BALTIMORE — Maryland health agencies are continuing to negotiate with federal Medicare to avoid losing up to $2 billion in federal health care dollars.

After months of tense dialogue, Maryland officials believe that they are making progress. John Colmers, the chair of the Health Services Cost Review Commission, said he was optimistic about the outcome of the talks during his testimony before the Senate Budget and Tax Committee.

“We have been very greatly encouraged,” Colmers said, explaining that the Obama administration has been supportive of Maryland’s efforts to contain Medicare costs. “They are excited to see a state as a whole take on the challenge.”

Only state with a Medicare waiver

Maryland is the only state in the nation that has a Medicare waiver. Unlike the other 49 states, it is exempt from federal Medicare rates and is permitted to set health care prices for all payers. This exemption translates into over $1.6 billion in additional revenue for Maryland hospitals, which are not required to grant Medicare patients discounts on health services as they otherwise would.

This money is in jeopardy, because Maryland’s special status depends upon its ability to ensure that state Medicare costs rise more slowly than those in the rest of the country. As the price of state health care rapidly increases, it is fast approaching that limit.

The statewide campaign for Medicare cost control began last year when public officials realized that the state risked losing eligibility for its Medicare waiver if the average cost of inpatient care exceeded the national norm.

Their challenge is compounded by the fact that many Maryland Medicare patients have been diverted to outpatient facilities, because of a renewed emphasis on preventive health care and a concerted effort to minimize the number of hospital stays.

Hard-to-treat cases wind up in the hospital

“Those are sound policies, but they all have the effect of leaving the most sophisticated, hard-to-treat cases in the hospital while removing the simpler cases, which makes us deteriorate on the waiver test,” says Patrick Redmon, the executive director of the Health Services Cost Review Commission, which has been setting Maryland hospital rates for decades.

State health officials hope to convince the Obama administration to change the requirements of Maryland’s Medicare waiver. They argue that the proper measure of medical efficiency is not the average cost per hospitalization but rather the average cost per capita, i.e. the amount of money spent annually on the typical Medicare recipient in Maryland.

Great health care would keep most patients out of the hospital, Colmers said, so the most economical Medicare system would emphasize disease prevention and focus limited hospital resources on the sickest individuals.

“We think that will result in better care and lower cost,” Colmers said. But he told senators that the obstacles to this transformation are formidable.

“I don’t want to minimize the challenges in front of us,” he said. “This effort involves transforming 40 percent of the state healthcare system.”

But Bob Chrencik, the president and CEO of the University of Maryland Medical System, said the state had no choice but to confront these challenges. “The loss of the waiver would be catastrophic,” he warned, describing a doomsday scenario where Maryland hospitals had their credit ratings downgraded and doctors shuttered their practices.

Since health care providers are operating on “razor thin profit margins,” Chrencik said, they cannot afford to lose the federal funding granted by the state’s Medicare waiver.

Stuart Erdman, assistant treasurer of Johns Hopkins Health System, agreed and cautioned Maryland legislators not to take the waiver for granted. Congress would not continue to allow the state to receive more Medicare dollars than everyone else, he said, so containing costs is crucial if the state wants to retain its control of health care pricing.