Chapter 10.A.2--Certificate of Need Laws

The Federal Trade Commission recently called on states to re-exaimine the need for CON laws, noting their anticompetitive risks.Improving Health Care: A Dose of Competition (July 2004).

Albany Surgical, P.C. v. Georgia Dep't of Community Health, No. S04A1359 (Ga. Sept. 13, 2004) upheld the constitutionality of Georgia's CON statute, but Martin Mem'l Med. Ctr., Inc. v. Tenet Healthsystem Hosps., (Fla. Dist. Ct. App. June 29, 2004) struck down a portion of Florida's statute as unconstitutinal "special legislation" because it exempted hospitals  in only five counties from CON review for open-heart surgery programs.

Addressing the question of whether hospitals can enforce contracts for services provided in violation of CON laws, Judge Posner held "yes," reasoning that CON laws do not raise the same public policy considerations as licensing laws because they are addressed to mainly economic and not quality issues.  Rush Presbyterian-St. Luke’s Medical Center v. Hellenic Republic, 980 F.2d 449, 453-54 (7th Cir. 1992).

Problems and Prospects for Health Planning:
The Importance of Incentives, Standards, and Procedures in Certificate of Need
Randall Bovbjerg
1978 Utah L. Rev. 83
Reprinted with permission of the Utah Law Review.

Certificate of need singles out investment by institutions, mainly hospitals, for public control. Public assessment of the desirability of new investments is thought necessary because private investment decisions are insufficiently cost conscious. Indeed, it is believed that institutional capacities are overbuilt to the point of waste and unnecessary duplication, with excess capacity going unused. Other producers in our society would be undercut in the marketplace if they raised their costs by investing too heavily in extra production capacity; the threat of losing business to more efficient competitors, who are able to charge lower prices and still make a profit, is a powerful disincentive to "unnecessary" investment.

But health care institutions are different. Several peculiarities of the marketplace for institutional health services allow and encourage providers to indulge in overinvestment that would not occur in more competitive sectors of the economy. The industry is dominated by non-profit institutions, which, lacking share holders or other residual claimants seeking a profit, have diminished incentive to count costs. Indeed, the "edifice complex" of non-profit organizations is often noted. Large, new, well-equipped facilities add to institutional prestige and administrators' status. Moreover, many communities seek to have their own facilities to provide easy access, to boost local pride, and to attract doctors. Expansive investment decisions are further supported by non-profit hospitals' charitable status, which encourages private philanthropy, and by the attendant indirect subsidies of tax exemption. . . .

Moreover, excess assets themselves are thought to generate pressures to utilize them, thus increasing operating costs as well as fixed costs. Obviously, hospitals, in the business of rendering services, prefer their assets to be used and generating income; consequently, subtle (and not-so-subtle) pressures may be put on staff doctors to increase utilization. Doctors themselves, paid on a fee-for-service basis, have little reason to restrain utilization. Health care institutional providers, in short, like individual providers, are thought to be capable of creating their own demand for services in addition to simply responding to patient demand or objective medical needs. This phenomenon of demand creation is sometimes called "Roemer's law" [pronounced "R ome-er"], after the man who first reported that hospital utilization was affected by the number of beds available to be utilized. While Roemer's hypothesis may not be an iron law of health care delivery, it is certainly an important intellectual underpinning for certificate-of-need laws and health planning. Of course, there are limits to the Roemer effect; not every bed that is built can be filled. Quite apart from the extent that supply-induced demand exacerbates the cost problem, unused excess capacity means wasted resources, which planning and certificate-of need laws are meant to prevent. . . .

Irvington General Hospital v. Department of Health
374 A.2d 49 (N.J. Super. 1977)

Irvington General Hospital submitted an application for a certificate of need in November 1973. It sought permission to construct an addition to the hospital and to add . . . 19 medical/surgical beds. After several delays attributable both to the Department [of Health] and the applicant, hearings were held in September and October 1975. The hearing officer recommended that the application be approved . . . .

Between the time of the hearing and the time when the Health Care Administration Board considered the hearing officer's recommendation, the Board reclassified 150 long-term care beds at Clara Maas Hospital as medical/surgical beds, thereby creating an excess of medical/surgical beds in Essex County, the county in which Irvington General Hospital is located. . . . [O]n May 6, 1976 the Board remanded this application to the hearing officer, instructing him to make additional findings of fact "particularly pertinent to the current effect of the reclassification of the beds in the area."

The remand hearing was held, and thereafter the hearing officer recommended that the application be denied solely on the ground that Department of Health statistics now showed an excess of medical/surgical beds in the county . . . .

We agree with plaintiff's contention that the Board erred in giving conclusive weight to the[se] Department of Health statistics. . . . [T]he Legislature has required the Health Care Administration Board to take into account several factors:

. . . (a) the availability of facilities or services which may serve as alternatives or substitutes, (b) the need for special equipment and services in the area, (c) the possible economies and improvement in services to be anticipated from the operation of joint central services, (d) the adequacy of financial resources and sources of present and future revenues, (e) the availability of sufficient manpower in the several professional disciplines, and (f) such other factors as may be established by regulation. It is clear, therefore, that in light of those established considerations and the general policy of providing the highest quality health care, it is not sufficient for the Board to consider only the number of beds available in the area, particularly where the area designated by the Department as the "area to be served" may not, in fact, coincide with the area for which the services will, in fact, be provided. Total reliance upon bed statistics would permit the Board to make its decision solely on the basis of the first factor noted in N.J.S.A. 26:2H--8: "the availability of facilities, or services which may serve as alternatives or substitutes." It would permit the Board to ignore the remaining factors, notably, in this case, the second one: "the need for special . . . services in the area."

The extensive record compels the conclusion that Irvington General Hospital primarily serves the population of the Town of Irvington. That town has the largest density of citizens over 65 of any municipality in this State. Testimony of various experts establishes that the elderly patients who make up the largest portion of the Hospital's population have a greater need than other patients for the support of relatives and friends during their illnesses, and that the knowledge that they and their families are secure is a significant factor in their successful medical treatment.

The testimony also shows that public transportation to other hospitals in Essex County is poor and that many elderly patients are at least reluctant to go to those hospitals because they are located in high crime area. Moreover, their elderly spouses and friends are unable to visit them at other locations because of the lack of transportation and threats to their safety. . . .

[W]e believe that the Board, in deciding whether to grant a certificate of need, may not, as it did here, rely solely on bed need statistics. Unquestionably, it must also take into account all of the factors set out in N.J.S.A. 26:2H--8 and must, if appropriate, recognize and accept a need for special services in any local area smaller than the larger health care area established by the Department.

Because the Board failed to make those considerations a remand is required. On remand we direct that the Board take into account an additional factor: At the time of the original hearing the Department statistics showed that Essex County needed 73 more medical/surgical beds. By the time of the remand hearing 150 beds at Clara Maas Hospital had been reclassified to medical/surgical. That fact created an excess of beds in the county. The reclassification had been made upon application by Clara Maas suggested by the Department. We cannot tell from the record when the Clara Maas application was made. If, in fact, it was made after the application by Irvington General, we direct that the Irvington General application be considered first, since it was submitted first. In other words, on remand the Irvington General application should be considered as if the Clara Maas application had not yet been determined. . . .

Certificate of Need for Health Care Facilities: A Time for Reexamination
Roberta M. Ross
7 Pace Law Review 491 (1987)
Reprinted with Permission

[A. The Scope of CON Laws]

[The model federal act, the National Health Planning and Resources Development Act (NHPRDA) of 1974,] required . . . CON review prior to:

1) acquisition of major medical equipment costing in excess of $400,000;
2) other obligations of capital expenditures in excess of $600,000, indexed for inflation;
3) capital expenditures resulting in a substantial change in bed capacity;
4) capital expenditures resulting in a substantial change in health services provided by a health care facility; and
5) offer[ing] of a new health service or reinstatement of a discontinued health service.
Institutional health care providers, such as hospitals or nursing homes, were subject to CON review [but doctors' offices were not]. Federal regulations defined "health care facilities" as hospitals, skilled nursing facilities, kidney disease treatment centers, intermediate care facilities, rehabilitation facilities, and ambulatory facilities. Health maintenance organizations (HMO's) were largely exempt from CON review.

NHPRDA's focus on institutional health care providers created a loophole that permitted private physicians to purchase equipment for their offices without CON review, while hospitals could purchase the same equipment only after going through CON review.... In response to this concern, an amendment ... broadened NHPRDA's scope to include noninstitutional health care providers, such as individual physicians or groups of physicians, to the extent that they acquired expensive equipment located outside of a hospital but used to service inpatients of a hospital. Another provision of the 1979 amendment brought within the scope of CON acquisitions made "on behalf of a health care facility" as well as acquisitions made "by" the health care facility itself....

B. Burdens Encountered in Complying with Requirements

Once a health care facility decides to make an application for a Certificate of Need, there are many potential sources of delay. The actual application can take months to prepare and, regardless of how lengthy it is, additional information is frequently requested. For example, the CON application filed by a group of Connecticut hospitals for a magnetic resonance imaging (MRI) center was over 1400 pages, and the required supplement exceeded 1700 pages. From conception until final approval, Greenwith Hospital's noncontroversial and unopposed request for a CON to replace its telephone system took one year, and that period was "brief" only because the hospital agreed to waive its right to a hearing.

Review of an application may also be delayed by "batching," which requires applications for similar facilities or services to be evaluated contemporaneously and measured against each other.... Further delays may be caused by declarations of moratoria on review of CON applications.

The cost of applying for a CON can be considerable, exceeding $100,000 for major projects. If litigation is required, the cost may reach $350,000....

C. Circumventing the Requirements

The burdens imposed by CON review have prompted health care facilities to seek ways of avoiding the requirement. Among the approaches they have taken are: piecemeal acquisition of major equipment where the components are below the monetary threshold for CON review; use of parent corporations and their subsidiaries to provide benefits to health care facilities; and arrangements between health care facilities and private physicians whereby the private physicians obtain major medical equipment, the benefits of which are made available to the health care facility....

The first of the circumvention devices, piecemeal acquisition, is illegal in most instances....

There is a paucity of cases involving the use of parent corporations to avoid review. This method, however, is not uncommon, and is openly employed. In a typical situation, a hospital seeks to construct a parking garage for the convenience of its patients and staff. Because the hospital is a health care facility, and because the garage may involve a capital expenditure in excess of the threshold, the hospital must apply for a CON. To avoid this, the hospital creates a parent corporate entity with two subsidiary corporations, one of which is the hospital. The second subsidiary is not a health care provider and, arguably, not subject to the CON statute. It builds and operates the garage with the result that the hospital has the parking facilities it requires, without subjecting the project to CON review.

... The use of creative corporate structuring devices to avoid review depends upon whether the state statute includes a CON requirement for acquisitions "on behalf of" a health care facility and, where it does have this requirement, how the phrase on behalf of is interpreted. For example, a Washington, D.C., court read this language to include the benefit to a hospital of a parking garage developed by a subsidiary of the hospital's corporate parent. An injunction was granted, halting the construction of a four and a half million dollar garage. . . . District of Columbia v. Washington Hosp. Center Health Sys., No. 6970-83 (D.C. Super. Ct. Jul. 25, 1983). ... A Nebraska court, on the other hand, has interpreted "on behalf of" more narrowly, holding that a separate tax entity that constructs a physicians' office building adjacent to a hospital is not subject to CON, because on behalf of does not necessarily mean for the benefit of. State v. Coleman, No. 354-194 (Lancaster County Dist. Ct. Sept. 24, 1982)....

The third device, arrangements between health care facilities and private physicians, has been possible in states that failed to extend their CON statutes to physicians' offices in accordance with the federal amendment. Challenges to such arrangements have occurred in New York and New Jersey.... Using private funds, Clifton Springs Sanitarium purchased a trailer which it installed on its grounds eight feet from its hospital building. A walkway and electrical lines connected the trailer to the hospital building. The trailer was leased to a staff radiologist who leased, and later purchased, a CAT scanner. The radiologist performed CAT scans on inpatients of Clifton Springs Sanitarium, inpatients of other hospitals, and outpatients in the area. No CON was obtained. . . . The Administrative Law Judge concluded that the hospital had violated the law, and the state then ordered the doctor to discontinue performing CAT scans on patients of Clifton Springs Sanitarium. The Appellate Division annulled the determination, holding that a CON was not required because the CAT scan services were provided by a private physician and not by the hospital. Clifton Springs Sanitarium Co. v. Axelrod, 115 A.D.2d 949, 497 N.Y.S.2d 525 (4th Dep't 1985). The court took note that the trailer was purchased with private money and was not part of the hospital or constructed according to the hospital building code; that the scanner was the property of the doctor; that the doctor was not required to perform scans on the hospital's patients; and that the radiologist paid the staff and billed the patients directly....

Conversely, a New Jersey court, deciding Radiological Society of New Jersey v. New Jersey State Department of Health, Hospital Rate Setting Commission, 208 N.J. Super. 548, 506 A.2d 755 (1986), read that state's CON statute as being applicable to private physicians who provide services to inpatients of a hospital. Despite the New Jersey statute's private physician exclusion, the Radiological court held that a physician who acquires a CAT scanner and magnetic resonance imaging (MRI) equipment must first obtain a CON....

Whether it is desirable to close the loopholes that permit circumvention of the CON process is a policy decision that should be made only after an evaluation of the efficacy of the process. If the process does not make a significant contribution toward cost containment and equitable distribution of health care resources and if it provides, as some critics suggest, an obstacle to improved health care, it may be that the CON requirement should be abandoned.

[D. The Impact of CON Laws]

Viewed in terms of equitable distribution of health care resources, the effect of the CON process has been limited. There is little evidence that HSA's have initiated programs for underserved areas.... Success of the CON process in cost containment is similarly questionable.... [E]ven with CON, health care costs are growing at a substantially greater rate than the rest of the economy. The extent to which CON has kept health care costs from growing at an even faster rate remains to be established.

The enormous expenditure of time and money by both administrative agencies and health care providers in complying with the CON process substantially reduces any savings that might be attributable to it. For all its promise, CON review has resulted in the elimination of few projects. Of over 20,000 CON applications reviewed throughout the country between 1979 and 1981, only ten percent were ultimately disapproved.211 Such statistics prompt understandable concern as to the wisdom of continuing to invest significant amounts of time, money, and effort on the CON process.

It has been suggested that the CON process actually increases the cost of providing health care.... The substitution of expensive labor for capital investment in an already labor intensive industry increases total health care costs. By discouraging the entry of new providers, giving, in effect, a franchise to existing providers, CON eliminates competition and the restraining effect that competition can have on prices. P. Joskow, Controlling Hospital Costs (1981)....

The lack of convincing evidence that CON programs make a significant contribution to health care cost containment, or to a more equitable distribution of health care resources, suggests that states should dvelop and implement alternative approaches to solving these problems. Should a state determine, however, that CON programs have value and merit a role in the state's health planning scheme, the state must make a judgment regarding the scope of the program--the activities and providers that should be included.... Failure of legislatures to engage in this re-examination will result in continued circumvention of the law on the one hand, and overreaching by administrative agencies on the other. More importantly, failure to engage in a probing re-examination of the problems of rising health care costs and inequitable distribution of health care resources will create an even greater distance between those problems and their solutions.

211 OFFICE OF THE ASSISTANT SECRETARY FOR PLANNING AND EVALUATION, DEP'T OF HEALTH AND HUMAN SERVICES, REPORT TO CONGRESS, HOSPITAL CAPITAL EXPENSES: A MEDICARE PAYMENT STRATEGY FOR THE FUTURE 48-50 (1986). This figure, however, represents only the percent of filed applications that were rejected and not the percent of dollar expenditures rejected. This figure may be tempered by the fact that the prospect of CON review may dissuade hospital administrators from developing plans for projects they anticipate will be rejected. The result, however, may not be entirely salutary because among the abandoned projects may be ones of great value to the quality of health care.

Notes: Certificate of Need Review Criteria and Process

1. Competing Criteria. How is an agency to "take into account all of the factors set out in [the CON statute]" as required by Irvington when those factors are as diverse and opposed as quality, cost, and access?

Most CON programs . . . have one stated goal: the promotion of equal access to quality health care at reasonable cost. The problem is that this single, seemingly unimpeachable goal is in reality three goals that compete and are often mutually irreconcilable: quality, accessibility, and cost control. How these three goals are interpreted and implemented varies directly with who is doing the interpreting and for what purpose. Health care providers, for example, tend to perceive need from the quality side of the spectrum. . . . Consumers, while also oriented to issues of quality, tend to view accessibility as a major goal of CON. . . . As for the regulators, there can be little doubt that CON has one essential purpose: to keep costs down. Medicine in the Public Interest, Certificate of Need: An Expanding Regulatory Concept (1978).

2. "Perhaps the chief source of discouragement about health planning is the complexity of the task. Among the factors relevant in the planning effort are [the nature of existing facilities and their service areas, population size and characteristics, and current use patterns.] Even this list fails to convey the difficulty of projecting changes in population, technology, . . . and patterns of utilization. . . . The complexity is such that the agencies themselves lack confidence in their ability to make hard-and-fast judgments, and the result is a lack of firm standards for decision making. In such circumstances, the pressures of politics necessarily become dominant." Havighurst supra, 59 Va. L. Rev. 1202-04. See D. Altman, R. Greene & H. Sapolsky, Health Planning and Regulation: The Decision-Making Process (1981);

3. The Scope of CON Laws. States have departed from the federal model in several ways. About a dozen states have entirely repealed their CON laws. Many others have modified their laws to narrow the range of health care facilities and projects subject to review. For instance, many states have raised the dollar thresholds to double or more the original federal levels. A few states have reinvigorated this regulation by adopting an entirely different approach to defining the scope of their CON laws. These states cover specified new health services regardless of their capital or operating cost and regardless of whether a "health care facility" undertakes the expenditure. This approach is typical for organ transplant and heart surgery programs and for expensive diagnostic machinery.

4. Circumvention Techniques. The doctor's office exemption has proven to be quite a large loophole. For instance, the exemption has been used frequently to purchase magnetic resonance imagers (MRIs) without CON approval. Boulware v. State Dept.of Human Resources, 737 P.2d 502 (Nev. 1987). MRIs are highly sophisticated diagnostic scanning devices that cost up to $ 3 million installed. Although they originally were found only in major medical centers, the majority of MRIs are now located outside the hospital setting, largely because of the CON laws. See Earl Steinberg, et al., X-Ray CT and Magnetic Resonance Imagers: Diffusion Patterns and Policy Issues, 313 New Eng. J. Med. 859 (1985). As Ross summarizes, a number of states have attempted to close this loophole by extending CON laws to outpatient facilities intended primarily to treat inpatients, while others apply CON review to specified equipment and services regardless of institutional sponsorship.

Health care facilities have found various other inventive techniques for circumventing the CON laws. One is suggested by Irvington's willingness to "recognize and accept a need . . . in [a] local area smaller than the larger health care area established by the Department." For instance, a hospital applicant in an overbedded metropolitan area may try to carve out an unserved area in the affluent, growing suburbs. Whether this technique is successful turns on whether the suburbs are considered to be within the service area of the existing "downtown" hospitals. States vary in their methodologies for defining service areas. Without entering into the full complexities of service area gerrymandering, consider what the policy implications are of: (a) refusing local hospital facilities to newly emerging communities; (b) locating new construction in affluent white suburbs to the detriment of patient census in older, city-center hospitals.

Another technique for circumventing numerical bed-need limitations is for an existing hospital to construct a new facility that "replaces" older beds, sometimes in an entirely different location. This technique of trading in old beds for new ones has created a lively market in the sale of older hospitals. In some cases, the replaced capacity consists of only "paper beds," i.e., licensed bed capacity that has long since been taken out of operation to make room for other uses and services.

5. Review Procedures. Irvington required the earlier CON application to be considered first. But what if both applications were filed at approximately the same time? In such circumstances, courts require the applications to be considered in a comparative hearing, which seeks to determine not only whether there is a need for the service or facility, but, if so, who among many hospitals will best serve that need. Bio-Medical Applications v. Dept. of Health and Rehab. Servs., 370 So.2d 19 (Fla. App. 1979). Comparative hearings can turn into surprisingly complex affairs that last for weeks. Once one application is filed, it is usually followed by several other competing ones that are batched together in the same review cycle. In the experience of one of your authors, these contests quickly degenerate into disputes over trivia such as who has the superior parking lot design or who is cutting down the most trees. See, e.g., In re Health Care and Retirement Corp., 364 S.E.2d 150 (N.C. App. 1988).

Among the controversial procedural disputes that arise in CON litigation are:

(a) whether states are authorized to impose a moratorium on CONs for certain types of services--United Hospital Center v. Richardson, 328 S.E. 2d 195 (W.Va. 1985) (moratorium invalid);

(b) whether expiration of the statutory period for the agency to review an application results in the application being "deemed approved" automatically--Platte County Medical Center v. Missouri Health Facilities Review Comm., 734 S.W.2d 608 (Mo. Ap p. 1987) (deemed approved); Myers v. State, 503 N.E.2d 451 (Ind. App. 1987) (same); Benedictine Sisters Benevolent Association v. Petterson, 299 N.W.2d 738 (Minn. 1980) (contra);

(c) whether competing hospitals have standing to challenge the grant of an application--Community Care Centers v. Missouri Health Facilities Review Comm., 735 S.W.2d 13 (Mo. App. 1987) (no standing); St. Joseph Hosp. v. Dept. of Health, 87 P.2d 891 (Wash. 1995) (standing); Andrew Dolan, Who Has Standing to Appeal Certificate-of-Need Decisions?, 1978 Utah L. Rev. 155; and

(d) Whether an approved project can be altered without further approval. Appeal of Rehabilitation Assoc's of New England, 556 A.2d 1183 (N.H. 1989) (yes).

See generally, J. Simpson & T. Bogue, Guide to Health Planning Law: Topical Digest of Case Law (1985); E. Flash, et al. supra; Annot., 61 A.L.R.3d 278 (1994).

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