Public Certification of Need for Health Facilities EDDIE CORREIA, MPP

The nature of certificate of need regulation, the possible ways such regulation can reduce health care costs, and the likely problems that state governments will face in practical implementation of the regulation are discussed.


By Influencing Treatment Patterns to Be More Efficient

The problem of rapidly rising medical care costs has prompted discussion of a variety of possible solutions. The cost of hospital care, in particular, has received much attention for two reasons. First, hospital services are the largest component of all medical expenditures, and, second, the average hospital day rate has risen at a rate considerably faster than that of medical prices generally. One approach to reducing costs, already adopted by a number of states and discussed in others, is regulating the construction of health facilities, including hospitals, by requiring that a "certificate of need" be granted by the state before construction can take place. Some states have included a wide range of health facilities in addition to hospitals under such certification requirements. Proponents of certificate of need legislation expect it to reduce costs in one or both of the following ways:

This argument is quite different from the first although the distinction is sometimes not made. Proponents of this view believe that the supply of hospital beds in an area can be maintained so that hospital utilization levels are "appropriate." Costly new facilities that would allow higher utilization of services but would not improve the health status of the consumer enough to justify their cost could be prohibited. Granting certificates of need or engaging in the "franchising" of health facilities represents a fundamentally new way to deal with an old problem. The need for better planning of health facilities, particularly hospitals, has been recognized and discussed for many years. The rapid construction of hospitals in the early post-World War II period and the federal Hill-Burton program gave a particular boost to the significance of this issue in the minds of government officials and health administrators. But, with few exceptions, the planning that has been done up till now has been voluntary in the sense that lack of compliance has not resulted in legally imposed sanctions such as fines or prison terms for recalcitrant hospital owners.' Certificate of need regulation, then, is a new policy departure for state governments. It can be seen, however, as an extension of what has been a long-standing responsibility of the states-the licensing of construction of health facilities based on safety and quality standards. The policy innovation in certificate of need regulation is essentially to incorporate an additional criterion-proof of the public's need for the facility. Since experience with certificate of need regulation is quite limited, a discussion of its potential for actually

By Preventing the Construction of Facilities That Will Be

Underutilized Hospitals, it is argued, can be prevented from "overbuilding" in an area so that resources will not be wasted in constructing and maintaining unused beds. Costly duplication of certain kinds of equipment (e.g., radiological therapy units) will be prevented by prohibiting the addition of "unneeded" facilities. Mr. Correia is a doctoral candidate, Kennedy School of Government, Harvard University. At the time of this study, he was with the Division of Health Analysis, Department of Health, Education, and Welfare, Washington, DC 20201. 260 AJPH MARCH, 1975, Vol. 65, No. 3

reducing costs must be rather speculative. This paper reviews the nature of this kind of regulation in regard to the theoretical basis for cost reduction, the process of need determination, and the likely problems in practical implementation of such regulatory powers by a state decisionmaking agency such as state health departments or comprehensive health planning (CHP) agencies. In addition, it suggests a new way to determine the "right" number of hospital beds in a given geographic area.

The Theoretical Basis for Certificate of Need Regulation Regulation of health facility construction by the states is an admission of the failure of the free market to ensure efficiency. Some of the characteristics of the health care market which justify some kind of government intervention have long been recognized. Four phenomena in particular are the primary bases for regulation of hospital construction: * Hospital reimbursement from third party payers is made on a "reasonable cost" basis; * Health care facilities, including hospitals, are not generally owned and managed by competitive profit maximizers; * Much of the funds for expansion of hospitals are not obtained from the private capital market; * Consumer decisions about purchases of hospital care are greatly influenced by providers and are based on very limited information. Most hospital care is paid for by third parties (36 per cent by private insurers-the commercial carriers and Blue Cross plans-and 48 per cent by publicly sponsored programs-primarily Medicare and Medicaid-in 1969).2 Reimbursement rates for services covered by third parties are set by insurance companies on the basis of "reasonable" and "allowable" costs for each individual institution. This practice tends to ensure that hospitals recover their costs, thereby reducing the risk of financial losses to a hospital which overbuilds. Decisions about additions to the stock of hospital beds by existing or potential owners are not made as in other sectors of the economy where profit-oriented businessmen determine a prospective rate of return on their investment based on the expected market price of a product. As is the case for most nonprofit institutions, the primary objective of hospitals is not profit per se (although they must be concerned with breaking even financially in the long run) but rather a combination of providing good service to the community and gaining and maintaining prestige. Much of the capital investment in hospitals is fi'nanced outside the private capital market (over 9 per cent from public sources and 38 per cent from philanthropy in 1964).1 Charitable donations, in particular, are based to a large extent on the prestige of the hospital. Thus, sheer size leads to prestige and prestige facilitates expansion by attracting donations from philanthropic organizations and

individuals. Hospitals are also under pressure from their physician staffs to offer broader and more technologically sophisticated services. These forces push in the direction of expanded facilities and equipment while the reimbursement process helps to ensure that costs will be met by increased revenues. The conditions for a perfect, competitive market fail, not only in respect to the behavior of those who own and manage hospitals, but also in respect to those who buy hospital services. Because of the prevalence of both public and private insurance, hospital services cost the consumer (at the time he uses them) only a small fraction of the total costs. Physicians, who, for the most part, decide who is to be hospitalized and for how long, tend to base their decision on "medical necessity" primarily and on whether the care is worth the cost only secondarily. When physicians do consider the costs of care, they almost certainly consider the out-of-pocket cost to their patients rather than the full cost of the resources used. As a consequence, neither the physician nor his patient adequately weighs the real cost of hospital care in deciding to use it; and overutilization inevitably occurs to some extent.

Estimating the "Right" Number of Hospital Beds Traditionally, there have been two ways of determining the "right" number of hospital beds in a given geographic area-first, estimating the need for hospitalization on the basis of socioeconomic characteristics and some, perhaps implicit, medical treatment standards, and, second, estimating the future use of hospital care on the basis of past use. The Hill-Burton formula for determining the appropriate number of hospital beds has in past years been based on uniform bed to population ratios: 4.5 beds per 1000 population in high population density states, 5.0 in medium density states, and 5.5 in low density states. Others have suggested more elaborate formulas for determining need which take into account past morbidity and mortality rates, age, race, and so on. Such approaches typically do not take account of income or the price of hospital care and, of course, assume that observed patterns of use among certain sectors of the population should be followed by others with similar demographic characteristics. The second traditional method of determining the appropriate number of beds is to extrapolate future requirements from past levels of utilization. The Public Health Service in 1964 amended the Hill-Burton formula for need determination to include the method of comparing past utilization levels with the expected increase in population and assuming an occupancy level of 85 per cent in order to calculate the number of beds that should be added to an existing stock. The primary deficiency of this method is that it assumes that the original level of use of hospital care was somehow optimal. If the community has used "too many" beds in the way described above, then assuming the same utilization level for additions to the population simply compounds the problem. CERTIFICATION OF NEED


It is not surprising, however, that the simple HillBurton formulas have gained a substantial measure of acceptance among health planners. Their very simplicity and ease of calculation make them attractive, and, in addition, they avoid the controversial issue of whether the insurance system and physician decision making can result in overutilization of hospital care. The experience of prepaid, comprehensive health care organizations casts doubt on the adequacy of the HillBurton formula, however, and on the generally accepted bed to population ratios of 4 to 5 beds per 1000 population. Prepaid health plans have significantly reduced the use of short term hospital beds by their patient populations. While the average use of short term hospitals in 1970 was almost 1200 days per 1000 persons per year in the United States, patients in prepaid plans use the hospital at the rate of 500 to 600 days per 1000 persons per year.3 ,4 After adjusting for the unrepresentative character of prepaid group populations (since they normally have a smaller percentage of older persons than the nation as a whole) and hospital use outside the plan by plan enrollees, these organizations exhibit a hospital utilization rate that is at least 20 per cent below the national average.5 This lower rate, apparently with no adverse effects on the health of the patient population, is good evidence that the "true" value to consumers of hospitalization in the traditionally organized health sector is often not worth the cost. This phenomenon strongly suggests that we do not measure the "right" amount of hospital beds by past utilization levels, but rather that we aim for that supply of beds that is needed if hospitalization only occurs when it is worth its cost and, at the same time, that we try to encourage doctors in the traditional sector to make admission decisions on the same basis as prepaid physicians do. Nevertheless, the traditional method of determining the right number of beds has been based on past levels of utilization. This type of determination is "passive" in that it takes as given existing demand patterns and does not try to influence utilization. Rosenthal has made perhaps the most sophisticated attempt to construct a model for estimating the demand for hospital beds using a crosssection multiple regression analysis using the states in 1960 as observations.6 The very high cost of hospital care and the potential for very inefficient allocation patterns suggests that health planners take an "active" approach to determining the need for hospital beds-that is, manipulating supply in order to influence the level of utilization. Such an approach to determining bed needs might proceed by utilizing a statistical analysis applied to prepaid group practices only. Age, sex, income, and other important factors which affect utilization could be included as exogenous variables. Such an analysis should also take into account the existence of alternative facilities since the need for hospital beds is certainly related to the presence of other types of inpatient facilities. The analysis might also take into account the resource cost of hospital care in different prepaid group practices. (The relationship found between resource cost and use would not be a demand schedule in the traditional sense because it would represent 262

AJPH MARCH, 1975, Vol. 65, No. 3

the allocation decisions of the prepaid group practice organization, not those of its consumers. The patients pay little or nothing at the time of hospital use.) After a model for explaining the variation among hospital bed use in different group practices was derived, it could be used to estimate the number of beds required for a given community if allocation decisions were to be made essentially the way they are made in prepaid group practices. In order to justify such an approach to determining the appropriate number of beds, it would have to be assumed that the allocation of resources to hospital care should be made more like that made in prepaid group practices and that, in fact, if bed supply were limited, the available beds would be used in such a way. In other words, it would have to be assumed that: 1. Physicians would react to a limitation in bed supply by hospitalizing those who needed hospital care most (or by reducing the length of stay of those who needed additional days least); 2. The preferences of the rest of the population would be reasonably reflected in the allocation decisions of prepaid group practices; that is, the rest of the population is willing to spend roughly the same amounts on hospital care relative to other goods and services; and 3. The real income distribution would not significantly be affected by the supply of hospital beds. (Since medical care is a major type of "in kind" transfer made to low income families, the limitation of the bed supply might lead necessarily to reducing the amount of this transfer.) These assumptions are probably not too unreasonable, particularly in light of the assumptions we are forced to make in order to justify our current patterns of allocating resources to hospital care. It seems certain that our society is using too much hospital care in relation to its preferences because of the imperfect market for suppliers of hospital services, the "moral hazard" resulting from extensive insurance coverage, and the uncertainty of the value of hospital care on the part of consumers.7 It is, therefore, the responsibility of government to devise the best methods for rationing resources devoted to hospital care and for influencing how these resources are used. It is suggested here that we "borrow" from the experience of prepaid group practices in order to guide such a policy of rationing.

Implementation of Certificate of Need Regulation The method of determining the appropriate level of hospital beds suggested above obviously requires acceptance by health planning authorities if it is to be implemented. There is likely to be substantial opposition to this method among health providers, particularly physicians and hospitals. After all, the method would tend to lower the estimate of the appropriate number of beds closer to that of prepaid health plans. The present ratio of short term, general hospital beds to the population in the United States is about 4.2 beds per 1000 persons while the ratio of beds to population in prepaid group plans is much lower-e.g., 1.73

per 1000 enrollees in Kaiser-Permanente of Northern California and 1.66 per 1000 enrollees in Kaiser of Southern California.3'4 Nevertheless, a method for determining the best level of beds conceptually can be divorced from the means of "coming close" to these levels through government regulation. In many areas, the number of currently available beds in communities in the United States is likely to be too high, both for the current population and for projected population increases in the near future. What is often required, then, is a politically acceptable method of determining need which can serve as a basis for a governmentally imposed ceiling on future construction. For all practical purposes, the Hill-Burton formulas can serve as the ceiling in many cases, even though they overestimate bed needs, simply because of the prevalence of communities where overbuilding has occurred. In the communities where hospital bed levels are not yet up to the Hill-Burton ceiling, the method suggested above can be used as an argument for limiting the bed level below the Hill-Burton estimates of need. And perhaps in the future such a methodology for determining need may be more acceptable to health authorities. As for now, however, certificate of need regulation can accomplish a great deal by imposing ceilings on future construction based on the Hill-Burton formulas. The structure of the decision-making process which grants certificates of need is as important for implementing good public policy as the methodology used for determining need. As of August, 1971, a total of 14 states had enacted some form of certificate of need legislation, 10 states were considering proposed laws, and nine state legislatures had defeated submitted bills.8 The states differ in the way certification decisions are made and what types of health" facilities are covered. The typical certificate of need law includes provisions for review of an application for a certificate of need by the areawide comprehensive health planning agencies and gives final authority for issuing a certificate of need to the state health department or state comprehensive health planning agency. Currently, the areawide planning organizations-called "B" agencies because of the section of federal legislation which created them-are made up of an advisory council, a director, and a planning staff. The areawide planning councils are not usually appointed by elected officials although they inevitably are partly made up of representatives of public agencies. A council is originally recognized as legitimate by the state CHP agency and thereafter makes provisions for its own perpetuation and for hiring a director and staff. The state organization, called the "A" agency, is more directly accountable to the public. Its council is normally appointed by the governor of each state while the director is either directly appointed or responsible to an appointed official. Provisions of the federal comprehensive health planning law require that consumers make up a majority of each council. There is a strong tendency for the "B" agencies to be advocates for health facilities in their own geographic area for two reasons. First, consumer representatives on health planning councils tend to accept the judgment of providers

unless they are aggressive or at least moderately sophisticated in their knowledge of the health care industry. Health providers, except for health insurance companies, normally are advocates for more health care resources for their area.* Consumer members, particularly at the areawide level, tend to accept provider judgments enough to give them a council majority. A council oriented toward getting "more" will tend to inhibit the agency director in taking a stand against hospital and other health facility expansion. Second, the interested public in an area served by an areawide health planning agency will typically want the agency to win more facilities for them. First, they are not generally conscious of the effect of health facility expansion on health care costs. Second, even if they were aware of the relationship between hospital expansion and health insurance premiums and taxes, they might-quite rationally-demand more hospital beds in their area. The costs of these facilities are primarily borne by the population outside the area, either by the whole state in higher insurance premiums or by the entire country in higher federal taxes for Medicare and Medicaid. Consequently, the areawide agencies should probably not be given final authority to approve or reject certificate of need applications. Nor should a certification process be structured so as to rubberstamp the recommendations of the areawide organizations. In other words, some other agency, either the state health department or the state "A" agency, should maintain a technical capacity to evaluate need, at least that level of technical capacity that prevents them from inevitably having to accept the recommendations of the "B" agencies. If certification is given to a CHP agency, the state agency is greatly preferable to the areawide. It is more directly accountable to the public since the director and council will tend to be more responsive to the wishes of the governor. The consumers on the state advisory council will tend to be more aggressive in relation to their provider counterparts on the council. And increases in health insurance premiums can be more directly attributed to loose regulation by the state level agency. Certificate of need laws will be likely to have some form of grandfather clause exempting health care institutions already in existence. Such a clause will, of course, result in pernitting underutilized facilities and ineffi'cient treatment patterns to be maintained. There have been suggestions that a certifying agency not be limited to vetoing or approving new facilities or services but that it also be able to promote rationalization of existing facilities and services. That is, it would have some legal authority to close facilities operating inefficiently, to require a merger of certain services by health care facilities (say, requiring the use of a common radiological therapy unit by two hospitals), and to require services not provided by an existing institution to be offered in the interest of efficiency and/or higher quality (say, the institution of a * In these councils, "health providers" include those persons whose "major occupation" is related to the provision of health services. This definition includes representatives of the health insurance industry.


home health care program by a hospital). Such authority would, of course, represent substantial power over health providers' activities by the certifying agency. Although it seems likely that in the long run these proposals will be more seriously considered, in the near future they will be bitterly opposed by health providers themselves. The exemption of existing facilities from certification of need has probably been politically necessary in order to enact legislation. Certifying need is, after all, a mixed blessing to health providers. It threatens future expansion, but it helps prevent other, potentially competitive institutions from becoming established. It is natural that economists should be concerned about the "barriers to entry" that may result from certificate of need laws. The tendency in markets for other goods and services is for efficiency to be impaired by artificial restrictions on supply which raise prices above the natural level of the market equilibrium and result in a "rent" or "surplus" accruing to suppliers. Restricted entry may, in fact, be one of the principal imperfections in the market for physician services. Restrictions on the construction of health facilities, however, do not seem likely to lead to major economic harm to communities by creating monopolies or restricting supply below the optimal levels. Little price competition takes place now among hospitals. While there is undoubtedly an aspect of vigorous competition for patients and doctors, it is more likely to take the form of acquiring sophisticated equipment and facilities which raise costs rather than bidding down prices to average costs. In addition, in many cases, the supply of hospital beds is probably already too high. Much greater gains will come from preventing additional overbuilding than could result from whatever competition is inspired by the establishment of new hospitals. There are dangers that certification of need can deprive consumers of an additional alternative from which to choose their source of care and that certification of need can hinder the development of what would ultimately prove to be more efficient ways of providing care (for example, by preventing the introduction of a prepaid group practice hospital into an area which appears to have an adequate bed supply already). However, there is a tendency for even relatively inefficient health care institutions to stay in operation and not be "driven out" by competition from other institutions. Consequently, there might be no gain in allowing a more efficient facility to be established if it will only result, in practice, in underutilization of all available resources. Moreover, the certifying agency should have some flexibility to deal with special cases and be able to determine when the allowing of what appears to be a short term oversupply will do more good than harm in the long run. Most states which have enacted certificate of need laws have focused on certifying construction and equipment purchases. In order to avoid forcing health care institutions to apply for certificate of need for minor capital expenditures they have usually specifled some minimum capital expenditure above which these expenditures are 264

AJPH MARCH, 1975, Vol. 65, No. 3

subject to certification. This figure ranges from $10,000 in New York to $350,000 in Kansas.8 But certifying the expansion of institution of new services as well as capital expenditures is also consistent with the same objective and is preferable under some circumstances. Personnel are, of course, more mobile than facilities and equipment and are not likely to be "underutilized" in the same way. The most important issue in certifying the need for certain services, however, may be to maintain high quality. There is widespread opinion among health authorities that certain services, which may not involve substantial equipment or physical facilities, should not be practiced on a small scale or without a close relationship to a range of other sophisticated services.' For example, a certifying agency might want to prohibit neurosurgery in hospitals which do not have adequate supporting staff or kidney transplants in hospitals in which this procedure is performed only rarely. The most acceptable provisions, therefore, may be those which only certify fairly expensive capital expenditures, say, those above $150,000, but which also require certification for the institution of major services. Most discussions of certification of need regulation argue for coverage of a wide range of health facilities, including those of extended care, inpatient and outpatient care, and rehabilitative services. There are, however, political limitations on what a state can attempt to regulate. Very comprehensive certificate of need legislation would require private physicians to apply for permission to establish a practice in a particular community. Although such regulation is a potentially positive developmentparticularly because of its implications for both geographic and specialty distribution of physicians-it seems unlikely that state legislatures will be willing to assume this authority for a number of reasons. First, private physicians, unlike those who want to establish other types of health care facilities, can threaten to leave the state if they are not allowed to practice where they desire. Since almost every state believes it needs more doctors, this threat can make legislators hesitant to subject physicians to such regulation. Second, there may be fears that the constitutionality of certification of need regulation applied to physicians' offices would be challenged. While states have traditionally licensed certain types of health facilities-hospitals, nursing homes, etc.-they generally have not required that a private practitioner's clinic facility be licensed (although the practitioner is himself, of course). Finally, physicians are a potentially powerful force in state political decision making and would certainly vehemently protest such restrictions of their existing freedom to practice where they wish. In practice, states are likely to exempt private physicians' clinics from certification of need requirements. There is, of course, a danger that discrimination in regulation based on ownership or type of service will stifle the development of certain types of institutions while unregulated facilities-even if they are less desirable-will absorb a greater proportion of health care dollars. For example, while states will generally exempt private physicians' offices, they may be quite willing to regulate other,

less traditional outpatient institutions-prepaid group practices, neighborhood health centers, and so on. Certification of need requirements for outpatient facilities may give physicians who want to avoid competition from other providers of ambulatory care in their area a means to exert pressure to prevent their establishment. These problems may warrant the exclusion of all outpatient facilities from certification of need requirements. Finally, whatever the method used for determining need, it is important that planning authorities set down fairly explicit criteria before certification applications must be considered. The administrative officials or boards which grant certificates of need will refuse to be bound by a method of need determination which does not allow them some ability to make "adjustments" both for political purposes-to accommodate the wishes of interest groups who want a facility built-and for special considerations which cannot be anticipated in guidelines or formulas. However, if criteria that are intended to serve as. guidelines are quite vague, the certifying agency will tend to follow a "decide as you go" pattern which will inevitably lead to

inconsistent and often poor decisions and less ability to resist interest group demands. References 1. Somers and Somers. Medicare and the Hospitals, pp. 198, 211. Brookings Institution, Washington, DC, 1967. 2. Basic Facts on the Health Care Industry, p. 105. Committee on Ways and Means, U.S. House of Representatives. U.S. Government Printing Office, Washington, DC, 1971. 3. Guide Issue. Hospitals 45 :464-467, 1971. 4. Report of the National Advisory Commission on Health Manpower, Appendix IV, p. 214. U.S. Government Printing Office, Washington, DC, 1967. 5. Donabedian, A. An Evaluation of Prepaid Group Practice. Inquiry 6:12-16, 1969. 6. Rosenthal, G. The Demand for General Hospital Beds. A.H.A. Hosp. Monogr. Ser. No. 14, p. 47, 1964. 7. Arrow, K. Uncertainty and the Welfare Economics of Medical Care. Am. Econ. Rev. 53:941-973, 1964. 8. Survey Report: Review of 1971 Certificate of Need Legislation, pp. 1, 3. American Hospital Association, Chicago. 1971.

HOW I STOPPED SMOKING ... (Excerpts from letters received by the APHA Smoking and Health Project from former smokers.)

FAMILY SUPPORTS NO SMOKING POLICY I smoked (started when I was in college-I pack a day for 10 years). I stopped smoking in 1965 and haven't had a cigarette since. It began when my husband was told to quit smoking in 1961 by his physician. He tried and was unsuccessful. In 1962 he started to smoke a pipe. He managed to have either the pipe or the tobacco with him but had a difficult time remembering both items at once. This became a nuisance so in August, 1962, he successfully stopped smoking (3 packs of cigarettes a day for 15 years). I didn't smoke before him during the 3 years and finally realized how foolish the smoking habit was. We are much healthier, I'm sure. Food and fresh air are more appreciated. My father, a physician, has been off ciagrettes for over 20 years (he smoked 2-1/2 to 3 packs a day). I'm very happy that we don't see advertising on T.V. any more, especially since T.V. has so much influential power over children. By example, our family supports a no smoking policy and I often flnd opportunities to state reasons why one shouldn't smoke. Rosemary Lamson Public Health Nurse Cook County Grand Mara is, MN CERTIFICATION OF NEED


Public certification of need for health facilities.

Public Certification of Need for Health Facilities EDDIE CORREIA, MPP The nature of certificate of need regulation, the possible ways such regulation...
1MB Sizes 0 Downloads 0 Views