Ed Herbert shuffles through the inbox atop his immaculate cherry desk until he finds the report. There he reads news of a cataclysmic trend facing the hospital industry, quantified and spelled out in black and white for the first time. The news comes as no surprise to Herbert, a vice president at Mountain States Health Alliance. The date is April 14, 2004, and Nashville-based HCA, the nation’s largest hospital chain and an industry bellwether, has announced an increasing number of uninsured and underinsured patients coming through its doors. The resulting rise in unpaid bills is choking its earnings.

Like hospital executives elsewhere, Herbert knows the hospitals in Mountain States’ system—six of which are former HCA facilities—are not immune to this issue, which has set in motion a series of events eroding revenue for U.S. hospitals. As an optimist, Herbert says of uninsured patients, “We’ve got to take these people under our wings.” But as a realist, he wonders, “How can we help keep this problem from hitting our system hard?” Although Johnson City-based Mountain States has maintained positive cash flow for three years, those funds have not been sufficient to cover much-needed capital improvements at the system’s nine facilities. Every dollar counts.

The stats behind the announcement are grim. According to the Tennessee Hospital Association, un-reimbursed costs for Tennessee’s hospitals totaled almost $1.1 billion in 2002, up from $1 billion in 2001. In one case, the Regional Medical Center in Memphis (The Med) had more than $85 million in uncompensated care costs in 2002.

More worrisome, one of the principal culprits is also one of the core components of the traditional hospital mission—providing care for all who need it in a community. “The plight of the uninsured is the Achilles heel of health care,” says Craig Becker, president of the Tennessee Hospital Association. To make matters worse, many of the uninsured and underinsured have increasingly sought basic care at the state’s trauma care facilities: The Med, Nashville General, Vanderbilt, Erlanger, UT Medical Center and Johnson City Medical Center. This places a higher financial burden on institutions with higher cost operations. Warren Beck, director of finance for Vanderbilt University Hospital, says patients who need routine care—and should be treated in community facilities—are coming to very expensive hospitals like Vanderbilt, and Vanderbilt wants to be paid for its services. Beck says the hospital has an annual operating loss between $35 million and $50 million for TennCare patients and the uninsured.

Such fiscal strain places hospitals, traditionally places of succor for the needy, in the delicate position of trying to redirect patients elsewhere without violating core tenets of their underlying philosophy, or the federal law that requires them to treat all who come to their emergency rooms. It’s a delicate balance.

At Mountain States in East Tennessee, efforts are underway to alleviate the system’s financial strain by keeping uninsured patients out of the expensive emergency department for non-emergency treatments. Patients are encouraged to call the “Ask a Nurse” phone line with medical questions and visit Mountain States’ ValuCare clinic, located in a local grocery store. (A second ValuCare clinic is slated to open this fall.)

Many hospitals are changing their collections procedures to pocket as much money on the front end as possible. When a patient enters one of Mountain States’ hospitals, he or she is asked for payment up-front, with case managers on hand to help patients with financing and checking whether they qualify for Medicare or TennCare.

The collections issue is particularly sensitive since a recent lawsuit accused a slew of not-for-profit hospitals of unfairly and aggressively pursuing patients for payment after care was provided. To clean up an inefficient process, hospitals are working to train staff to help patients adjust to the new procedures. After all, in-hospital discussions about the cost of care are almost non-existent when managed care plans pay the bill. Donna Abney, executive vice president at Methodist Healthcare in Memphis, says the hospital system is learning more about what is reasonable and what is not when it comes to charging patients directly. “It’s not a skill set we’ve ever valued—having to retrain staff to teach them how to engage in that conversation about financial payments. But we’re getting better,” Abney says.

Hospitals will have to look beyond collections policies and financial counselors to more extensive adaptive measures, as increased consumer control of health care purse strings extends beyond the uninsured population. As health insurance has become too expensive for many employers and individuals, new methods of paying for health care are shifting control and power to consumers. Renowned health care expert and Harvard Business School professor Regina Herzlinger recently authored Consumer-Driven Health Care, in which she writes, “Across the United States a silent revolution is creating a new kind of health care. Its creators are largely unaware of each other’s existence. Their methods and ways differ considerably. But they breathe the same air—the zeitgeist of consumerism.”

Paul Keckley, executive director for the Center for Evidence-Based Medicine at Vanderbilt University, says, “Consumer involvement isn’t a fad. It’s a trend, and it’s here.” Keckley notes that consumers already have been given incrementally more responsibility, paying higher co-pays and deductibles for plans offering less coverage; however, he is not convinced that unbridled consumerism is the best way. He prefers shared decision-making, or guided self-care management. It’s up to providers, he says, to guide patients and equip them with the tools they need.

While some industry observers are skeptical about the extent to which consumer-driven health care can damage hospitals’ revenues, early evidence shows a dramatic impact on hospitals. A recent survey by the National Business Group on Health and Watson Wyatt Worldwide showed 32% of large companies expect to offer a consumer-directed health plan to workers next year, up from 21% currently offering such a plan, typically alongside other health plan options.

If consumer-driven health care represents storm clouds for hospitals, health savings accounts (HSAs) could well be the first drops of rain. HSAs are the principal component of a new, less expensive health insurance option that cuts insurance premium costs and encourages consumers to be more price-sensitive when making health care purchasing decisions. That sensitivity, hospital administrators fear, may decrease hospital utilization and cut into revenues as patients skip elective treatments and opt for less expensive remedies.

The recent Medicare legislation established the HSA as a savings mechanism, with portability akin to 401(k) plans, to accompany cheaper high-deductible health plans. Tax-free contributions to an HSA are then used to pay for qualified medical expenses, and preventive services can be covered. Aetna was the first insurer to offer an HSA-compatible plan with accompanying HSAs. This fall, insurers such as BlueCross BlueShield of Tennessee and UnitedHealthcare also plan to roll out HSA-qualified plans.

HSAs already have started to rock the boats in the industry, and their captains have taken notice. In a June hearing before a U.S. House of Representatives subcommittee, Jack Bovender, chairman and chief executive of HCA, warned that HSAs and higher levels of co-pays and deductibles will increase the hospital chain’s level of bad debts. Bovender pointed out that hospital bills are already one of the last bills to be paid by Americans—only student loans are paid later. Even if effective collections procedures were in place, hospitals can do very little to control patients’ ability to pay, and that uncertainty is alarming.

Though health care execs might denounce them, HSAs and the trend they represent may help dispel one of the great mysteries of the modern-day hospital—pricing. As HSAs gain traction and hospitals increasingly sell direct-to-consumer, hospital administrators will have to make prices transparent, triggering a reexamination of their pricing methodology. Unlike a restaurant menu with itemized prices, hospitals’ listed prices for care have been opaque and arguably baseless. Some prices are set through negotiations with different insurance companies. Other prices are derived from certain reimbursement rates from government programs. Most troubling of all, there are the astonishingly high rates sometimes charged to patients who lack insurance.

The confusion surrounding health care pricing played out in the June meeting, where HCA’s Bovender joined a panel of hospital chiefs who were asked to explain the highest price an uninsured patient could pay at their hospitals. A variety of awkward answers were given by the panel, which was made up of top brass at Tenet Healthcare (the second largest U.S. hospital chain) and the parent companies of Nashville-based Saint Thomas Health Services and Chattanooga-based Memorial Healthcare System. Bovender explained HCA’s charity care and discounted care policy, adding that the hospital chain is working to begin charging everyone eligible for discounts a rate in the 95th percentile of HCA’s managed care charges. The subcommittee chairman, Jim Greenwood, praised Bovender, saying, “That’s the clearest answer I’ve heard so far.”

The government is doing its part to force hospitals to accept the consumer’s role as the direct purchaser of care. A recent joint report from the Federal Trade Commission and the Department of Justice encourages private payers, governments and providers to improve measures of price and quality. FTC Chairman Timothy Muris says vigorous competition promotes cost-effective health care. The report urged these groups to “give consumers more information on prices and quality in ways that they find useful and relevant, give consumers greater incentives to use such information, and align the interests of providers and consumers.” This message is supported by extensive research and invested with the authority of the two federal bodies handing it down to the industry. The FTC and DOJ go on to say, “The American free-market system is built on the premise that open competition and consumer choice maximize consumer welfare—even when complex products and services such as health care are involved.”

Arguing against the claim that health care is too complicated for patients to safely navigate as payers, proponents of consumer-driven health care draw a comparison to the domestic automotive industry’s transformation a few decades ago, after the notion was dispelled that automobiles were too complicated for consumers to understand. Recall J.D. Power and Associates polling consumers and relaying their desires to auto manufacturers, and the subsequent demand for higher-quality and lower-cost automobiles changed what is offered by the auto industry. J.D. Power sees the same wave of change coming for hospitals. The firm has formed a new health care division to provide the industry with product information, joining a host of organizations already collecting data from hospitals.

Ultimately, consumer-driven health plans may affect hospital revenue in the simplest of ways—lessening the number of patients who walk through their doors. Early evidence shows consumers’ cost-sensitive decisions are likely to reduce their utilization of hospital services. A recent report by consulting firm Mercer says 73% of employers are likely to offer HSAs by 2006, and if the example of employer Whole Foods Market is any indication, hospitals will feel the pinch. Whole Foods was cited in a recent Wall Street Journal article for its adoption of a consumer-driven health plan that gives employees more of a financial stake in their medical care by putting money into accounts for each worker to use when they pay for health care expenses. As a result, overall medical claim costs fell 13% last year, and hospital admissions per 1,000 employees fell 22%, a statistic not easily digested by hospital administrators who rely on patient volumes to boost revenue.

Similarly, Aetna recently released findings from its study of first-year members in its new consumer-directed plan, revealing that medical costs decreased 11% for employers that replaced their health plans with consumer-directed plans. Aetna attributes these savings to lower member utilization of physician and facility services.

With plans designed to give members access to preventive care, consumers’ utilization of preventive care measures increased by as much as 23%. These members are on the road to better health, and providers of preventive care and certain chronic health treatments are financial beneficiaries of this trend. But hospitals that rely primarily on consumers’ illnesses and injuries, along with elective services, for revenue have every reason to be worried. In fact, Vanderbilt’s Keckley says some hospitals could transform into chronic care management centers built around such conditions as asthma, diabetes, heart disease and obesity. Considering at least 30% of the U.S. population have one or more of these chronic conditions, a transition into chronic management facilities might be the perfect solution for some hospitals.

Whether or not HSAs are the perfect solution for patients could be irrelevant. As employers struggle to fund health insurance benefits for their employees, many will embrace consumer-driven plans, just as they did with health maintenance organizations (HMOs) in the ’80s, says Michael Young, senior vice president with Aon Consulting. “Most of them will embrace it not because they philosophically believe it’s the right thing, but quite frankly because they have no other option, and they’re desperate.” Young’s comments were part of the testimony used to create the recent FTC/DOJ report on competition and health care. Furthermore, if penny-pinching employers do not contribute to the HSAs of their employees, health care costs will come right out of consumers’ pockets. A recent report from consulting firm Mercer shows that 39% of employers surveyed said they would not make any contribution to the HSA account. This finding means trouble for hospitals, as consumers will be even tighter with their health care dollars.

In the end, the push for consumer-driven health care will compel hospitals to address some endemic problems: antiquated pricing methodology, ineffective collections and reliance on negotiated insurer rates to be profitable. And regardless of how much the process stings, the result will be less reliance on third parties for their free market viability.