Bud Barrows has run hospitals in Louisiana for years. But last year, when he took over as CEO of the parish hospital in Opelousas, his world turned upside down. Just before he took over, a brand-new ambulatory surgical center opened in town. For procedures in such specialties as podiatry and ear, nose and throat, patients flocked to the new surgery center. Barrows saw millions of dollars disappear almost immediately from Opelousas General Hospital.

It isn't just his new neighbor that's causing him financial consternation. In nearby Lafayette, a specialty cardiac hospital, a spine hospital and a surgery center are all under construction. To compete with the private cardiac facility, two community hospitals are attempting to build their own specialty hospitals to keep some of the business in-house. For Opelousas General, Barrows expects the end result will be a steady loss of paying customers. "When you strip out the highly profitable patients and the more profitable procedures, then you leave the community hospitals on the brink of financial disaster," he says.

Since 1990, the number of for-profit specialty hospitals in the U.S. has tripled. In states such as Louisiana, specialty hospitals have already changed the health care landscape. Although these hospitals are often favored by doctors and patients, there is concern that, left unchecked, the hospitals are a real threat to taxpayer-supported facilities. Not surprisingly, some state and local governments are searching for ways to keep the newcomers at bay.

THE FISCAL FACTOR

Specialty hospitals are not a new phenomenon. For decades, they have existed to serve distinct segments of the population, such as children or veterans. But the recent wave of them focuses on special procedures instead of special populations. And the rise of these boutique or niche hospitals is rooted in modern hospital economics.

For starters, some patients are more financially lucrative than others. If a patient shows up at an emergency room in cardiac arrest, doctors have to treat him regardless of whether he has insurance. Traditionally, hospitals have built into their rates the cost of caring for the uninsured.

But hospitals have another way to subsidize the cost of non-paying patients. When a hospital performs a procedure on a patient, it is reimbursed a set amount from insurance companies and Medicaid, based on the type of procedure. In certain cases, however, hospitals can consistently perform the procedure at a cost significantly below what they are being reimbursed. For example, many health care economists estimate that hospitals can make a 10 percent profit on heart surgeries and that some hospitals bring in 35 percent of their overall profits from heart surgeries alone.

Several years ago, investors figured out that a for-profit heart hospital could capture only the profitable parts of a hospital, with minimal drag from the uninsured or from other procedures, such as emergency room care and diagnostic tests, which are reimbursed below true cost. At this same point, physicians' incomes were flagging, thanks to managed care; doctors were eager to be more entrepreneurial to increase their cash flow.

Enter the niche hospital. Now, according to a U.S. General Accounting Office report released in February, there are 92 specialty hospitals in existence, with the facilities located in urban, rural and suburban settings. About 70 percent of the hospitals have some physician ownership and, GAO reports, patients at specialty hospitals tend to be less sick than those at general hospitals.

For community hospitals, the loss of highly profitable patients to specialty hospitals throws their economic underpinnings out of whack. "As soon as a specialty hospital opens, you have a huge volume of business gone overnight," says Ellen Pryga, director of policy development for the American Hospital Association. The AHA argues that if specialty hospitals are allowed to proliferate, community hospitals will be unable to survive, either requiring increased governmental subsidies or leaving thousands of the neediest patients without health care. As Louisiana's Barrows puts it, "it's a runaway freight train of disaster for community hospitals."

THE COMPETITIVE EDGE

Not surprisingly, proponents of specialty hospitals see the issue somewhat differently, arguing that although they are profitable, they also provide superior health care. When they can focus on just one type of procedure, they say, they can improve the quality of care and produce new scientific efficiencies. Beyond questions of quality and fairness, however, the issue has "everything to do with competition," says Dennis Kelly, chief operating officer of MedCath, one of the largest specialty hospital companies in the country. "If you're an existing business, you don't like new competition coming to town-- particularly one that does it better than you."

Reducing the issue to business does not sit well with advocates of community hospitals. Hospitals, they point out, cannot be treated like any other business since there is not a regular market in health care: People who don't have the money to pay can still receive health care.

Ultimately, the debate boils down to what the role of community hospitals should be. Are community hospitals businesses, expected to vie competitively in the market, or are they quasi-governmental agencies, providing a service outside the bounds of the business environment?

Regardless of these abstract notions, many government officials are dealing with policy implications from the specialty hospitals that are already in existence. In addition to the financial ramifications, operators of community hospitals say that specialty hospitals exacerbate the nursing shortages plaguing the hospital industry. Nurses prefer specialty hospitals because the hours are more regular and the pay is often higher. Barrows says that there have been days where his hospital in Opelousas has had to stop admitting patients because there weren't enough nurses on staff.

REGULATORY VIGOR

Complaints from community hospitals have led to regulatory efforts on the federal, state and local levels. The most prevalent means of regulation thus far has been conflict-of-interest laws. During the 1990s, the U.S. Congress passed a law that prohibits doctors from referring patients to any practice that they own or in which they have a financial stake. The law contains an exception, however, for "whole hospitals." Specialty hospitals are considered to be whole hospitals, and therefore, the conflict-of-interest laws do not apply.

Because of the need for referrals in managed care, doctors often determine where patients will end up for their procedures. Community hospital advocates argue that when doctors have a financial stake in specialty hospitals, they will refer patients who can afford to pay to their hospitals. As part of the Medicare reform bill debated this spring, both the U.S. House and the Senate versions incorporated language that would challenge the whole-hospital exemption. The Senate bill would repeal the exemption; the House would set up a committee to study the issue. The bills are currently in conference committee.

Several states have attempted to repeal the whole-hospital exemption on their own. A bill to do just that is scheduled for a vote this month in the Ohio legislature. "When you've got that combination of referral and ownership, it's anticompetitive and it's inappropriate and it's not good for the community as a whole," says Mary Yost, vice president for public affairs at the Ohio Hospital Association. Both the federal and the state laws would apply only to new hospitals, grandfathering in the existing specialty hospitals. If passed, the law is expected to severely curtail specialty hospital growth.

In addition to conflict-of-interest laws, states have also proposed a variety of other legislation, with little success. In Louisiana, for example, policy makers attempted to force any new hospital to have an emergency room, limiting its ability to pick and choose patients. Even with an emergency room, however, specialty hospitals probably wouldn't see nearly the volume of crisis patients that a community hospital would. Other states, Ohio among them, have considered a moratorium on new specialty hospitals.

States have also looked at reforming their certificate-of-need laws. In the 1940s, the federal government gave health-planning money to states but required them to have laws on the books stating that hospitals would go only where they were needed. In the mid-1990s, the federal government decided that it shouldn't constrain growth in health care services and withdrew the requirement for the certificates of need. About one-third of the states subsequently dropped their laws. Even in the remaining two-thirds that have the laws, hospitals are often just rubber stamped without much analysis. For the most part, growth in specialty hospitals has been concentrated in states without certificate-of-need laws, because companies would rather not deal with the red tape.

Surprisingly, where certificates of need have been successful is on the local level. Faced with a prospect of a specialty hospital coming to their area, several cities in Oklahoma, including Duncan and Norman, passed ordinances that require permits for hospitals based on community need.

The nature of the regulation--or lack thereof--at the federal, state and local levels will determine the future of specialty hospitals. In his corner of Louisiana, "it's almost too late" for regulatory intervention, says Barrows. "But maybe it can keep other communities from suffering in the same way that we do."