Medical Care at Michigan responds to changes sweeping the industry
A Revival At
The Health System of Last Resort

Lloyd Jacobs woke up on May 30, 1996, knowing it was going to be a really bad day. For months, Dr. Jacobs and members of his cost-effectiveness committee had been analyzing budget reports and meeting with hospital executives searching for a way to avoid what had to be done. But there was no alternative. As chair of the committee, it was his job to walk into a press conference and announce the layoff of 200 employees and the elimination of l,055 jobs at the University of Michigan Medical Center--all part of a three-year plan to cut expenses by $200 million.

News of the first widespread layoffs at the Medical Center in more than 20 years sent shock waves through Ann Arbor and the University community. Demonstrators picketed the U-M Board of Regents meeting. Reporters interviewed stunned employees who had just received termination notices. Economists speculated about the impact on the local economy.

Michigan residents were used to hearing about auto industry layoffs and corporate downsizing. But pink slips at the U-M Medical Center? With a $913 million budget, over 8,000 employees and $151 million in research funding, how could one of the world's most prestigious academic medical centers be in financial trouble?

Like many hospitals around the country, the Medical Center was a victim of forces beyond its control. It was trapped between skyrocketing costs of medical care and fundamental changes taking place in the US health care industry.

From 1980 to 1995, the total amount spent on health care in the United States soared from $247 billion to $988 billion. In an attempt to control medical costs and reduce a growing budget deficit, Congress started cutting back on Medicare and Medicaid payments to hospitals in the mid-1980s. About the same time, corporations-looking for a way to reduce the escalating costs of health insurance-began moving employees from traditional fee-for-service health plans to what has come to be known as "managed care." The simultaneous loss of millions of dollars in income from two major funding sources devastated the nation's teaching hospitals.

The beautiful, new U-M Medical Center looked great on the outside. But the people who balanced the budget knew it was only a matter of time. With a $16-million operating loss and a falling admissions rate, the hospital's prognosis was grim.

The coming of 'managed care'/HMOs
"Things were a lot simpler back in the 1980s," sighs Tom Marks, who coordinates financial services for U-M Hospitals. "Back then, individualized payment plans and special contractual arrangements were the exception. There were fewer billing rules and less negotiating with managed care firms or Medicare. Basically, we billed the full amount; they paid the full amount."

Coping with the financial impact of managed care is one of the more challenging aspects of Marks's job these days. The concept of managed care originated 40 years ago but wasn't widely adopted until the late 1980s in California. The most common form--the health maintenance organization or HMO--manages health care costs through a process called capitation. Under capitation, HMOs give local physicians and hospitals a fixed amount of money to provide medical care for HMO members. All the expenses for treating HMO patients come from one common pot. If there is anything left in the pot after health care expenses, then physicians and hospitals make money; if not, they break even or take a loss. Managed care companies can be either for-profit or not-for-profit.

For-profit managed care is less common in Michigan than in California, Minnesota, Massachusetts or New York, where it was introduced much earlier. Michigan's health care market has always been influenced by the automobile industry, and employees at Ford, General Motors and Chrysler wanted traditional fee-for-service medical plans from firms like Blue Cross/Blue Shield of Michigan. This gave Michigan hospitals and health systems time to create their own non-profit managed care plans, of which U-M's M-CARE is one. Like other industries nationwide, the auto industry is now encouraging its employees to join HMOs in an effort to cut health care costs.

"Five years ago, the Medical Center received less than 10 percent of its revenue from managed care," Marks says. "This fiscal year, 28 percent of our gross revenue will come from managed care. We expect that percentage will continue to increase."

Managed care creates its own set of winners and losers. Because the primary goal is to cut costs, HMOs favor hospitals that provide medical care at a lower price. To survive under managed care, hospitals need large networks of primary care physicians who refer patients to that hospital. Increased patient volume helps cover the hospital's fixed operating costs.

Unfortunately, the U-M Medical Center as it existed in the early 1990s was a big loser under the terms imposed by managed care. It had fewer than 50 primary care physicians on the faculty, and it was the most expensive hospital in the state.

Why academic centers cost more
Why is the Medical Center more expensive? One big reason is that it has always been, first and foremost, a teaching institution. U-M administrators point out that tuition doesn't begin to cover the costs of training a medical student. Because clinical revenue must subsidize the costs of medical education, they say, teaching hospitals are always more expensive than non-teaching hospitals.

When the first University Hospital opened in 1869, it was the only university-owned teaching hospital in the United States. Its purpose was to provide a clinical practice setting for students at the U-M Medical School, which was established in 1850. Since 1869, the patient care and educational missions of U-M Hospitals and the Medical School have become so intertwined that it is virtually impossible to separate the costs associated with each.

Before managed care, when government agencies and insurance companies were willing to reimburse hospitals on a full fee-for-service basis, it really didn't matter that part of each patient's bill went to cover educational expenses. Many of today's managed care companies, however, maintain it's not their responsibility to subsidize medical education. The HMOs want academic medical centers to document exactly how much they spend on education, so educational costs can be excluded when HMOs set prices for patient care.

A task force of Medical School faculty and administrators currently is trying to identify the true costs of educating medical students and house officers (what the U-M calls residents or new MDs), who spend three to eight years specializing in their chosen field. The task force's job will not be easy.

For example, third-year medical students now spend about half their time working with house officers and faculty physicians in 30 outpatient Health Centers in southeast Michigan. Medical students don't treat patients, but they do take medical histories and observe patient visits. At the end of the day, how much of the supervising physician's time was spent on education and how much on patient care? How many more patients could she have seen that day if she hadn't spent time working with students?

Residents treat patients, but only under the direct supervision of a faculty physician. Even though they never set foot inside a classroom, these physicians spend part of each day on instructional tasks--time which otherwise could be devoted to patient care or research. Also, there are additional demands on nurses who train residents in basic hospital or clinic procedures, and on support staff who handle the extra scheduling and paperwork.

"Teaching in a hospital or clinic setting is not well understood or appreciated by people who are only familiar with teaching in a traditional classroom setting," says Steven A. Goldstein, a professor of surgery and biomedical engineering in the U-M Medical School. "It's intense, one-on-one and requires a major commitment of time and energy."

Medicare supports residency training
Since its establishment in 1965, the tax-funded federal Medicare program has paid academic medical centers a share of the costs of training the nation's 102,000 medical residents. Medicare's share is determined by the percentage of a hospital's patients who are covered by Medicare.

In 1983, Congress established an additional payment for academic medical centers, called the indirect medical education (IME) payment. IME payments are designed to help teaching hospitals cover higher costs incurred from treating sicker patients who need more complex and expensive medical care. The exact amount varies from hospital to hospital, because of a complicated adjustment formula written into the Medicare statute.

In 1995, IME payments to academic medical centers totaled $6.1 billion. "IME is the lifeblood of a place like this," says Rick Bossard, government relations officer for the U-M Health System. Unfortunately, that lifeblood is slowly draining away, as Congress-in an effort to control health care costs and balance the federal budget-keeps reducing the reimbursement amount. When the program started in 1983, the reimbursement rate was nearly 12 percent. The current rate of 7.7 percent will be reduced to 5.5 percent by the year 2001. Since 26 percent of the U-M Health System's annual gross revenue comes from Medicare, every percentage point drop in IME translates into a multimillion-dollar revenue cut.

And just to make life even more interesting for the folks in the budget office, all the old fee-for-service payers-Medicare, Medicaid and Blue Cross/Blue Shield of Michigan-are threatening the Health System's future revenue even more by encouraging members to leave traditional programs and join managed care plans.

Nearly 28 percent of the Health System's gross revenue comes from Blue Cross/Blue Shield of Michigan, according to financial director Marks. Just a few years ago, most BC/BSM members were enrolled in traditional, fee-for-service health plans. Today about 15 percent of all BC/BSM members are enrolled in the Blue Cross HMO, Blue Care Network. Nearly one-third of Michigan's one million Medicaid recipients are in managed care plans now and that number is expected to double within the next few years. And many HMOs in Michigan are offering "senior plans" to encourage people to switch from Medicare to managed care.

As managed care becomes a more dominant force in Michigan, Marks worries about what will happen if the Health System has to compete with less expensive community hospitals on the basis of cost alone.

"So far, most of our major payers have been willing to pay more for basic health care here in order to give their members access to our high-end tertiary care," Marks says. "The question is, how long will they continue to do this?"

'Grading' the hospitals
Just as universities use grade-point averages to evaluate applications from potential students, managed care administrators compare hospitals on the basis of cost-per-case. The hospital with the lowest cost-per-case number has a big advantage in the managed care market. The basic premise behind calculating cost-per-case is simple: Add up all your expenses and divide by the number of patients treated in a given period of time.

In actual practice, it's not so easy. A complex formula is used to factor in differences in the case-mix ratio between the number of patients admitted, say, for open heart surgery vs. the number going to a clinic to see their doctor about a sore throat. Some hospitals include expenses for depreciation, malpractice insurance and even the hospital gift shop. Others limit expenses to direct costs of patient care.

But no matter how you run the numbers, the hard truth is that the UMHS is more expensive than competing hospitals, although not nearly as much as it used to be. James A. Bell, assistant finance director, is co-chair of a committee that recently analyzed how UMHS calculates cost-per-case. According to the committee's report, the re-adjusted cost-per-case calculation for fiscal year 1997 was $7,662. That's $565 more than the average cost-per-case for comparable academic teaching hospitals in the US and $1,630 more than non-teaching hospitals in southeast Michigan that compete directly with the UMHS for patients and managed care dollars.

"If all you do is take total expenses and divide by the total number of patients, of course we're going to appear more expensive, because the numbers don't capture the severity of our case mix," says Gilbert Omenn, the U-M's executive vice president for medical affairs. "Before comparing these numbers, employers, insurers and the media need to look at what they're paying for. High-risk patients must have access to the specialized treatment we provide, which often is unavailable at other hospitals."

Transfer patients are expensive
Omenn points out that about 15 percent of admitted patients are transferred from another hospital. Many of these people would die without the advanced treatment technology available at U-M Hospitals and the expertise of its specialists. But intensive care for high-risk patients does not come cheap. A statistical analysis of nearly 85,000 patients admitted to U-M Hospitals from 1989 to 1993, published in the journal Academic Medicine, shows that transfer patients require longer hospital stays and more expensive care than non-transfer patients.

Patients in C.S. Mott Children's Hospital, for example, come to Ann Arbor from all over the world for Mott's specialist treatment programs. In a national study of children's hospitals conducted by the National Association of Children's Hospitals and Related Institutions, Mott was rated almost twice as high as other children's hospitals on the association's patient severity index. Patient care costs at Mott raise the cost-per-case calculation for the entire Health System by several hundred dollars per case, according to Omenn.

No one is considering turning away transferred patients or shutting down Mott Children's Hospital. "We are a state institution, and we have a responsibility to care for the state's children," says Jean E. Robillard, professor and chair of pediatrics at the U-M Medical School.

But as the Health System struggles to come up with the money to carry out its responsibilities, the people who balance the budget understand that altruism has its price in the bottom-line world of managed care. Every patient transfer increases the cost-per-case for the U-M Health System, while it reduces the cost-per-case for a competing hospital.

"We are the hospital of last resort," says Jim Bell. "We treat the sickest, most difficult cases. All our competitors transfer their most difficult and expensive cases to us."

Changes in the Health System
The Medical Center has seen many changes in the two years since Lloyd Jacobs announced the bad news at that 1996 press conference. For one thing, there's a new CEO--Gilbert Omenn, the University's first executive vice president for medical affairs, joined the U-M in September 1997. The Med Center also got a name change to the U-M Health System. And there's a new organizational structure. All three U-M Hospitals, 30 Health Centers, the Medical School and M-CARE are now together in one organization directed by Omenn.

Instead of a $16 million loss, the Health System expects a $20 million gain from basic operations this fiscal year. A major initiative to expand and reorganize its primary care network has added 85 new primary care physicians to the faculty and 25 new outpatient Health Centers. Hard work and creative suggestions from employees have made it possible for the Health System to implement more efficient operating procedures and cut expenses by millions of dollars. The number of outpatient visits climbed to nearly 1.1 million last year with inpatient admissions of 33,761. Business is so good that most of the nurses who were laid off in 1996 have been rehired and there are job openings for 150 more.

While the current financial status of the Health System is excellent, Jacobs cautioned that the crisis is not over. "We've been successful at getting costs down and developing a cost-conscious culture," Jacobs said. "We're far more fiscally stable and competitive than we were two years ago. But we have to continue to respond to market pressures to reduce costs, and we have to work harder to become more patient friendly and improve our quality of care."

Lorris A. Betz, interim dean of the U-M Medical School, adds, "There is a stronger sense of partnership between the Medical School faculty and the hospital administration, which has grown from the mutual recognition that we need each other to provide the highest quality patient care while supporting our academic mission in the face of a threatened loss of clinical revenue."

The Faculty Group Practice
Physicians and administrators agree that one of the most important changes in the Health System was the formation in July 1996 of the Faculty Group Practice, which combined clinical activities of 15 separate departments into one self-governing organization.

"The Faculty Group Practice could be considered analogous to the federal government and the clinical departments to the states," says John F. Greden, professor and chair of psychiatry and current chair of the FGP's Board of Directors. "Ideally, they should work together. Before the Faculty Group Practice, departments often had competing, or at least not synchronous, missions and agendas with little consensus on what we should be doing. Our current goal is to speak with one voice and improve the efficiency and quality of patient care."

Since its creation, FGP has helped implement a centralized billing service, so patients no longer receive multiple bills from physicians in different specialties. Its 12-member board of directors determines the share of overall clinical revenue each department should receive. The organization has developed professional service standards that are now being implemented throughout the Health System. These standards specify guidelines for everything from patient appointment scheduling to billing procedures and patient satisfaction surveys.

Customer service and quality of care are crucial to the success of the Health System's new Ambulatory Care Division, according to David A. Spahlinger, FGP's executive medical director. "Ambulatory care is the gateway to the entire health system," Spahlinger says. "It's important to make a good first impression, because patients have the freedom to walk out and take their business elsewhere."

FGP's professional service standards are an example of how managed care has generated some positive changes in health care, according to John E. Billi, associate professor of internal medicine and medical education in the Medical School. "Under managed care, physicians are held accountable and responsible for the quality of patient care they provide," Billi says. "Patient satisfaction is one important measure of quality."

"Another development fostered by managed care is the creation of clinical practice guidelines, which are developed by physicians based on the results of scientific studies to specify the most appropriate medical care for a specific condition," Billi adds.

Reinforcing the trend toward evidence-based medicine, the Health System is doing more to encourage clinical research-research that evaluates the effectiveness of new drugs or treatments for specific diseases on human subjects. This is a research area that many scientists say has been overshadowed by the Medical School's national reputation as a leader in basic scientific research.

"Part of the obligation of an academic medical center is to take basic science advances from the laboratory through the steps required to produce an effective and practical treatment for patients," Betz says. To do this, he and Omenn have set aside $8 million to fund various joint research initiatives involving clinical and basic scientists in the Medical School. Another $10-million Clinical Venture Investment Fund established by the Faculty Group Practice and U-M Hospitals and Health Centers, also will be used to support new clinical research studies and other initiatives.

"What's been most satisfying to me is seeing people recognize the need to work together to identify and solve our problems," Jacobs says. "Everyone is working a lot harder now, but people are more engaged and committed to the future of the institution. We also are taking our responsibility to patients more seriously and realizing that the patients don't work for us. We work for them."

Sally Pobojewski is a health and science writer for U-M News and Information Services and the Health System.