The Care of Strangers: The Economic Story of Hospitals ~ Section three – American Hospitals Before and After the Great Divide

by faithgibson on May 16, 2013

After holding humanity hostage for many millennia, the invisible but nonetheless lethal power of germs was finally unmasked and beaten back. Living on the right side of the “Great Divide” was definitely the better place to be, as the new biological sciences freed humanity from the death grip of contagion and transformed our knowledge of public health and advanced medical practice.

For society, the Great Divide also translated into an equally important difference between hospitals as a location for supportive social services and the new science of modern medical care, which represented a dramatic difference in form and function and represented the new sceince-based ability to correctly diagnose and effectively treat — even cure — many diseases and injuries that previous had been untreatable and eventually fatal. However, these new miraculous abilities did not come cheap.

They instead began with capital-intensive and technologically enriched enterprise orders of magnitude beyond its humble beginnings in hospitality. This dramatically changed the role that hospitals played in society, the type of medical care they provided, a dramatic shift in the equipment and technology that entailed, and a completely different economic basis for these expanded and sophisticated medical services.

Few people on the staff of a 19th century hospital would have realized in 1881 that traditional era of hospitals as places hospitality were in their last hours. For more than a thousand years they had functioned as medical hotels that provided a labor-intensive, low-tech social service for the sick and dying, as well homeless pregnant women and abandoned infants. The most important piece of equipment was the ordinary bed; the primarily role of the staff was the manual labor required to cook and clean and semi-skilled nursing care  – making beds, serving meals, and emptying bedpans. The equipment was simple and cheap – pillows and blankets, bedpans, food trays, etc.

Until antibiotic drugs became available in the 1940s, the majority of all human illness and major cause of death was due to infectious disease, so hospitals in a pre-scientific, pre-antibiotic era had little to offer in the way of treatment, but much to risk. People with resources (money or family) avoided them at all costs. But the final straw was the social stigma and low status associated with being a patient in one — a hold-over from the long tradition of charity institutions that served a homeless population peopled by the desperately poor, the mentally-ill and those of ill-repute.

For all these reasons, hospitals played an insignificant role in ‘polite’ society before the second decade of the 20th century. But compared to expense of our technologically-enriched institutions, the hospitable care they provided affordable. Even a patient from a middle-class family could afford a short stay in a private hospital. As for the economic ‘health’ of the institution, the number of paying customers they served was not great, but it didn’t have to be since the cost of care was also low. Bills for the medically indigent were often picked up by charity organizations and state and local governments. The expense for housing a poor sick person who was little more than what it would have cost local governments to house orphans or prison inmates – the same “3 hots and cot” and a staff to run the show. But even this rudimentary form of hospital care depended on support from state coffers and the ‘kindness of stranger’ in the form of philanthropists with deep pockets and a generous disposition. Bottom line, this was an economically stable model in which supply and demand — number of sick people seeking hospitalization — was relatively well-matched by supply hospital beds.  While it was a stable system, its therapeutically-ineffective services were mostly irrelevant to those in polite society, who received their medical care from physicians who made house calls and their nursing care from family members or hired help.

In the last decades of the 19th century, almost no one would have upset to learn that hospitals, as places of last resort, had been rendered obsolete by four scientific breakthroughs and the technologies they engendered: Pasteur’s introduction of the ‘germ theory’ of infection disease, Lister’s the principles of asepsis, the German scientist Roentgen’s invention of the x-ray machine and Dr. Morton’s discovery of anesthetic gases in 1846.

In an astonishingly short time, these ‘wonders of medical science’ converged to produce the building blocks of modern medical practice. Knowledge about microbial pathogens, Lister’s technique for sterile surgery, and the discovery of relatively safe anesthetic agents produced our current model of modern surgery. For the first time in human history, diagnostic methods, medical treatments and safer surgery under general anesthesia gave medical practitioners the ability to effectively treat and actually cure patients of formally fatal diseases, horribly deforming or chronically painful conditions. From this comes our idea of improving ‘quality of life’ as a legitimate area of activity for the medical profession.

Not only were these effective medical treatments a blessing to the patient and his or her immediate family, but it allowed other aspects of society to flower in ways that were not possible before. A longer life span and an improving standard of living was a crucial ingredient in creative problem solving, inventiveness in science and commerce and our growth as a nation.  While the scientific milestones responsible for these improvements were mostly invisible to the population of that era, they changed our world just as dramatically and permanently as the Wright Brother’s first airplane on a sandy beach in North Carolina in 1908[?].

The Economic San Andreas fault line in the post-scientific era of American hospitals.

However, the ink was barely dry on the 1881 report of Pasteur’s Germ Theory when a cascade of post-microbial scientific issues descended on hospitals, one that deserves the otherwise overused term of “paradigm change”. As each new discovery contributed something of value to a scientific feedback loop, better diagnoses were soon matched by better treatments and better treatments almost always translated into new technologies, new equipment and newly expanded roles for a specially-trained staff. With the exception of the pasteurization of milk, and the principles of asepsis – hand washing, disinfectants, the isolation of patients with contagious diseases, “universal precautions”, the principles of asepsis and sterile technique – all these new medical breakthroughs depended, for the first time ever, on large capital outlays. After all, how do you identify pathogenic ‘wee-beasties’ if not for a microscope, how do you sterilize surgical supplies if not in an autoclave? X-ray machines were not available at the local hardware story.  As medical science advanced by leaps and bounds during the late 19th and early 20th century, so did the capital investments required to have a state-of-the-art medical institution.

In fairly quick succession, the new biological sciences of microbiology, bacteriology, pharmacology, radiology, and pathology resulted in dramatically improved diagnosis and treatment. But each of these world-altering developments – these jewels in the crown of modern medicine — required a more sophisticated systems for the delivery of these additional services including clinical laboratory services, x-ray departments and operating rooms, which in turn required them to reorient themselves to the capital-intensive nature of “modern’ medicine. The result was a technological Tsunami in expensive ‘must have’ equipment and supplies.

Each new medical miracle had its own expensive technology with special equipment that required a bigger, better brick-and-mortar building to house these new departments. Every state-of-the-art purchased by the hospital came with a cascade of on-going expenses that included a specially trained professional staff and a plethora of specialty supplies – x-ray film, chemical developing solution, lead aprons, petre dishes, glass slides, tanks of oxygen, sterile instrument, surgeons’ sterilized gloves, canisters of drop-ether, scrub gowns, — in turn required. Of course this also meant more office space and specially trained professional staff.

Each new ‘medical miracle’ had it own special technology, which meant that clinical laboratories equipped with microscopes and sterilizers and a radiology departments with expensive x-ray machines and surgical departments needed ceramic-tiled operating rooms, specially strong lights, OR tables, large steam autoclaves for sterilizing surgical instruments and anesthesia equipment.

Of course, these big-ticket items were all accompanied by a plethora of small and medium-sized supplies that gave rise to a thriving new industry of medical equipment suppliers and generated a cascade of on-going expense. X-ray departments required lead aprons, oceans of photographic film and special (and expensive) chemicals that included a silver alloy to develop the x-ray plate. Laboratories needed petre dishes and glass slides by the carload lot. Surgical supplies included canisters of drop-ether, scrub gowns, gallons of antiseptics soap, tanks of oxygen, surgical needles, and miles of suturing material and sterile bandages – a list that was nearly endless. The miracles of modern medicine did not come cheap. Whether they liked it or not, hospitals were being forced to reorient themselves across the board to the capital-intensive nature of “modern” medicine.

Even large university hospitals had to scramble to keep current, which meant going hat-in-hand to wealthy entrepreneurs – the Rockefellers, Carnegies, Vanderbilts, JP Morgan, and other well-known names. In return for investing in expensive new equipment and up-graded facilities, the family name of the generous philanthropist would be emblazoned over the entrance, and he’d get a hero’s welcome and his picture on the front page of the local newspaper. But the story was not so rosy for the numerically most frequent type of healthcare institution — physician-owned private hospitals — and the less frequent but larger county hospitals that depended on public funds and philanthropy. These facilities couldn’t afford the up-front cost of the latest lab and x-ray equipment, nor did their budgets allow for the salaries of specialists needed to use the new equipment.

The dramatic and drastic changes from the 19th century low-tech, low-cost custodial care to the extraordinary expensive a state-of-the-art 20th century facility introduced something else that was unprecedented: the inescapable fact the “business model” had become the single most crucial factor for the modern American hospital. Simply put, somebody had to pay for these big-ticket purchases and each hospital had to insure a revenue stream that consistently equaled its overhead and operating expenses.

Historically, hospitals had never been run as a business. No one expected the capital investments in the buildings that housed 19th century public institutions to generate profit or even pay the full cost of their operation. Caring for the indigent was simply a necessary public service. In this “Land Before Time”, physicians weren’t reimbursed for each 5-minute increment of their professional time, nor were there billing codes for medical supplies or medical procedures. The only other alternative to institutional care was to step over the sick on the streets as they were lying, and sometimes dying in public.

In most developed countries, this humanitarian service was supported by the generosity of the Church or the largess of the Crown. In the US, charity institutions were run by state and local governments or owned by major universities with medical schools, such as Columbia Presbyterian and Johns Hopkins. In these big teaching hospitals, patients received free medical services in exchange for agreeing to be teaching cases for the clinical training of med students and interns.

By 1910 this now quaint, non-technological system of simple custodial care no longer applied.  In a mere 15 years since the x-ray machine was invented, hospitals had become a capital-intensive enterprise with a ‘cash-flow’ problem and increasingly complex legal issues. In the US, the care provided by the hospital staff not only included specific medical treatments, but also a promise to meet all the personal needs of the patient. This was not the case in many 3rd world countries, where the patient’s family lived on the hospital grounds and wives and mothers — not the hospital staff — were responsible for cooking, feeding and taking personal care of their sick child, spouse or patent. In our system, free room and board (traditional hospitality) and responsibility for wellbeing were all part of the package deal. This promise not only created an additional expense in staff salaries, but also established legal liability. The nursing nurse nuns at the Hotel Deu never had to worry about being sued but the 20th century institution now also responsible for making sure their paying customers didn’t fall out of bed or slip on his way to the bathroom.

Added to this simple liability was the newly expanded arena of professional liability – what we now call ‘malpractice’. Hospitals were no longer just hotels with medical room service. They wanted everybody to know that the modest fee for hospital care include the ability to cure many diseases, perform safe surgery and successfully treat many formally fatal injuries. This promise added the unwelcome burden of professional liability for bad outcomes and adverse events to the already large economic burden of the 20th century hospital. In this new legally-defined system, hospitals were now responsible for patients getting their pills on time, seeing that no medication errors were made and that no doctor with privileges in their hospital operated on the wrong body part.

The staggering overhead associated with the responsibilities of providing hospitality, plus paying extra for liability, was tacked on to the constantly advancing, ever-more-expensive technologies of modern medicine. This trifecta — hospitality, liability and technology — meant that hospitals were businesses that above all had to pay their bills and that bill was huge! Institutions of all kinds — big charity hospitals supported by the Catholic Church, teaching hospitals run by well-endowed universities and small for-profit hospitals owned by a couple of physician-partners — were all in the same boat, which was bleeding red ink.

In other developed countries, funding for hospital care were funded the same way as public schools, police & fire departments, road building, running libraries, and maintaining a military – by collecting small sums in the way of taxes from a huge number of essentially healthy people. At this point in time, many of the larger, more prosperous European countries had nationalized healthcare. This included a system of public hospitals, with a small number of private ones. Although the United States had a smattering of public hospital in every state (mostly in the northeast) the European economic model was not an option in the US for several social and political reasons.

One of the most influential was the preference of the medical profession in the US for a private hospital business model that offered their physician-owners a variety of entrepreneurial opportunities (more about that later). In the state-sponsored European system, physicians were employees of the hospital and American doctors didn’t like the restrictions that imposed. (level II – who & why it was opposed)  Lacking a tax-supported national system as existed in many parts of Europe, hospitals in the US had no choice but to look to patients to pay for the care they received in these new, scientifically-enhanced and technologically-enriched and ever more therapeutically-effective hospitals.

Hospital patients as paying customers an engine of economic activity

As a category, patients are individuals with a sudden, extreme, urgent or on-going medical need, a situation that befalls them independent of income or ability to pay for these much needed services. The ill and injured often die or may be so disabled they will never walk (or work) again. For those with a serious medical condition, injury or terminal disease –heart attack, fatal brain tumor, spinal cord injury – acute medical treatment may go on for months and at the end of this expensive care, the patient might still die or be permanently disabled. Infants, dependent children and the mentally-disabled is a large category of hospital patient that never had and never will have an independent income. While adult patients are legally ‘responsible’ for their debts, it’s unlikely that the hospital will ever collect of a dime from those who are severely disabled, dying, or mentally-ill. Even when the patient’s family agreed to pay, it was often a promise they couldn’t keep. It’s hard to collect from a bereaved widow to left support a big family, or worse, from the deceased patient’s orphaned children.

Aside from the issue of the patient’s ability to pay, fee-for-service as a business model for hospital care has other problems. Even if a hospital owned it’s brick and mortar facility free and clear, it would have on-going operating costs that are year-round, rain or shine, regardless of the daily patient census: salaries, lights, heat, daily maintenance, fire and liability insurance, etc. While this obviously requires a steady, 365 days-a-year revenue stream, the nature of illness is seasonal; injury is erratic and major disease – heart attacks, cancer – is just plain unpredictable both in timing and it frequency. Hospitals certainly don’t have the option of increasing revenue by sending people with contagious diseases out to mingle with the crowds at the local park and in public meetings or promoting danger products or behaviors to fill up empty hospital beds.

Then there is the ‘other’ number of intense interest – what percentage of the sick, crippled and terminally ill can realistically be expected to foot the bill for capital-intensive hospitals, no matter how sick they get or how long they need to be hospitalized, even if they die? Given these grim circumstances, the conclusion was pretty much inescapable – sans a tax base, there were just not enough sick people who happened also to be independently wealthy and thus able to support the 20th century ‘modern’ hospital.

Obviously a business model whose revenue stream depends on sick people as paying customers would quickly be put out of business.

Patient revenue not only reflected the cost of the specific care they personally received, but also the full cost of running the system.  In addition to the paying the mortgage and utilities, this includes the purchase of expensive equipment. Any business model whose revenue stream depends solely on sick people as paying customers would quickly go out of business. It’s a bit like sending elementary school kids a bill for the services rendered by their teachers or expecting the inmates of a super-max prison to pay for their incarceration. Sad but undeniably true, depending on the patronage of sick people is risky. Sick people may be perfect for a charity-based or nationalized hospital system, but are the very worst choice for hospitals as a self-sustaining or profit-making business model. 

The Fundamental Mismatch between Hospital Economics and Patient Populations

The economics of sick people as a business model is similar to the relationship between hungry people and restaurants and homeless people and hotels.  Restaurants feed those who can pay full-price for their restaurant meals, not those who are the most hungry. Likewise, hotels have a ‘no-pay, no-stay’ policy that provides lodging based on who can pay, not simply those who have the greatest need for shelter. A slightly different version of this economic mis-match applies to prison inmates and children in foundling homes and orphanages. These are all categories of people that have an intense and urgent need that is not matched by the resources to pay; nonetheless, all 50 states recognize the need to support orphanages and prisons out of general tax funds.

As a business model, the issue isn’t the level of a patient’s need for medical services, but instead become their level of ability to pay or tap into family, insurance company programs that can pay. Merely being a patient (person with medical needs) does not necessarily mean that you will get care, while those with the ability may bet care they don’t need.

Obviously, depending on sick people to pay the full cost of science-based, capital-intensive, technologically-enriched 20th century hospital care was clearly not a workable model in America.

Given the social and political realities of this situation, what to do?

Section 4 – Help is on the way – A New economic model for a new tomorrow

The next section tells the story of a famous American physician who trained in surgery at Johns Hopkins and help set up the new GYN surgery department at Johns Hopkins in 1893 [ref], just four years after the hospital opened. His extraordinary vision, first published in 1914, was for a national system of well-equipped, full-service community hospitals that would become as ubiquitous as “schools and libraries”. Each one was to have modern surgery and x-ray departments as well as laboratory services, which would allow them to provide the same sophisticated level of medical and surgical services as larger teaching hospitals in urban areas.

The immediate barrier to this grand vision was the economic issue of how to underwrite the capital investments needed to up-grade small local hospitals to the new 20th century scientific standard. Who would pay for the technologically-enhanced but much more expensive care this enable them to provide – patients or taxpayers?

Organized medicine in America was opposed to the model of state-sponsored hospitals prevalent in Europe, which it described as ‘socialized medicine’. In state-owned hospitals, doctors were public employees and as such, individual physicians were not free to depart from institutional standards be inventive or independently entrepreneurial. Supervisors and department heads had the authority to second-guess the decisions of the medial staff and impose their own preference (i.e., their personal interpretation of institutional policy) over the clinical judgment over its doctors. This bureaucratic quality was seen as unwelcome interference in the doctor-patient relationship, as well as usurping the physician’s right to the economic product of his own professional skills. American doctors rejected any arrangement that interfered with the freedom to set the terms of their own practice. The only acceptable arrangement in the US was medical practice as a privately-owned small business; most physicians wanted the same market forces to apply to American hospitals.

Given these restraints, our famous surgeon-turned-economic strategist was actively looking for a free-market business model that would generate a steady stream of revenue for hospitals and also preserve the position of doctors as independent agents. He realized that the medical profession in the US needed to re-examine the traditional idea that acute-cases hospital services were only for the seriously ill or critically injured. His brilliant, think-outside-the-box conclusion was to expand the market for hospital services by creating a whole new class of ‘elective’ hospitalization and healthier paying ‘customers’ that would be profitable to the institution. The perfect choice for this new category of elective hospitalization was to identify a type of patient whose medical needs were minimal and would be relatively inexpensive to provide, so fees paid by the patient would be substantially greater than the cost of care. Ideally, these new customers would provide consistent year-round patronage, thus providing a dependable revenue stream not usually associated with the unpredictable and erratic nature of illness and injury.

As a business plan, the profitable category of elective hospitalization, combined with fee-for-service billing, makes up for the expensive and uncompensated care provided to the medically indigent. All these factors together had the potential to produce a business model that would support hospitals as private entities, free from government sponsorship and other forms of economic and clinical interference. This is the market-based model that we have depended on since the early 1900s, one that still forms the bedrock of hospital economics in the US.

Link to Chapter Four