The Hospital Wars Are specialty hospitals a model for the future--or a time bomb?
By Peter Carbonara and Joan Caplin

(MONEY Magazine) – There's a fight going on in Columbus, Ohio. It's about who can own a hospital and what choices patients should have about who takes care of them--and where. The focus is New Albany Surgical Hospital, a 42-bed operation that is owned and run by local doctors and does mostly orthopedic surgery. New Albany, which will be run as a for-profit business, opened in December.

The 30 founding New Albany doctors, each of whom put between $20,000 and $400,000 into the $40 million hospital, say that their venture is a model of what American health care should be--and everything most hospitals are not: efficient, specialized and responsive to its patient-customers.

The operators of the four nonprofit general hospital systems in the area say New Albany is a crass grab for dollars by greedy doctors. Worse, they say, it will rob general hospitals of the lucrative surgical cases they need to pay for the treatment of the very sick and the very poor. The Columbus hospitals are sufficiently threatened that some will no longer allow doctors who are investors in New Albany to admit patients.

More than just a turf battle between doctors and hospital administrators, the Columbus dustup, like similar bouts in other states, is an important public policy question in disguise. Several questions, actually: Who gets to decide how limited medical resources are allocated? Should the way hospitals get paid be radically revamped? And is it bad medicine to run a hospital--or any medical institution--as a for-profit business?


About nine o'clock one December morning, his first in the new hospital, Dr. Carl Berasi is standing outside one of New Albany's operating rooms in blue surgical scrubs while a scrum of nurses and technicians prepare his third case of the day. Berasi is a 50-year-old osteopathic orthopedist. (Osteopaths are not M.D.s, but their training is almost identical. Most M.D.s these days accept them as peers.)

Since 6:30 a.m., Berasi, who is also New Albany's chairman and its most prominent public face, has been cranking out knee arthroscopies, each of which takes him about 20 minutes. Berasi hopes to do five operations today. Clasping his hands, still dripping with water and sterilizing soap, Berasi says, "I want the doctor to be the guy looking the patient in the face and hearing his complaints, hearing about the complications. Not some administrator cutting [nurses] on the floor."

The New Albany doctors are members of five practice groups, the largest of which is Berasi's 14-physician OrthoNeuro. "This is something we did out of hope for the future, not frustration with the past," Berasi says. But there was a lot of frustration with the local hospitals where Berasi and his partners have practiced. The doctors were frustrated with the amount of control they had over which nurses treated their patients, over how long they sometimes had to wait to schedule operating room time, over having their volume and mix of cases subject to scrutiny and second-guessing by hospital administrators.

These are the standard gripes of the modern doctor. The OrthoNeuro group, though, was sufficiently unhappy to start planning their own inpatient orthopedic surgery center, which they would run in partnership with a local hospital. They'd get an added measure of control and also a piece of any profits the facility might earn. (Doctors and hospitals are generally paid separately by insurers.) Joint ventures are not unusual these days, and there are several in the Columbus area. The doctors approached the local hospital groups, talking most seriously to the largest, OhioHealth, which runs seven hospitals. In the end, however, there was no deal.

"There were lots of efforts to work it out," says OhioHealth's chief medical officer, Dr. David Morehead, but "there was a line in the sand. We weren't willing to joint-venture in beds. We've joint-ventured with ambulatory services. But for hospitals, inpatient is the core."

Eventually the orthopedists found their way to Surgical Alliance, a privately held Nashville company that develops for-profit hospitals and ambulatory surgical centers. At New Albany, its first completed project, the doctors got the control they wanted: a 60% ownership stake and 10 of the 12 seats on the hospital board.


The United States has about 5,000 hospitals. Most of them offer all kinds of medical services and are run as nonprofit, tax-free institutions. But there are a growing number of exceptions to that model. According to two recent reports by the General Accounting Office (GAO), Congress' nonpartisan investigative arm, there are now 92 specialty hospitals in the U.S. that provide mainly one kind of medicine--usually surgery, either cardiac or orthopedic. Most were built in the past 10 years; another 26 are under development. (See "Growth Spurt" on page 152.) They tend to be concentrated in the West, Midwest and South, where there are fewer legal restrictions on hospital construction. The GAO estimates that three-quarters of these hospitals are owned, at least in part, by the doctors who practice in them.

Over the past several years, doctors have had a tougher time making money. Expenses like malpractice premiums have soared, while the amounts that doctors are paid by insurers have dropped. And in hospitals, doctors have increasingly found themselves answering to that new and unloved species of bureaucrat, the hospital administrator with an M.B.A.

But as hospitals became less friendly to doctors, they also became less necessary. Medical and technological advances make it possible to treat in a clinic setting a lot of conditions that used to require hospitalization. Doctors began opening ambulatory clinics, places they owned, which treated patients and sent them home. For doctors this was great--more control and more money, because they were paid both as physicians and as clinic owners.

The party came to an end for doctors in 1989, when Congress, reacting to a wave of unnecessary procedures in ambulatory clinics, prohibited Medicare payments to a doctor for treatment of a patient in a clinic, lab or rehab center in which he had an ownership interest. But the law, known as the Stark Act (for Rep. Pete Stark, the California Democrat who sponsored it), has one critical loophole: It does not prevent a doctor from referring a patient to a hospital he owns. And that makes the specialty hospital business legally possible.

What makes the specialty hospital business financially possible is the imbalance in the way both insurance companies and Medicare pay for different kinds of hospital services. Generally speaking--and for reasons that have more to do with tradition than logic--surgery is more lucrative for hospitals than equally important services like maternity wards, emergency rooms and burn units. That stuff typically loses money and is subsidized by the profits hospitals make on hip replacements and coronary bypass operations. For most hospitals, E.R.s and delivery rooms are loss leaders. Hospital administrators keep them because they bring customers in the door who may buy something more profitable later and--well, because hospitals are supposed to take care of sick people. Specialty hospitals, though, don't do everything. They can offer exclusively moneymaking services like hip surgery without having to lose money on an emergency room.


Specialty hospitals--like ambulatory clinics before them--have made the hospital establishment very unhappy. Carmela Coyle, a senior vice president for advocacy and representation at the American Hospital Association (AHA), says, "This is right at the top of our list. It's among our most important issues, something that can make or break the existence of a full-service community hospital in a very short period of time." Over the past few years the AHA--not to mention numerous state hospital associations--has put its lobbying weight behind proposed state and federal laws designed to close the Stark Act loophole for specialty hospitals.

"If you did a case study of every city where there is a specialty hospital, you'd see there's been a brawl," says Randolf Fenninger, a Washington, D.C. lobbyist for the American Surgical Hospital Association, a trade group for specialty hospitals. The list includes New Orleans, Milwaukee and Kansas City, Mo. And now Columbus.

Since Berasi and his partners announced their plans for New Albany, they've been called "greedy" and "selfish" by the editorial page of the Columbus Dispatch, whose president and associate publisher is the chairman of the board of directors of a local hospital. The Ohio legislature considered legislation outlawing specialty hospitals; instead it passed a two-year moratorium on new projects.

But the most immediate threat to the New Albany doctors is losing their admitting privileges at the other hospitals in the area. It's common for a doctor to have admitting privileges at more than one hospital, and the New Albany investors had intended to continue seeing patients in other hospitals.

OhioHealth has already closed its doors to the doctors who invested in New Albany. "It's been painful," says OhioHealth chief medical officer Morehead. "I respect them, but I wish they hadn't done it. We're not talking about bad people. We're talking about people who have chosen a different path."

What Morehead and his peers at Columbus' other major hospitals fear about that path is that it will lead doctors who have invested in New Albany to send the well-insured and lucrative cases to their new hospital and leave the general hospitals to take care of the rest--the orthopedic patients who need long hospital stays, the elderly people with pneumonia, the trauma victims in the E.R. and all the other money losers. For their part, the New Albany physicians have said they have no such intention and rejected the charge that they are less committed to providing charity care than are the general hospitals.

Denying or revoking doctors' privileges has been the hottest issue in fights over specialty hospitals around the country, and the one that, so far at least, most directly affects patients. If your orthopedist loses privileges at your local hospital, that means he can't operate on your hip there, so you either have to go to another hospital or find a new doctor.

Doctors, even those not associated with specialty hospitals, have bitterly protested what they call "economic credentialing." But hospitals appear to be within their legal rights. In 2001, for instance, the South Dakota Supreme Court upheld a lower court ruling permitting a general hospital to deny privileges to doctors who were also involved with a local specialty hospital.


Whether New Albany can succeed as a business remains to be seen. Its most immediate hurdle is persuading insurance companies to pay its bills. For insurers, that means risking the ire of the general hospitals that dominate the Columbus market. With only 42 beds, New Albany is a tiny player. Berasi declines to say which insurers New Albany has made deals with, but UnitedHealthcare, the largest hospital insurer in the state, tells MONEY that it will pay for treatment of insured patients at New Albany. In Dayton, however, two of the three largest insurers in the state have not provided coverage for a five-year-old cardiac specialty hospital.

Above and beyond whether it is good business, the key question is whether New Albany--and the whole specialty hospital idea--is good medicine. Do physician-owned specialty hospitals really drain crucial resources from traditional hospitals?

The American Hospital Association has compiled reports on general hospitals around the country that it says have been hurt by specialty hospitals. Doctors like Berasi tend to reject those claims as anecdotal. They are likewise unmoved by GAO reports concluding that specialty hospitals have treated people who were less sick than those in general hospitals.

MedCath, a public company that has developed 11 specialty hospitals, sponsored its own study comparing seven heart hospitals it partly owns with 1,192 general hospitals that do open-heart surgery. Not surprisingly, its study concluded that its hospitals treated a higher proportion of seriously ill cardiac patients than its competitors did, had lower in-hospital mortality rates and sent its patients home more quickly.

The main problem with these studies is that they're based on tiny, and therefore not very useful, samples. For-profit specialty hospitals, after all, constitute less than 2% of U.S. hospitals. And neither the MedCath nor the GAO analyses had anything to say about what financial damage, if any, specialty hospitals have done to their general-service competitors.

So we're in for yet another study. The Medicare drug bill that President Bush signed in December mandates an 18-month national halt on the construction of new specialty hospitals and a study of the financial effects of those already in existence by a Medicare advisory panel.

Sen. John Breaux, a Louisiana Democrat who supported the measure, is one among numerous members of both houses of Congress who have expressed opposition to physician ownership of specialty hospitals. "Specialty hospitals do a good job," says Breaux, whose home state has eight such hospitals, with 12 more in the works. "The problem is the overall effect. What's the problem from a financial standpoint? Should doctors be banned from owning specialty hospitals, or should other procedures get higher reimbursement?"

And that may be the real point. As long as certain kinds of medicine are more profitable than others, someone is going to try to capture the profit. Surgery's higher profit margins are embedded in Medicare (and insurance company) rates, and the political will to retool that part of the system seems, at the moment, to be zero. Changing any part of Medicare is politically difficult, as the battle to pass the Medicare drug bill made painfully clear.

In the meantime, it will be interesting to see what happens in Columbus. Berasi says, "I've had hospital administrators say, 'We are going to crush you.'" They will certainly try, but Berasi is sure that in New Albany he's got a better mousetrap. He likes to tell a favorite, no doubt apocryphal story about an orthopedic surgeon who was clocked on the golf course one day by an errant five iron. He finished his round as if nothing had happened. Says Berasi: "We're pretty hardheaded."