare would pay 
hospitals for each patient case and calling on the Department of Health 
and Human Services to develop a legislative proposal for a prospective 
payment system by December 1982.^^ Following the Administration's 
proposal for a prospective payment system based on diagnosis related 
groupings (DRG's),^^ Congress adopted a prospective payment system 
the following spring in the Social Security Amendments of 1983.^^* 

The legislative initiatives of Congress and the Reagan Administration 
to purchase health care services more efficiently in the Medicare and 
Medicaid programs and to encourage private payers to do likewise seem 
to have been quite successful. In 1984, the rate of inflation in the 
hospital industry declined dramatically, and Medicare expenditures for 
hospital services rose only at 9.6% in 1984 compared to 16.7% between 
1977 and 1983.^^ This result alone was significant for it defused the 
problem of hospital costs, which was becoming a serious economic and 
political problem for this nation. The problem of costs also posed a 
host of ethical issues of quite another dimension about the allocation 
of health care services, including whether resources that could be allocated 
to other social needs, i.e., housing, food, energy, became unavailable 
because of the need to purchase expensive health care services. ^^ 

There are indications that structural efficiencies in the delivery of 
health care services have occurred as well. Hospital admissions for the 
elderly decHned for the first time since 1965, average length of stay 
continued to decline and data suggest that hospitals were taking care 



"Executive Office of the President, Office of Management & Budget, Budget 
OF THE United States Government: Fiscal Year 1983 3-23 (1982). 

«2Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, § 101, 96 
Stat. 331-36 (codified as amended at 42 U.S.C. § 1395ww(a)-(c) (Supp. 1985)). 

"Secretary of the Dep't of Health & Human Services, Report to Congress 
ON Hospital Prospective Payment for Medicare (1982) [hereinafter HHS Report to 
Congress] . 

«^Social Security Amendments of 1983, Pub. L. No. 98-21, § 601(c)(1), 97 Stat. 65 
(codified as amended at 42 U.S.C. § 1395ww (Supp. 1985)). 

^^Prospective Payment Assessment Comm'n, Medicare Prospective Payment and 
THE American Health Care System: Report to the Congress 19-20 (1986) [hereinafter 
ProPAC Report on the American Health Care System]; see also National Health 
Expenditures, 1984, supra note 14. 

^^See P. Mentzel, Medical Costs, Moral Choices: A Philosophy of Health Care 
Economics in America (1983). 



1 986] MEDICARE PROSPECTIVE PA YMENT 1171 

of sicker groups of patients than before.*' Also, there was greater uti- 
Hzation of outpatient services in 1984 than in previous years.^^ Fur- 
thermore, all this has been accomplished while maintaining the financial 
position of the hospital industry. Indeed, hospitals have, as a whole, 
done quite well under these new strategies with profits in 1984 increasing 
27.6% over 1983. «^ 

The redirection of federal health pohcy since 1981 has precipitated 
concern among providers, consumers, and other observers as to whether 
the American health care system can continue to strive for quality and 
accessible health care for all Americans. Some have wondered whether 
constraints imposed by new payment methodologies will require the 
"rationing" of health care services among those in need.^ Also many 
are concerned that the quality of health care services will decline because 
of incentives in these purchasing strategies that encourage providers to 
curtail the amount of services in the treatment of individual patients. ^^ 
Also, philosophers have questioned the morality of payment systems that 
place providers in a position of having to balance the cost of resources 
used to treat patients against their anticipated benefits — particularly when 
the provider stands to gain personally from saving costs or is at risk 
for excessive costs. ^^ 

However, there is no evidence that this nation is now in a position 
where it must really "ration" health services in any draconian sense. 
Rather, the federal government as well as the states and private payers 
have decided only that they must pay less for health services. Further, 
as the Reagan Administration's tax and budget poUcies indicate, there 
are societal resources that could be devoted to health services for those 
in need. This Administration has simply decided to limit resources available 
to government to address such needs and look to other quarters for solu- 
tions. Thus, federal and state payers have made choices about the alloca- 
tion of health services at least for vulnerable, poor groups prematurely 
and frankly unnecessarily. 



^^ProPAC Report on the American Health Care System, supra note 85, at 19- 
20. 

''Id. 

'^Id. at 47-51; National Health Expenditures, 1984, supra note 14, at 7-8, 23. 

^See, e.g., Friedman, Rationing and the Identified Life, Hospitals, May 16, 1984, 
at 65; Fuchs, The "Rationing" of Medical Care, 311 New Eng. J. Med. 1572 (1984); 
Perkins, The Effects of Health Care Cost Containment on the Poor: An Overview, 19 
Clearinghouse Rev. 831 (1985); Schwartz & Aaron, Rationing Hospital Care: Lessons 
from Britain, 310 New Eng. J. Med. 52 (1984). 

"5ee, e.g.. Leaf, The Doctor's Dilemma and Society's Too, 310 New Eng. J. Med. 
718 (1984); Omenn & Conrad, Implications of DRG's for Clinicians, 311 New Eng. J. 
Med. 1314 (1984); Sandrick, Quality: Will It Make or Break Your Hospital, Hospitals, 
July 5, 1986, at 54; Schramm, Can We Solve the Hospital Cost Problem In Our Democracy!, 
311 New Eng. J. Med. 729 (1984); Thurow, Learning to Say No, 311 New Eng. J. 
Med. 1569 (1984). 

^See supra note 6 and accompanying text. 



1172 INDIANA LAW REVIEW [Vol. 19:1151 

IV. Making Hard Choices Under the Medicare Prospective 

Payment System 

In the prospective payment system, Congress adopted a payment 
methodology to purchase hospital services for Medicare beneficiaries 
more efficiently and to curtail the amount of resources the federal 
government devoted to medical care for the elderly and disabled. The 
chief objective of this payment system was to change incentives in hospital 
financial behavior. ^^ No longer would Medicare pay virtually all costs 
associated with services that hospitals and physicians decided were needed 
to treat individual Medicare patients. Rather, the Medicare prospective 
payment system pays a fixed price per case and allows hospitals to keep 
savings while putting hospitals at risk for costs incurred over and above 
the price per case.^"^ 

Congress understood that the prospective payment system would give 
the executive branch considerable power in deciding the amount of total 
federal resources to devote to hospital services for Medicare beneficiaries. 
Congress was frankly concerned that the executive branch, faced with 
tremendous pressure to curtail the ever increasing federal budget deficit 
of $107.2 billion^^ and the threatened bankruptcy of the Hospital In- 
surance Trust Fund,^^ would set payment rates arbitrarily low with little 
regard to maintaining the quality of services for Medicare beneficiaries.^^ 



^^With respect to incentives, the House Ways and Means Committee stated, "[The 
Prospective Payment System] is intended to reform the financial incentives hospitals face, 
promoting efficiency in the provision of services by rewarding cost-effective hospital 
practices." H.R. Rep. No. 25, Part 1, 98th Cong., 1st Sess. 132, reprinted in 1983 U.S. 
Code Cong. & Admin. News 219, 351. 

Similarly, the Administration in its report to Congress on the prospective payment 
system stated: 

The ultimate objective of PPS is to set a reasonable price for a known product. 

This provides incentives for hospitals to produce the product more efficiently. 

When PPS is in place, health care providers will be confronted with strong 

lasting incentives to restrain costs for the first time in Medicare's history. 
Dep't. of Health & Human Services, Hospital Prospective Payment for Medicare: 
Report to Congress Required by the Tax Equity and Fiscal Responsibility Act of 
1982, 101 [hereinafter HHS Report to Congress]; see also 20 Years of Medicare and 
Medicaid, Health Care (Supp. 1985) (comments of J. Alexander McMahon, at 93-94; 
comments of Congressman Dan Rostenkowski, at 113-14). 

^*See infra notes 107-25 and accompanying text. 

^^See supra notes 66-92 and accompanying text. 

'^Svahn & Ross, Social Security Amendments of 1983: Legislative History and Sum- 
mary of Provisions, Soc. Security Bull., July 1983, at 3, 40-7. 

^^See Hospital Prospective Payment System, Hearing Before the Subcomm. on Health 
of the Senate Comm. on Finance, 98th Cong., 1st Sess., Part I, 47-48, 97-98, 134-35, 
212 & Part II, 89-90, 162-204, 213 (1983) [hereinafter Senate Finance Comm. Hearings 
on the Hospital Prospective Payment System]; Medicare Hospital Prospective Payment 
System: Hearings Before the Subcomm. on Health of the House Comm. on Ways and 



1986] MEDICARE PROSPECTIVE PAYMENT 1173 

Afterall, Medicare expenditures for hospital services comprised an es- 
timated seven percent of the federal budget for fiscal year 1983,^^ and 
thus posed an excellent target for budget reductions. 

Hospitals were especially concerned about the administrative process 
by which payment rates would be set. The American Hospital Association 
(AHA) urged that the Secretary of HHS not have sole responsibility for 
updating hospital payment rates but that updating rates be done "on 
a regularly-scheduled basis, with the formula specified in law and cal- 
culated by a technical body that is independent of HHS and capable 
of providing an objective adjustment. "^^ The AHA and other groups 
also objected to proposals eliminating rights to appeal issues with respect 
to the composition of hospital payment rates. '°^ 

Congress and beneficiaries were concerned about the incentives in 
the prospective payment system for hospitals to maximize payment through 
admitting patients to the hospital unnecessarily and encouraging their 
physicians to use fewer resources to treat patients. ^^' Specifically, they 
were concerned that the quality and accessibility of hospital care for 
Medicare beneficiaries, particularly those who were seriously ill and had 
the greatest need, would be compromised.'^^ With respect to quality 
assurance, the Senate Finance Committee and some interest groups ques- 
tioned the ability of fiscal intermediaries, i.e., Blue Cross plans and 
insurance companies with which HHS contracts to administer Medicare 
coverage and payment determinations, '°^ to carry out this key function, 
and wanted Peer Review Organizations (PRO's), with their mandated 
physician control, to assume this monitoring responsibility.'^^ 

Congress disagreed with the Reagan Administration about the ap- 
propriate administrative structure for the prospective payment system in 



Means, 98th Cong., 1st Sess. (1983) [hereinafter House Ways and Means Comm. Hearings 
on Medicare Hospital Prospective Payment System]. 

'^Executive Office of the President, Office of Management & Budget, Budget 
OF THE United States, FY 1984 5-129 (1983). 

This figure was derived by dividing estimated Medicare budget outlays for FY 1983 
by total federal budget outlays for FY 1983. 

"^^Senate Finance Comm. Hearings on the Hospital Prospective Payment System, 
supra note 97, Part I, at 128, 135 (statement of J. Alexander McMahon, President, 
American Hospital Association). 

^^See id. at 123-27; House Ways and Means Comm. Hearings on Medicare Hospital 
Prospective Payment System, supra note 97, at 19-30. 

""See Senate Finance Comm. Hearings on the Hospital Prospective Payment System, 
supra note 97, Part I, 47-48, 96-98, Part II, 162-204, 213, 293-98; House Ways and Means 
Comm. Hearings on Medicare Hospital Prospective Payment System, supra note 97, at 
123-29, 139-44. 

""Hd. 

''''See 42 U.S.C. § 1395h (1982 & Supp. 1985). 

'^'^ Senate Finance Comm. Hearings on the Hospital Prospective Payment System, supra 
note 97, Part II, at 9-90, 162-204, 213. 



1174 INDIANA LAW REVIEW [Vol. 19:1151 

several respects. The Administration had proposed that the Secretary set 
the hospital payment rates with input from an outside panel of experts 
on hospital finance appointed by the Secretary and that fiscal inter- 
mediaries monitor hospital admitting and discharge practices and the 
quality of care accorded Medicare beneficiaries. ^^^ Further, under the 
Administration's proposal, providers would have no right to appeal any 
payment issue — an approach justified as necessary to preserve the integrity 
of the rate structure under the prospective payment system. ^°^ But it is 
fair to say that some of the congressional distrust of the Administration's 
approach for structuring the prospective payment system came from a 
perception of this particular Administration's ideological behef that the 
federal government's role in addressing social problems should be min- 
imal. 

A. The Administrative Structure for Making Allocation Decisions 
Under the Prospective Payment System 

Congress decided that decisions by the federal government at the 
societal level as well as by hospitals and physicians at the individual 
level about the allocation of medical resources under the Medicare 
program would be made by setting a price for each Medicare case. 
Specifically, through the pricing process, the federal government would 
make the decisions about what federal resources to devote to Medicare 
hospital services versus other public obligations such as defense and 
further, about what resources to dedicate to all public obligations versus 
those that should be left for private purposes. At the individual level, 
price would also influence how individual hospitals and physicians would 
decide what resources to use for the care of individual Medicare be- 
neficiaries. 

In designing the administrative structure for the prospective payment 
system. Congress had four chief objectives: (1) ensure that the price was 
fair compensation for services rendered and thus would not compromise 
access to hospital services particularly for the more seriously ill; (2) 
ensure that the process for updating the price would account for new 



^°^ Senate Finance Comm. Hearings on the Hospital Prospective Payment System, 

supra note 97, Part I, 5-11. 

"^HHS Report to Congress, supra note 83, at 41. In this report, HHS stated its 

position on proscribing hospital appeals altogether: 

Payment amounts, exceptions, adjustments, and rules to implement the pro- 
spective payment system would not be subject to any form of judicial review. . . . 
As with any service sold to the Government, the remedy for providers dissatisfied 
with the rate offered is to convince the purchasing agency that a higher rate 
is appropriate or, failing that, to refrain from offering services to the Government. 

Id. 



1986] MEDICARE PROSPECTIVE PAYMENT 1175 

medical technology, inflation, and other factors that legitimately affect 
the ability of hospitals to provide care; (3) monitor the quality of hospital 
services for Medicare beneficiaries under the prospective payment system, 
and (4) provide a mechanism through which beneficiaries and hospitals 
could resolve problems with their treatment under the system. '^^ 

In designing the administrative structure for the prospective payment 
system, Congress assigned responsibilities to organizations outside the 
executive branch to participate in decisions about allocation of resources 
at the societal level as well as at the individual level. Through the use 
of independent organizations in this unprecedented manner, Congress 
sought to create a check on the executive branch's control of the 
prospective payment system and to provide input from the hospital 
industry, the medical profession, and Medicare beneficiaries on its im- 
plementation and operation. This approach to designing an administrative 
structure for a public insurance program is unique and extraordinary. 
It provides one model for how a government health insurance program 
can be structured to enable the government as both payer and repre- 
sentative of the public to make ethical decisions in allocating societal 
resources to medical care for its beneficiaries and, further, to ensure 
that providers make fair allocation decisions with respect to individual 
beneficiaries. 

1. The Medicare Rate Structure. — Congress gave HHS primary re- 
sponsibility for setting and updating hospital payment rates. '^^ In de- 
termining the rate setting methodology initially. Congress faced four 
central issues: (1) how would Medicare cases be classified for pricing 
purposes without jeopardizing the availability of services for seriously 
ill patients requiring above average amounts of hospital services per 
hospital stay; (2) what costs would be included in the prices and what 
costs would be reimbursed separately; (3) how would the rate structure 
accommodate the various missions, characteristics and geographic lo- 
cations of different hospitals; and (4) how would the transition from 
cost reimbursement to the new payment system be accomplished. '°^ Con- 
gress was also aware that precise data were not available to address 
these questions adequately and thus flexibility had to be incorporated 
into the rate setting methodology to address these questions and other 
unanticipated problems in the future. ^'° 



'""'See generally H.R. Rep. No. 25, 98th Cong., 1st Sess. 132 (1983); S. Rep. No. 
23, 98th Cong., 1st Sess. Ill (1983). 

"'M2 U.S.C. § 1395ww(e)(5)(A) (Supp. 1985). 

""See Senate Finance Comm. Hearings on the Hospital Prospective Payment System, 
supra note 97, at 3-11; House Ways and Means Comm. Hearings on the Medicare 
Prospective Payment System, supra note 97, at 10-13. 

"°H.R. Rep. No. 47, 98th Cong., 1st Sess. 202 (1983). 



1 176 INDIANA LA W REVIEW [Vol. 19:1151 

Under the prospective payment system, the Medicare program pays 
hospitals a fixed price for each Medicare case based on the diagnosis 
related grouping (DRG) in which the patient's particular condition falls."' 
The basic concept of the DRG classification system, which is comprised 
of 470 mutually exclusive DRG's, is that all human disease can be 
classified according to organ system, length of stay, intensity of resources 
consumed, morbidity, and sex and that such categories reflect the average 
cost of providing hospital services to all patients with diseases that fall 
within the particular category. '^^ 

The price is determined using a formula by which a figure representing 
the average price per case for all Medicare cases, called the "standardized 
amount," is multiplied by the DRG ''weight" assigned to the particular 
patient's case."^ However, if a particular case greatly exceeds the cost 
and length of stay ordinarily required for a case in the DRG to which 
the case would be assigned. Medicare will pay more for that "outlier" 
case than the DRG price.'*'' Some costs are excluded from DRG's, in- 
cluding capital costs of interest and depreciation,''^ as well as the direct 
costs of medical education."^ 

In a transition period from fiscal year 1983 through fiscal year 1987, 
the standardized amount is based in part on the actual costs of individual 
hospitals although in following years, the standardized amount will simply 
be a national average cost per case for all rural and all urban hospitals.''^ 



'"42 U.S.C. § 1395ww(d)(l) (Supp. 1985). 

"^This case classification system is based on the International Classification of Diseases, 
Ninth Revision, Clinical Modification, developed by the World Health Organization. See 
Preamble to Interim Final Rule, Medicare Program; Prospective Payments for Medicare 
Inpatient Hospital Services, 48 Fed. Reg. 39,752 (Sept. 2, 1983), at 39,760-61. 

'"42 U.S.C. § 1395ww(d)(l) (Supp. 1985). The DRG weight is a figure representing 
the proportion of hospital resources that patients in the DRG use on average compared 
to the average cost of all Medicare cases. Id. § 1395ww(d)(4)(B), 

"Vcf. § 1395ww(d)(5). 

"^/rf. § 1395ww(a)(4), Congress intended to incorporate capital costs in the DRG 
prices within a few years after the inception of the prospective payment system. Social 
Security Amendments of 1983, Pub. L. No. 98-21, § 601(d), 97 Stat. 65 (codified as 
amended at 42 U.S.C. § 1395ww(g)(l) (Supp. 1985)). HHS proposed taking this step for 
fiscal year 1987 as did the Prospective Payment Assessment Commission. See Dep't of 
Health & Human Services, Report to Congress, Hospital Capital Expenses: A Med- 
icare Payment Strategy for the Future (1986); Prospective Payment Assessment 
Comm'n, Report and Recommendations to the Secretary, U.S. Department of Health 
and Human Services [hereinafter ProPAC Report and Recommendations to the Sec- 
retary, April 1, 1986]. Congress did not take this step for fiscal year 1987 but only 
imposed limits on reimbursement of hospitals' capital costs for the next few years. Omnibus 
Budget Reconciliation Act of 1986, Pub. L. No. 99-509, § 9303, 100 Stat. 

"*42 U.S.C. § 1395ww(a)(2) (Supp. 1985). The prospective payment system also pays 
an additional allowance to teaching hospitals for higher costs associated with teaching activities. 
Id. § 1395ww(d)(5)(B). 

"Vc?. §§ 1395ww(b)(3)(A), 1395ww(d)(l). 



1986] MEDICARE PROSPECTIVE PAYMENT I 111 

The Standardized amount is updated for inflation and other factors 
discussed below; '* standardized" to remove costs attributable to ex- 
plainable differences between hospitals, i.e., area wage rates, teaching 
status, and case mix; and adjusted to reflect payments in outlier cases 
and the wage level for the area in which the hospital is located. ^'^ 

Congress required HHS to update payments to hospitals annually. 
This process involves (1) adjusting the standardized amount to reflect 
inflation, hospital productivity, and new technology, and (2) readjusting 
the DRG's to reflect changes in resource consumption due to new 
technology and other factors. ^'^ In updating the standardized amount, 
the Secretary must take into account changes in the hospital ''market 
basket" (i.e, the goods and services hospitals purchase to care for 
Medicare beneficiaries), hospital productivity, technological and scientific 
advances, quality of health care, and the "long term effectiveness" of 
the Medicare program as well as recommendations of the Prospective 
Payment Assessment Commission (ProPAC).^^^ The Secretary, also with 
the advice of ProPAC, must annually adjust the DRG classification and 
weighting factors "to reflect changes in treatment patterns, technology 
and other factors which may change the relative use of hospital re- 
sources."^^' 

There have been serious concerns about the fairness of the prospective 
payment system's rate setting methodology. First, do the DRG prices, 
which are based on averages, discriminate against more seriously ill 
patients who require more resources for their care and cause hospitals 
to incur costs over and above the DRG price for the patient's diagnosis? '^^ 
Second, does the exclusion of certain costs from the DRG prices com- 
promise the cost saving capability of the pricing system and equity 
between hospitals by allowing hospitals to push as much of their costs 
as possible into accounting categories, i.e., capital and medical education, 
that are reimbursed separately on a cost basis? '^^ Third, are hospital 
payment rates and particularly the DRG prices, which are established 
according to older data on hospital cost experience, flexible enough to 



' "«M § 1395ww(d). 

>'Vg?. §§ 1395(d)(3)(A), (d)(2)(D). 

''"Id. § 1395ww(e)(2). 

'''Id. § 1395ww(d)(4)(C). 

'''See Horn, Bulkley, Sharkey, Chambers, Horn & Schramm, Interhospital Differences 
in Severity of Illness: Problems for Prospective Payment Based on Diagnosis-Related 
Groups (DRG's), 313 New Eng. J. Med. 20 (1985); Horn, Sharkey & Bertram, Measuring 
Severity of Illness: Homogeneous Case Mix Groups, 21 Medical Care 14 (1983); see also 
Am. Hosp. Ass'n, Medicare Prospective Price Blending on a DRG-Specific Rate: A 
Potential Means of REAcmNG the Most Equitable Method of Determining the 
Medicare Prices to Be Paid to Each Hospital (1984). 

"^See Verville, Medicare Rate Setting and Its Problems: A Fixed Price Per Bundled 
Product, 6 J. Legal Med. 85 (1985). 



1178 INDIANA LAW REVIEW [Vol. 19:1151 

permit development and diffusion of new and efficacious medical tech- 
nology. '^"^ Finally, are hospitals with special missions and characteristics 
fairly treated under the prospective payment system? ^^^ 

2. Making Decisions at the Societal Level: The Role of The Pro- 
spective Payment Assessment Commission. — Congress created ProPAC, 
a congressional commission, to participate in the process of setting and 
updating the DRG prices and essentially to evaluate the performance of 
the executive branch in making allocation decisions at the societal level. '^^ 
Congress conceived of this commission as serving as "a highly knowl- 
edgeable independent panel to advise the executive and legislative branches 
on the Medicare reimbursement system. "^^^ This commission is composed 
of seventeen experts in health care delivery, finance, and research ap- 
pointed by the Director of the congressional Office of Technology 
Assessment and must be representative of the health care industry with 
members from national organizations of physicians, hospitals, and health 
care equipment manufacturers as well as business, labor, and the el- 
derly. ^^^ 

ProPAC has two statutory responsibilities: (1) to recommend to the 
Secretary of HHS how to update hospital payment rates, and (2) to 
recommend to the Secretary necessary changes in DRG's, including the 
advisability of establishing new DRG's, modifying existing DRG's, or 
changing the relative weights of the DRG's.^^^ Congress sees ProPAC 's 
mission as extending beyond these responsibilities, as stated by the House 
Committee on Appropriations: '*[T]he Committee believes that the pri- 
mary role of the Commission lies in a broader evaluation of the impact 
of Public Law 98-121 [sic] on the American health care system. "'^^ To 
be sure that ProPAC has the requisite information to perform these 
responsibilities. Congress mandated that ProPAC would have access to 
all relevant information, data and research within the federal government 
as well as adequate funding to collect information and conduct its own 
research.'^* 



'^"Anderson & Steinberg, To Buy or Not to Buy: Technology Acquisition Under 
Prospective Payment, 311 New Eng. J. Med. 182 (1984). 

^^^See Senate Finance Comm. Hearings on the Hospital Prospective Payment System, 
supra note 97, Part I, 129-46; House Ways and Means Comm. Hearings on the Medicare 
Prospective Payment System, supra note 97, at 36-44. 

'^^Social Security Amendments of 1983, Pub. L. No. 98-21, § 601(e), 97 Stat. 65 
(codified as amended at 42 U.S.C. § 1395ww(e)(2) (Supp. 1985)). 

'^^H.R. Rep. No. 911, 98th Cong., 2d Sess. 140 (1984). 

'^^2 U.S.C. §§ 1395ww(e)(2), (6)(A), (6)(B) (Supp. 1985). 

'"M § 1395ww(d)(4)(D), (e)(3). See Prospective Payment Assessment Comm'n, Report 
AND Recommendations to the Secretary, U.S. Department of Health and Human Ser- 
vices, April 1, 1985, at 3 (1985) [hereinafter ProPAC Report and Recommendations 
to the Secretary, April 1, 1985]. 

'^°H.R. Rep. No. 911, 98th Cong., 2d Sess. 140 (1984). 

'^'42 U.S.C. §§ 1395ww(e)(6)(F), (I) (Supp. 1985). 



1986] MEDICARE PROSPECTIVE PAYMENT 1179 

Congress also mandated a formal schedule of public communications 
between ProPAC and HHS with respect to the annual updating of 
hospital payment rates. ProPAC must prepare three reports each year: 
(1) a report to the Secretary on adjustments to the prospective payment 
system; (2) a report to Congress on the prospective payment system and 
the American health care system; and (3) a report to Congress on the 
adjustments adopted by the Secretary in his annual October regulations 
to govern the prospective payment system for the upcoming fiscal year.^^^ 
The Omnibus Budget Reconciliation Act of 1986 included Congress and 
providers, beneficiaries, and other interested parties more directly in this 
dialogue with the requirements that HHS prepare documented recom- 
mendations to Congress on updating payment rates by April 1st and 
publish the proposed rule on payment rates no later than June 1st to 
allow a 60 day comment period.*" The Secretary must publish the final 
rule by September 30th. ^^"^ Through this dialogue. Congress sought to 
impose accountability on the executive branch in setting the hospital 
payment rates and to ensure that providers, beneficiaries, and other 
interested parties have ample opportunity over and above the informal 
rule making process managed by HHS to become involved in the rate 
setting process. 

3. Making Decisions at the Individual Level: The Role of Peer 
Review Organizations. — To ensure that hospitals and physicians make good 
decisions about the allocation of hospital services at the individual level. 
Congress gave Peer Review Organizations important monitoring and 
enforcement responsibilities over hospital conduct under the prospective 
payment system. '^^ PRO's are private, physician-controlled organizations 
designated under the Peer Review Improvement Act of 1982.^'^ HHS con- 
tracts with PRO'S to have PRO's perform certain functions and accompHsh 
specific objectives in return for payment. '^^ 

For the prospective payment system. Congress has required HHS to 
contract with PRO's to monitor four areas of hospital behavior to assure 
that services to Medicare beneficiaries are medically necessary, reasonable 
and appropriately provided on an inpatient basis: (1) the validity of 
diagnostic information supplied by hospitals for payment purposes; (2) 
the completeness, adequacy, and quality of care provided by hospitals 



''Ud. § 1395ww(d)(4)(D), (e)(3). See H.R. Rep. No. 911, 98th Cong., 1st Sess. 140 (1984). 

•"Omnibus Budget Reconciliation Act of 1986, Pub. L. No. 99-509, § 9302(e)(3), 
100 Stat. (amending 42 U.S.C. § 1395ww(e)(3) (1982 & Supp. 1985)). 

'^M2 U.S.C. § 1395ww(d)(4)(D) (Supp. 1985). 

'3^2 U.S.C. § 1395cc(a)(l) (1982 & Supp. 1985). 

"*Peer Review Improvement Act of 1982, tit. I, subtitle C of the Tax Equity and 
Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, §§ 141 e/ seq., 96 Stat. 324 (codified 
as amended at 42 U.S.C. § 1320c-2(b)(3)(A) (Supp. 1985)). 

'''A2 U.S.C. §§ 1320C-2, 1320c-3(a) (Supp. 1985). 



1180 INDIANA LAW REVIEW , [Vol. 19:1151 

to Medicare beneficiaries; (3) the appropriateness of hospital admissions 
and discharges; and (4) the appropriateness of care in "outUer" cases 
in which additional Medicare payment was made.'^^ As a condition of 
payment, all hospitals must have a contract with the designated PRO 
authorizing the PRO to conduct these review activities. ^^^ 

PRO'S have considerable power to force hospital compliance with 
HHS admission and other quality standards. They may deny payment 
to hospitals where abusive practices are found and, in some instances, 
report such practices to HHS for additional enforcement action. '"^^ In 
the Consolidated Budget Reconciliation Act of 1985, this punitive au- 
thority was expanded to permit PRO's to deny payment for specific 
cases in which the PRO finds that substandard care was provided to a 
Medicare beneficiary.''*^ In addition, PRO's handle appeals of benefi- 
ciaries and hospitals regarding coverage of and, in some instances, 
payment for hospital services under the prospective payment system. '"^^ 

The basic responsibility of PRO's is to see that the hospital services 
that the Medicare program purchases for individual beneficiaries are 
appropriate, necessary, and provided in the most cost effective manner. 
PRO'S are also the means by which beneficiaries as well as hospitals 
can challenge Medicare coverage and payment decisions that they find 
unfair. Implicit in these responsibilities are two critical functions from 
an ethical perspective. The first function is to oversee how hospitals and 
physicians allocate health care resources among individual Medicare be- 
neficiaries who need these services and specifically whether these services 
were of sufficient amount and quality. The second function, as explained 
below, is to provide a mechanism whereby individual beneficiaries can 
register complaints when they believe that hospitals, physicians, or the 
Medicare program have not allocated resources fairly in their individual 
cases. 

4. Protecting Individual Interests: Opportunity for Appeal. — The pro- 
cedures available for administrative and judicial review under the Social 
Security Act are a chief means for individual beneficiaries and also 
hospitals to raise specific objections about their treatment under the pro- 
spective payment system and to contest decisions about the allocation of 
Medicare services that affect them directly. Where allocation decisions 
affect the quality of services, tort law also offers some protection to 
individual beneficiaries vis-a-vis providers. The ability of hospitals and 



'''Id. § 1395cc(a)(l)(F). 

'''Id. 

''"Id. §§ 1320c-3(a)(2), 1 3 20c-5 (b)(1). 

'^'Consolidated Omnibus Budget Reconciliation Act of 1985, Pub. L. No. 99-272, 
tit. IX, § 9403, 100 Stat. 82, 200 (amending 42 U.S.C. § 1320c-3(a)(2) (1982 & Supp. 
1985)). 

'*^See infra notes 143-50 and accompanying text. 



1 986] MEDICARE PROSPECTIVE PA YMENT 1181 

beneficiaries to challenge the composition of DRG's is specifically pre- 
cluded by statute, '^^ thus effectively inhibiting the ability of individual 
beneficiaries and hospitals to challenge effectively the allocation of 
resources to Medicare hospital services at the societal level. 

Beneficiaries have a right to administrative and judicial review of 
disputes over coverage of and payment for hospital services under the 
Medicare program. If a beneficiary is denied coverage and payment for 
any inpatient hospital service, including admission or continued stay in 
the hospital, the beneficiary may appeal the decision to the PRO and 
seek reconsideration of the PRO decision by HHS.'"^ If the amount 
involved exceeds $200, the beneficiary can obtain a hearing before an 
administrative law judge in the Social Security Administration and, for 
claims exceeding $2000, judicial review in federal district court. '"^^ 

As noted, individual beneficiaries have the right to challenge sub- 
standard care under the common law tort system and this ability, ac- 
cording to some observers, provides an effective protection against 
substandard or insufficient care in a rationing context.'"*^ In this regard, 
a recent California decision, Wickline v. State, ^"^^ in which the court 
recognized that a payer could be liable for negligence in cases where a 
provider's decision to terminate treatment was predicated on the payer's 
poHcy of limiting payment for the treatment, is important. This case 
suggests tort law could provide greater protection in the future by 
imposing liability directly on payment programs that force hospitals to 
deliver services more efficiently and limit needed services in specific cases 
as well as some protection to providers forced to make treatment decisions 
because of cost considerations. 

Hospitals have more limited rights of appeal under the prospective 
payment system. Congress prohibited providers from challenging the 
DRG prices through administrative appeal or judicial review. Specifically, 
a hospital may obtain administrative or judicial review of any payment 
decision except the estabHshment of DRG's, the methodology for clas- 
sifying patient discharges into DRG's, or the appropriate weighting factor 



^*^See infra notes 149-50 and accompanying text. 

'"^2 U.S.C. § 1320C-4 (Supp. 1985); 42 C.F.R. §§ 473.16, .40 (1986). 

'^M2 U.S.C. § 1320C-4 (1982 & Supp. 1985); 42 C.F.R. §§ 473.16, .40 (1986). 

"*^Blumstein, Rationing Medical Resources, supra note 15, at 1392-99; see also Schuck, 
Malpractice Liability and the Rationing of Care, 59 Tex. L. Rev. 1421 (1981). But see 
Rosenblatt, Rationing "Normal" Health Care, 59 Tex. L. Rev. 1401, 1411-19 (1981). 
This article challenges Professor Blumstein's thesis that medical malpractice serves as an 
adequate check to the unfair rationing of resources on an individual basis. 

'^'183 Cal. App. 3d 661, 228 Cal. Rptr. 661 (1986), rev. granted, slip op. (Cal. Nov. 
20, 1986). See Comment, Provider Liability Under Public Law 98-2L The Medicare 
Prospective Payment System in Light of WickUne v. State, 34 Buffalo L. Rev. 1011 
(1985). 



1182 INDIANA LAW REVIEW [Vol. 19:1151 

for DRG's.^'*^ Congress, like the Reagan Administration which advocated 
even more restrictive appellate rights for hospitals, '"^^ expressly precluded 
such review out of concern that it would jeopardize the integrity of the 
rate structure under the prospective payment system. '^° 

B. Performance of the Model 

It is still early to assess fully the efficacy of this administrative 
model in making decisions about the allocation of limited Medicare 
resources either on a societal level or an individual level. However, at 
this point, the fourth year of the prospective payment system, some 
observations about the model and its ability to meet its important resource 
allocation responsibilities are possible and appropriate. In assessing the 
performance of this model, it must be appreciated that many hospitals 
have done quite well under the system'^' and serious scarcities requiring 
difficult allocation decisions have not occurred. 

To date, four issues have emerged that suggest how this administrative 
model is working in allocating resources for hospital services. First is 
the annual process of updating hospital payment rates.'" Second is the 
question of whether the prospective payment system should accord special 
financial treatment to hospitals that serve a disproportionate number of 
low income and Medicare patients. '^^ Third is the implementation of the 
peer review program and the specific problems of developing an adequate 
mechanism for monitoring the quality of care that hospitals provide 
Medicare beneficiaries.'^'* Finally there is the question of how this ad- 
ministrative structure dealt with reported problems that Medicare be- 
neficiaries were discharged from hospitals in a sicker condition, against 
their will, and with little recourse to contest such discharge decisions. '^^ 

1. Updating the DRG prices. — As discussed above, the federal gov- 
ernment makes decisions at the societal level about the allocation of 
federal resources to hospital services for Medicare beneficiaries by setting 
the price that the Medicare program will pay for each Medicare case. 
It is clear from performance to date that the executive branch has taken 



'^H2 U.S.C. §§ 139500(g)(2), 1395ww(d)(7) (1982 & Supp. 1985). 

'■"See supra note 106. 

'^°H.R. Rep. No. 25, Pt. 1, 98th Cong., 1st Sess. 142-3 (1983); H.R. Rep. No. 47, 
98th Cong., 1st Sess. 202 (1983). 

'^'5ee Dep't of Health & Human Services, Ofhce of Inspector General, Financlal 
Impact of the Prospective Payment System on Medicare Participating Hospitals - 
1984 (1984); ProPAC Report on the American Health Care System, supra note 85, 
at 47, 52-53; National Health Expenditures, 1984, supra note 14, at 23. 

"^See infra notes 156-75 and accompanying text. 

^"See infra notes 176-97 and accompanying text. 

""See infra notes 198-208 and accompanying text. 

'^'5ee infra notes 209-16 and accompanying text. 



1986] MEDICARE PROSPECTIVE PAYMENT 1183 

a Strict view of the federal resources that will be allocated to this purpose. 
This position has generated conflict with hospitals and also with Congress. 
HHS has not adopted ProPAC recommendations on various metho- 
dologies for updating hospital payment rates and has always developed 
lower rates than it would using formulas suggested by ProPAC. '^^ In 
recent years, Congress, relying on ProPAC's analysis, has legislatively 
supplanted HHS rules on updating hospital payment rates in order to 
establish more generous payment rates. ^^^ 

In its first recommendations for fiscal year 1986 payment rates, 
ProPAC conservatively confined its recommendations to updating hos- 
pital payment rates and changing one DRG which had permitted hospitals 
to make enormous profits. '^^ HHS adopted another method for updating 
payment rates, which resulted in a lower payment rate for fiscal year 
1986, and changed several DRG's.'^^ In its fiscal year 1987 recommen- 
dations, ProPAC was more activist. Besides recommendations on up- 
dating payment rates, ProPAC proposed that the Secretary include capital 
costs in the DRG prices beginning in fiscal year 1987 and that HHS 
adjust certain DRG's to reflect new treatment modalities and their use 
of labor resources. '^^ ProPAC also addressed issues outside its strict 
statutory mandate and made recommendations for improved appeals 
procedures for beneficiaries and improved quality of care review by 
PRO'S. '^' Again, HHS disregarded ProPAC's recommendations on hos- 
pital payment rates and adopted formulas and assumptions for fiscal 
year 1987 that resulted in lower payment rates than suggested by 
ProPAC. '^^ HHS also proposed folding capital costs into the DRG prices 
but in a manner different and less expensively than ProPAC had pro- 
posed. '^^ 

The Administration's action on updating hospital payment rates for 
fiscal years 1986 and 1987 has been controversial. In commenting on 
the fiscal year 1987 rates, hospitals charged that HHS was motivated 
chiefly by its desire to cut Medicare budgetary expenditures rather than 
setting a fair price for hospital services. Specifically, according to an 
AHA spokesman: 



^^^See infra notes 165-67 and accompanying text. 
^^''See infra notes 172-75 and accompanying text. 



'^^RoPAC Report and Recommendations to the Secretary, April 1, 1985, supra 
note 129, at 8, 33-35, 41-42. 

'^'Preamble to Proposed Rule, 50 Fed. Reg. 24,366. (1985); Interim Final Rule, 51 
Fed. Reg. 16,772 (1986). 

'*"ProPAC Report and Recommendations to the Secretary, April 1, 1986, supra 
note 115, at 32-33. 

'*'See infra notes 209-30 and accompanying text. 

'^^51 Fed. Reg. 16,772 (1986). 

■"51 Fed. Reg. 19,970, 19,983-85 (1986). 



1184 INDIANA LAW REVIEW [Vol. 19:1151 

In our response to the FFY 1986 proposed rule on PPS, AHA 
commented that *'the Health Care Financing Administration 
(HCFA) has an obHgation to the public to do more in the Notice 
than provide a statement of those beliefs that form the basis 
for the rule; HCFA must provide evidence which validates their 
beHefs." For a second year, the notice of proposed rates fails 
to document the appropriateness and validity of the update factor 
and other changes. Absent detailed evidence, AHA must assume 
that the primary motivating factor in the development of each 
component of the rate calculation is budget reduction. We can 
only conclude that HCFA is not truly interested in the adequacy 
of the rates that are promulgated, the equity of payments to 
hospitals or the administration of the Medicare program in a 
manner that reflects its responsibilities to Medicare beneficiaries 
and providers. If these issues had been considered in the de- 
velopment of the PPS rates for FY 1987, the update factor and 
other modifications identified by HCFA would be better doc- 
umented by quantitative and qualitative evidence of the adjust- 
ments and their appropriate levels. '^"^ 

ProPAC has also voiced complaints about HHS' conduct in updating 
hospital payment rates. In its comments to the proposed rule on payment 
rates for fiscal year 1987, ProPAC observed that its approach and that 
of HHS in updating hospital payment rates were ''diverging in significant 
ways" and this divergence appeared to be based on a ''difference in 
philosophy between the Commission and the Department. "^^^ ProPAC 
explained this difference in philosophy as based on ProPAC 's belief that 
the prospective payment system "should be a flexible and evolutionary 
system responsive to changing health technology and practice patterns 
and to the distributional impacts of payments within the system" and 
that adjustments in the system are "critical to maintaining an environment 
which fosters innovation and scientific advancement."'^^ HHS, in relying 
on averaging methodologies and ignoring adjustments in the payment 
system to reflect special circumstances and new developments in medical 
technology and their impact on specific DRG's, did not advance these 



'"Letter from Jack Owen, Executive Vice President of the American Hospital As- 
sociation, to William Roper, M.D., Administrator of the Health Care Financing Admin- 
istration (July 3, 1986) (comments on Proposed PPS Rules for FFY 1987). 

'^'Letter from Stuart H. Altman, Ph.D., Chairman of the Prospective Payment 
Assessment Conmiission, to WiUiam L. Roper, M.D., Administrator of the Health Care 
Financing Administration (July 2, 1986) (comments of the Prospective Payment Assessment 
Commission on the Notice of Proposed Rulemaking of June 3, 1986, Concerning Fiscal 
Year 1987 Changes in the Inpatient Hospital Prospective Payment System). 



1986] MEDICARE PROSPECTIVE PAYMENT 1185 

objectives. ProPAC commented further on HHS' response to ProPAC's 
recommendations: 

ProPAC was established by the Congress to provide independent 
advice and oversight on a new, untried prospective payment 
system. From the beginning, we have strived to make our de- 
cision-making analytically based, with careful consideration to 
a wide range of options on every topic which we review. We 
do not believe that the Secretary's response to our recommen- 
dations always gives full consideration to the detail and extent 
of the problems we have identified. We also do not believe that 
the response exhibits the flexibility which we believe is necessary 
to update and maintain the system. In order to encourage the 
confidence of beneficiaries, providers, suppliers, and taxpayers, 
we hope that the Secretary will reconsider the details of our 
analysis in developing the final fiscal year 1987 PPS regulations. ^^^ 

Finally, there was even debate within the Administration about the 
fairness of the updated payment rates, i.e., 0.5%, that the Administration 
had proposed in June 1986.'^^ In August 1986, the new physician Secretary 
of HHS, Dr. Otis Bowen, took the position that if the fiscal year 1987 
hospital payment rates were not updated at least 1.5%, then the quality 
of hospital care for Medicare beneficiaries would be jeopardized.'^^ 
Eventually, the Office of Management and Budget prevailed in the 
internicine debate, and the final rule updated fiscal year 1987 payment 
rates 0.5%.'^« 

In the context of setting the federal budget, Congress has taken an 
extraordinarily active role in updating hospital payment rates and thus 
in making allocation decisions as to how much federal resources should 
be devoted to hospital care for Medicare beneficiaries. Initially, Congress 
took a restrictive perspective as to the amount of resources to devote 
to this purpose and in the Deficit Reduction Act of 1984 tightened the 
formula for updating hospital payment rates to account for inflation.'^* 

But since 1984, Congress has taken a more expansive perspective, 
at least when compared with the executive branch. Congress has not 
approved of the Administration's positions on how to adjust hospital 
payment rates and has supplanted HHS rules for updating hospital 
payment rates with legislation for fiscal years 1986 and 1987. Specifically, 



''''Id. 

•^«51 Fed. Reg. 19,970 (1986). 

'^^Am Hosp. Ass'n, Washington Memo, (Memo #616, Aug. 29, 1986). 
''°51 Fed. Reg. 31,498 (1986). 

'^•Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 2310(a), 98 Stat. 1075 (codified 
as amended at 42 U.S.C. § 1395ww(b)(3)(B) (Supp. 1985)). 



1186 INDIANA LAW REVIEW [Vol. 19:1151 

Congress refused to uphold a freeze on hospital payment rates that HHS 
proposed for fiscal year 1986.'^^ Also, in the Balanced Budget Budget 
and Emergency Deficit Control Act of 1985 (Graham-Rudman-HolHngs), 
Congress mandated that hospital payments could only be reduced from 
fiscal year 1986 payment rates by one percent for the remainder of the 
fiscal year and by two percent in following years to assure that the 
Medicare program was not the target of excessive budget cutting. ^^^ Also, 
in the Omnibus Budget Reconciliation Act of 1986, Congress increased 
hospital payment rates by 1.15% for fiscal year 1987 compared to the 
0.5% proposed by HHS.^^"^ The House Ways and Means Committee 
expressed considerable displeasure with HHS' performance in updating 
rates and the consequent need for Congress to step in and change rates 
legislatively, stating: 

The Committee has given, in the past, a significant amount of 
discretion to the Secretary of Health and Human Services in 
developing the annual update factor for hospital payments under 
the [M]edicare program. The statutory language requires that 
hospital payments reflect the amounts necessary for the efficient 
delivery of medically appropriate and necessary care of high 
quality. 

The Committee has, however, for the last two years overridden 
the Administration's recommended update factor. The Committee 
finds itself in the same situation once again this year as it finds 
the Secretary's recommended FY 1987 update factor unaccept- 
able. The Committee concludes that the Administration, in de- 
veloping the update factor for fiscal year 1987 used factors other 
than those originally anticipated in the legislation. ^^^ 

It is clear that under the current administrative model, the executive 
branch has considerable authority to determine the proportion of federal 
resources that will be attributed to hospital care of Medicare beneficiaries. 
It is also clear that ProPAC's role and the mandated dialogue between 



'''See Emergency Extension Act of 1985, Pub. L. No. 99-107, § 5(c), 99 Stat. 480, 
amended by Pub. L. No. 99-201, § 34, 99 Stat. 1184 (1985); Consolidated Omnibus Budget 
Reconciliation Act of 1985, Pub. L. No. 99-272, § 9101, 100 Stat. 82 (codified as amended 
at 42 U.S.C. §§ 1395ww(b)(3)(B), (d)(3)(A) (Supp. 1985)). 

This legislation abrogated the freeze on fiscal year 1986 payment rates HHS pro- 
mulgated in its Final Rule of 1986 Rates, 50 Fed. Reg. 35,646 (1985), and substituted a 
freeze on payment rates at levels Congress determined. 

'"^Balanced Budget and Emergency Deficit Control Act of 1985, Pub. L. No. 99- 
177, § 3256(d)(1), 99 Stat. 1087. 

'^'Omnibus Budget Reconciliation Act of 1986, Pub. L. No. 99-509, § 9303(a), 100 
Stat. (amending 42 U.S.C. § 1395ww (1982 & Supp. 1985)). 

•^^H.R. Rep. No. 727, 99th Cong., 2d Sess. 427 (1986). 



1986] MEDICARE PROSPECTIVE PAYMENT 1187 

HHS and ProPAC have not functioned as intended to force HHS to 
state the rationale for its decisions about payment rates in a detailed 
manner and justify those that are contrary to the outside commission 
of experts. Indeed, this process has had little effect on influencing how 
HHS actually updates the DRG prices. This situation has precipitated 
a more interventionist role by Congress in the rate setting process and 
has changed the role of ProPAC. ProPAC has provided Congress with 
the information that it needs to substitute its own judgments for those 
of the executive branch in this complex, highly technical area, through 
the political process. This administrative model thus exemplifies a process 
by which the legislative branch can obtain the requisite technical infor- 
mation to make informed judgments that are generally left to admin- 
istrative agencies and their technical expertise. 

2. Treatment of Disproportionate Share Hospitals. — In the pro- 
spective payment system. Congress authorized the Secretary to make 
exceptions and adjustment for ''public and other hospitals that served 
a significant disproportionate number" of low income and Medicare 
patients. ^"^^ In authorizing this adjustment, Congress was concerned that 
such hospitals may serve patients that are "more severely ill than average 
and the DRG payment system would not adequately take into account 
such factors. "*^^ In refining the payment methodology for the prospective 
payment system initially, HHS refused to adopt an adjustment for such 
hospitals because "current data do not show that such an adjustment 
is warranted," and HHS has consistently maintained this position ever 
since. '^^ 

HHS' refusal to create an adjustment for so-called disproportionate 
share hospitals generated considerable litigation by public and other 
hospitals that serve primarily low income patients seeking a judicial 
mandate that HHS create an exception for disproportionate share hos- 
pitals. ^^^ In Redbud Hospital District v. Heckler, ^^^ the United States 



'M2 U.S.C. § 1395ww(d)(5)(c)(i) (Supp. 1985). 

'"H.R. Rep. No. 25 Part I, 98th Cong., 1st Sess. 192-3 (1983); see also S. Rep. No. 
23, 98th Cong., 1st Sess. (1983); H.R. Rep. No. 47, 98th Cong., 1st Sess. (1983). 

'^^Preamble to Final Rule, 49 Fed. Reg. 234, 276 (1984). 

^^'^See, e.g., Samaritan Health Center v. Heckler, [1986-1 Transfer Binder] Medicare 
& Medicaid Guide (CCH) 1 34,862 (D.D.C. Aug. 28, 1985); Sunshine Health Sys., Inc. 
V. Heckler, [1986-1 Transfer Binder] Medicare & Medicaid Guide (CCH) 1 34,858 (CD. 
Cal. July 22, 1985); Redbud Hosp. Dist. v. Heckler, [1984-2 Transfer Binder] Medicare 
& Medicaid Guide (CCH) 1 34,085 (N.D. Cal. July 30, 1984), modified, [1985 Transfer 
Binder] Medicare & Medicaid Guide (CCH) 1 34,669 (N.D. Cal. June 14, 1985), application 
for stay of preliminary injunction granted, 106 S. Ct. 1 (1985) (Rehnquist, J. sitting as 
Circuit Judge). 

•«°[ 1984-2 Transfer Binder] Medicare & Medicaid Guide (CCH) t 34,085 (N.D. Cal. 
1984), modified, [1985 Transfer Binder] Medicare & Medicaid Guide (CCH) 1 34,669 (N.D. 
Cal. June 14, 1985), application for stay of preliminary injunction granted, 106 S. Ct. 1 
(1985) (Rehnquist, J., sitting as Circuit Judge). 



1188 INDIANA LAW REVIEW [Vol. 19:1151 

District Court for the Northern District of California ruled that the 
Secretary of HHS had abused her discretion in not addressing the special 
needs of disproportionate share hospitals and ordered HHS to promulgate 
regulations or written policies that would "take into account the special 
needs" of disproportionate share hospitals. ^^^ HHS did issue regulations 
authorizing a very narrowly drawn exception applicable for very few 
hospitals^ ^^ when the Redbud district court ordered their promulgation 
by July 1, 1985.'^^ HHS rescinded these regulations when Justice Rehn- 
quist, sitting as circuit judge, stayed the court's order. ^^"^ 

Concerns about treatment of disproportionate share hospitals under 
the prospective payment system were raised in other arenas as well. 
Congress became concerned about HHS' refusal to address adequately 
the special needs of disproportionate share hospitals. ^^^ In the Deficit 
Reduction Act of 1984, Congress provided that before December 31, 
1984, the Secretary "shall" develop and publish a definition of dispro- 
portionate share hospitals, identify those which meet the definition, and 
notify the Senate Finance Committee and House Ways and Means 
Committee accordingly.'^^ 

HHS did not meet this deadline and, through its inaction, behaved 
in a fashion that suggested that it did not plan to comply with this 
congressional directive. Consequently, in Samaritan Health Center v. 
Heckler, ^^^ the United States District Court for the District of Columbia 
ordered the Secretary to comply with section 2315(h) of the Deficit 
Reduction Act of 1984 by December 31, 1985. However, the Samaritan 
Health Center court concluded that the Secretary did have discretion as 
to whether or not to create an adjustment for disproportionate share 
hospitals. '^^ 

In its report to the Secretary on the fiscal year 1986 hospital payment 
rates, ProPAC recommended that the Secretary develop a methodology 
for adjusting payment rates for hospitals that serve a disproportionate 
share of Medicare and low income patients that Congress authorized in 
the Social Security Amendments of 1983.'^^ ProPAC justified this rec- 



'«'M at 9884. 

"^50 Fed. Reg. 27,208 (July 1, 1985). 

'"[1985 Transfer Binder] Medicare & Medicaid Guide (CCH), at 1 34,669. 

'«M06 S. Ct. 1 (1985). See 50 Fed. Reg. 30,944 (July 31, 1985). 

^^^See Administration's Fiscal Year 1985 Budget Proposals: Hearings Before the Senate 
Comm. on Finance, 98th Cong., 2d Sess. (1984). 

•'^Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 2315(h), 98 Stat. 1075 
(codified as amended at 42 U.S. C. § 1395ww(b)(3)(B) (Supp. 1985)). 

'«11986-1 Transfer Binder] Medicare & Medicaid Guide (CCH) 1 34,862 (D.D.C. 
Aug. 29, 1985). 

^^^Id\ accord Sunshine Health Sys. v. Heckler, [1986-1 Transfer Binder] Medicare & 
Medicaid Guide (CCH) f 34,858 (CD. Cal. July 22, 1985). 

'^'ProPAC Report and Recommendations to the Secretary, April 1, 1985, supra 
note 129, at 37. 



1986] MEDICARE PROSPECTIVE PAYMENT 1189 

ommendation with analysis of data indicating that pubHc and other 
hospitals serving the poor and Medicare patients incurred greater costs 
in the treatment of these patients. '^° However, in its payment rates for 
fiscal year 1986, HHS refused to create an adjustment to reflect higher 
costs for disproportionate share hospitals, relying on its consistent po- 
sition that HHS data did not justify such an exception. ^^^ 

In December 1985, HHS published a definition of disproportionate 
share hospitals that provided that eligible hospitals must serve 39.55% 
low income patients and 91.01% Medicare patients. '^^ According to this 
definition, only 108 hospitals fit under the definition, and large pubhc 
hospitals that one would expect Congress intended to assist with the 
disproportionate share provisions were not included. *^^ 

ProPAC clearly was not convinced that this definition was adequate 
and, in its recommendations for fiscal year 1987 payment rates, ProPAC 
reiterated its recommendation that the Secretary implement an adjustment 
for disproportionate share hospitals. ^^"^ In the proposed rule, HHS re- 
sponded to ProPAC's recommendations by stating that it had compHed 
with the Deficit Reduction Act of 1984.^^^ Nor was Congress convinced 
that HHS had complied with its requirements that hospitals serving these 
special patients be treated specially and therefore fairly under the pro- 
spective payment system. In the Consolidated Budget Reconciliation Act 
of 1985, Congress redefined disproportionate share hospitals more gen- 
erously to include more hospitals, including those urban public hospitals 
that one would expect would care for large proportions of indigent 
patients on public health insurance programs. '^^ In the Omnibus Budget 
Reconciliation Act of 1986, Congress further refined the methodology 
for paying disproportionate share hospitals to provide additional assist- 
ance to those in rural areas. '^^ 

HHS' treatment of the disproportionate share hospital issue indicates 
that the executive branch has narrowly viewed the needs of hospitals 
serving underserved groups and restricted the allocation of Medicare 
resources to those hospitals. Further, it is clear that ProPAC disagrees 
with HHS' allocation decisions but is relatively powerless, except by 



'^Id. at 37-38. 

'^'50 Fed. Reg. 24,393 (1985). 

•'^50 Fed. Reg. 53,398 (1985). 

"^For a list of disproportionate share hospitals, see [1986-1] Medicare & Medicaid Guide 
(CCH) \ 35,102. 

'^'*ProPAC Report and Recommendations to the Secretary, April 1, 1986, supra 
note 115, at 37. 

'^=51 Fed. Reg. 19,970, 19,996 (1986). 

"'Consolidated Omnibus Budget Reconcihation Act of 1985, Pub. L. No. 99-272, 
§105, 100 Stat. 82 (amending 42 U.S.C. § 1395ww(d)(5) (Supp. 1985)). 

"'Omnibus Budget Reconciliation Act of 1986, Pub. L. No. 99-509, § 9306, 100 Stat. 
(amending 42 U.S.C. § 1395ww(d)(5)(F) (Supp. 1985)). 



1190 INDIANA LAW REVIEW [Vol. 19:1151 

virtue of is analytical authority, to get HHS to change its position. The 
key player in this allocation decision, as clearly conceived by the courts, 
is Congress. Congress has stepped in several times to address the problems 
of hospitals serving a poor clientele with special and expensive needs, 
indicating that the ultimate means of resolving allocation problems under 
the prospective payment system has been essentially political. 

3. Implementation of the PRO Program. — Reviews of PRO per- 
formance in monitoring hospital behavior and quality of care under the 
prospective payment system are mixed. By statute, hospitals had to have 
a contract with a PRO by October 1984, although this date was extended 
to November 1984 because of HHS' delays in entering contracts with 
pro's in all states and in issuing the requisite regulations for the selection 
and designation of PRO's and other administrative matters, a matter 
of grave concern to Congress. '^^ By November 1984, HHS entered con- 
tracts with fifty-four PRO's for all states and territories. ^^^ Many PRO's 
were slow getting started and the performance of some PRO's was so 
deficient that HHS terminated their participation in the program. ^^^ 

The chief complaint of PRO's, Congress, hospitals and beneficiaries 
about HHS's administration of the program in its first two years was 
that the contracts required PRO's to focus excessively on cost containment 
goals to the detriment of quality of care goals, with concentration chiefly 
on reducing unnecessary hospital admissions. ^^' For the first PRO con- 
tracts, HHS delineated five quality objectives: (1) reduce unnecessary 
hospital readmissions resulting from substandard care; (2) assure provision 
of medical services which, if not performed, have a significant potential 
for causing comphcations; (3) reduce "avoidable deaths;" (4) reduce 
unnecessary surgery and invasive procedures; and (5) reduce postoperative 
and other complications. ^^^ 

In the first year of the prospective payment program, concerns were 
raised that these objectives did not permit PRO's to determine whether 



""Deficit Reduction Act of 1984, Pub. L. No. 98-369, § 2347(c), 98 Stat. 494 
(amending 42 U.S.C. § 1 302c-2(b)(2) (Supp. 1985)). HCFA did not promulgate final regula- 
tions to govern PRO activities until April 1985. 50 Fed. Reg. 15,312 (1985). 

"'Dans, Weiner & Otter, Peer Review Organizations — Promises and Pitfalls, 313 New 
Eng. J. Med. 1131 (1985). 

^°^See Prospective Payment Assessment Comm'n, Technical Appendixes to the 
Report and Recommendations to the Secretary, U.S. Department of Health and 
Human Services, April 1, 1986, App. C at 158 [hereinafter Technical Appendixes to 
the ProPAC Report and Recommendation to the Secretary, April 1, 1986]. 

^°'Am. Ass'n of Peer Review Ass'ns, PRO's: The Future Agenda (1985); see also 
Dans, Weiner & Otter, supra note 200; Gosfield, Hospital Utilization Control by PROs: 
A Gu