Catch Me If You Can: Hospitals, Cost Shifting, and the Game of Medicare Payment Policy

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Catch Me If You Can Hospitals, Cost Shifting,
and the Game of Medicare Payment Policy

• Policy History Conference
• May 20-23, 2004 (St. Louis, MO)
• Rick Mayes, Ph.D.
• Asst. Professor of Public Policy Faculty
  Research Fellow
• Department of Political Science Petris Center
  on Healthcare Markets
• University of Richmond School of Public
  Health
• Richmond, Virginia University of
  California, Berkeley
• Jason Lee, Ph.D.
• Principal Senior Advisor
• National Organization for Research at Chicago
  (NORC)
• 1350 Connecticut Ave., Suite 500 NW
• Washington, D.C.

2
Overview

• This presentation examines
• the background and economic debate over cost
  shifting,
• hospitals unique position in our countrys
  health care system as risk-bearing institutions,
  and
• how cost shifting affects and is affected by
  Medicare.

3
Definition of Cost Shifting

• The phenomenon in which changes in administered
  prices of one payer e.g., Medicare lead to
  compensating changes in prices charged to other
  payers e.g., private insurers, employers for
  care.
• - Paul Ginsburg, former Chair of the Physician
  Payment Review Commission (PPRC)
• The allocation of unpaid costs of care delivered
  to one patient population through above-cost
  revenue collected from other patient
  populations.
• - Allen Dobson, President of The Lewin Group

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Hospital Cost Shifting Hydraulic"
B C MarginContribution
130
B
120
Cost Shift
C
A
110
Cost
100
Shortfall
Margin
90
80
70
Payment to Cost Ratio
60
Below Cost Payers
Above Cost Payers
50
40
30
20
10
10
80
90
70
60
50
40
30
20
0
100
Percentage of Market Share
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What is Cost Shifting? (continued)

• Cost shifting is an implicit social compact
  between public payers and providers.
• Cost shifting supplements public funding of
  safety net providers.
• Cost shifting varies geographically based on
  market power of the providers, public payer
  (Medicaid) payment levels, and the levels of
  uncompensated care.
• Without cost shifting, providers might not be
  able to modernize and replenish physical plants
  and equipment.

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What is Cost Shifting? (continued)

• Privately insured patients have generally
  financed losses from other payers
• below-cost (marginal cost) reimbursement rates
• uncompensated care
• The ability to cost shift to compensate for one
  payers reduction in revenue is limited if
  hospitals have already maximized revenues on
  remaining payers.

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Hospitals as Risk-Bearing Institutions

• hospitals bottom line total/overall margin
• This measure compares total revenues from
  patient care and other sources with the total
  expenses of the institution, including all of the
  hospitals activities.
• - Stuart Guterman, Director of Research (CMS)

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Economic Debate Over Cost Shifting

• Old joke about economists Theyre people who
  dont believe something can happen in practice
  until they can first demonstrate it in theory.
• In theory, cost shifting can occur only if two
  conditions are met (1) the provider must have
  sufficient market power to raise prices to
  private payers, and (2) the provider must not
  have been fully exercising this power.
• Looking back on the late 1980s/early 1990s, cost
  shifting appears to have died, killed off by new
  forms of insurance, price competition among
  hospitals, and greater cost consciousness in
  health care. Michael Morrisey
• Without exception, for all hospital types during
  all time periods, lower Medicare prices were
  associated with statistically significant
  increases in private pay prices. Jan Clement J.
  Zwanziger, G. Melnick, A. Bamezai J. Mitchell,
  J. Hadley, J. Gaskin

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Hospitals as Risk-Bearing Institutions

• For hospital administrators, theirs is a
  balancing act to make sure they keep their
  institutions doors open. So theyre thinking
  about maximization of revenue within the
  parameters of (1) retail prices, which are paid
  by few people, (2) wholesale prices, which are
  paid by many people, and (3) government prices,
  which are imposed on them.
• - Chip Kahn, President of the Federation of
  American Hospitals (FAH)
• One of the nice things about being an economist
  is that one can say that even if people dont
  consciously make a decision, they act as though
  they did. And that certainly sounds to me like
  hospitals acting as though they are cost
  shifting, because implicitly thats what theyre
  doing.
• - Stuart Guterman, Director of Research (CMS)

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Hospitals as Risk-Bearing Institutions

• On average
• Medicare represents 35-45 of most hospitals
  total revenue
• Private payers represent 40-50 and
• 5-25 comes from a mixture of Medicaid and other
  government and private subsidies (philanthropy,
  revenues from assets, etc .)
• All the revenues from these sources have to
  compensate a hospital for its charity care. So,
  as Chip Kahn explains, it doesnt matter whether
  its a not-for-profit or a for-profit hospital.
  In either case, youve got to make a profit.

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Hospitals as Risk-Bearing Institutions

• Similar to many service industries (e.g.,
  airlines, telecommunications, higher education),
  hospitals routinely charge different prices to
  different payers.
• Hospitals are also similar to many service
  industries in that they have high fixed costs
  (e.g., buildings, maintenance, utilities,
  equipment, capital, some salaried labor costs)
  and low variable costs (e.g., medication, paper,
  food, medical tests, disposable supplies).
• example computer tomographic (CT) scan
• On average, fixed costs account for 58-75 of
  hospitals costs variable costs account for
  25-42.

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Hospitals as Risk-Bearing Institutions

• The combination of high fixed costs and low
  variable costs produces low marginal costs.
• Thus, the overall change in a hospitals total
  costs for providing one additional service or
  procedure is low, often minimal. This reality
  frequently (if not constantly) encourages
  hospitals to try to increase their volume.
• Marginal cost is a critical concept because a
  hospital that seeks to reduce its total costs by
  reducing services will often only save on
  marginal costs and, in the process, decrease its
  revenues (a very great sin in any business).

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Hospitals as Risk-Bearing Institutions

• With low marginal costs and public patients as
  roughly half of their revenue base, hospitals
  expenses have often chased their revenues. In
  other words, when Medicare payments increase,
  hospitals frequently increase their purchase of
  new technologies and other capital investments
  and, consequently, increase their operating
  expenses in the long run . . .
• Mayes Others Ive interviewed have said that
  hospitals will cry, cry, cry about their
  financial status and Medicare reimbursement, but
  that you have take it with a grain of salt
  sometimes.
• Scully Oh, theyre doing great!  Ill tell you,
  go find me a hospital that hasnt built a giant
  new bed-tower in the last few years.  Theyve
  actually slowed down, because the government has
  phased out Medicare capital (reimbursement) We
  used to pay for capital in Medicare it was a DRG
  add-on for capital expenditures.  Well, if youre
  getting 40 of your revenues from Medicare and
  you want to build a new building and Medicare
  will pay for 40 of it, right? Then, why not?  So
  what you were getting all through the 1980s was a
  massive building spree up into the early 1990s
  and even through the 90s, because it was a
  10-year phase out. 
• If you wanted to build a new hospital wing in
  1990even if you didnt have any patients for
  itif you budgeted 100 million, Medicare would
  write you a check for 40 million!  So what do
  you get?  You got a hell of a lot of big new
  hospital wings, need them or not. This is one of
  the reasons weve had such massive over-capacity
  Youd have to be an idiot not to put up a new
  building every couple of years, because Medicare
  paid for such a big part of it.  That is slowing
  down now and youre starting to see the demand
  catch up on capacity in a lot of markets.i
• i Tom Scully, CMS Administrator, interview
  with R. Mayes (October 24, 2002).

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Hospitals as Risk-Bearing Institutions

• In their efforts to manage their financial risk,
  hospital administrators ultimately face two
  distinct challenges
• The first is to decrease the cost/per unit of
  each individual medical service to improve the
  management of their (variable) costs -- to
  increase efficiency/productivity.
• The second challenge is to maximize
  reimbursements relative to expenditures for the
  services it provides.

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Hospitals Administrators Behavior Over Time
Maximize Reimbursement First, Decrease Costs
Later
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Hospitals Administrators Behavior Over Time
Maximize Reimbursement First, Decrease Costs
Later
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The Origins of Large-Scale Cost Shifting

• transition in Medicares reimbursement model to a
  prospective payment system, 1983
• 467 Diagnosis-Related Groups (DRGs)
• Congress painless budgetary savings by simply
  restraining the annual increases in DRG payments
  rates below the market basket rate of medical
  inflation

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The Origins of Large-Scale Cost Shifting
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The Origins of Large-Scale Cost Shifting

• What was going on beginning in the late 1980s
  and even into the 90s was this enormous drive to
  balance the federal budget. At that time
  Medicare was, if it wasnt the biggest program,
  and/or the fastest growing program, it was pretty
  close to it. And Medicare was viewed as a
  deficit reduction device in a big way.
  Providers, particularly hospitals, were always
  viewed as an easier target than doing anything
  that would have ever affected beneficiaries It
  was all, How much money can we save by making
  this tweak to Medicares payment system or that
  tweak? For instance, the annual update factor
  for DRGs hospital payments was supposed to be
  based on the annual increase in the market
  basket a measure of the rate of medical
  inflation. But instead it has always been
  market basket minus some number.
• I dont know how many people on the Hill
  would be up front in admitting this, but they
  would sort of have a hole in the budget target to
  reconciliation and theyd save the PPS update
  factor to be the last thing to be determined.
  And they would say, Ok, we gotta save a billion
  bucks over three years, so lets just make it
  market-basket minus 0.5 percent. Or market
  basket minus 1.5 percent. At the end of the
  day, it was legislated in the back rooms and it
  was all a budget number.
• - Rick Pollack, Vice President (AHA) interview
  with R. Mayes (December 27, 2002)

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Cost Shifting as an Evolving Phenomenon in the
Hospital Industry
Medicare, Medicaid and Private Payer
Payment-to-Cost Ratios
Less need for cost shifting as public payment
increases relative to costs managed care
Re-emergence of cost shifting pressures?
Cost Shifting
Deficit
Source Allen Dobson MedPAC report to Congress,
March 2002, Figure 5-9 as modified by The Lewin
Group.
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Medicare as a Deficit Reduction Device
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Hospitals Perfect Storm 1997-1999

• BBA, 1997
• We looked at 5 or 6 different factors in
  adjusting Medicares payment policy The first
  one was not what was happening with health care
  spending or particularly what was happening with
  Medicare spending. The thing that drove us to
  the table to begin talking about the Balanced
  Budget Act was the overall level of the federal
  budget deficit. That was the number one thing we
  thought about in looking at health care policy.
  Im not sure I agree that thats what we should
  have been thinking about, but that was what
  precipitated the discussion.
• - Nancy-Ann DeParle, former Administrator of
  HCFA, interview with R. Mayes
• (November 4, 2002)
• Justice Departments increased anti-fraud
  campaign beginning in 1997
• the accumulated growth in managed cares market
  share

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Hospitals Response

• successfully lobbied Congress for two give back
  bills (1999, 2000)
• Increased consolidation, renegotiation of
  contracts with insurance companies and employers,
  and utilization of their existing
  economic/political leverage to negotiate better
  payment rates

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Results

• decade-long downward trend in hospital pricing
  reversed itself in 1999
• Average annual health insurance premium increases
  of between 10 and 14 since 2000 have reflected
  larger hospital payments.
• 2001 hospital spending (451.2 billion total)
  increased 8.3, its fastest growth since 1991
• Increases in hospital spending alone accounted
  for 30 of the increase in total health spending
  in 2001, the largest hospital contribution to the
  annual increase in total spending since 1992.

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Implications of Cost Shifting for Medicare
Policymaking

• Question Do policymakers knowingly take account
  and advantage of cost shifting?
• Answer well, yes and no
• Stuart Altman, former Chair of ProPAC I dont
  want to speak for all states . . . . But I can
  tell you that in Massachusetts and in several
  other states that I deal with, policymakers are
  very conscious of their ability to cost shift.
  And there is no question that they are much more
  willing to cut the rates or not pay hospitals
  anywhere near their costs than they are to do
  that to nursing homes. Why? Because they know
  Medicaid is only 10 of hospitals revenues on
  the patient side, but its 60 to 80 of nursing
  homes revenues. And this has a big impact on
  where policymakers put their marginal dollars.
  So, yes, Medicaid consciously knows that.
• Medicare, on the other hand, is a much bigger
  player on the hospital side. And, therefore,
  its more difficult for Medicare to play the Im
  just the marginal payer kind of a game
  Ultimately, the big cost shifter is Medicaid.
  And then next to that is Medicare.

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For Community Hospitals, as the Cost Shift Burden
Increases the Private Payment-to-Cost Ratio
Increases
Source The Lewin Group analysis of data
contained in AHA TrendWatch Chartbook Trends
Affecting Hospitals and Health Systems,
2001.Includes data for hospitals that reported
data in the AHA Annual Hospital Survey.
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Implications of Cost Shifting for Medicare
Policymaking

• Policymakers challenge in setting fair and
  appropriate payment rates is made all the more
  difficult by the fact that it is next to
  impossible to determine what exactly Medicare
  costs are.
• As discussed previously, the majority of any
  hospitals costs are fixed regardless of who
  receives its services. Moreover, hospitals do
  not have separate wards for Medicare and private
  patients that could, theoretically, allow an
  accountant to more clearly distinguish the costs
  a hospital incurred serving the two different
  patient populations.
• Therefore, as S. Altman explains, The reality of
  the situation is that with all the joint costs
  and interconnectedness, there is no such thing as
  Medicare costs. Nevertheless, we behave like
  there are Medicare costs and even under those
  definitions, Medicare consciously and
  unconsciously takes account of other
  implications.

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Implications of Cost Shifting for Medicare
Policymaking

• Two hospital sectors that policymakers have
  consciously subsidized for years with
  comparatively more generous payment rates
• (1.) teaching hospitals (GME, IME 6 billion in
  1999)
• (2.) indigent safety-net hospitals (DSH 5
  billion/per year)

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Cost Shifting among Academic Health Center
Hospitals has Declined
Source Allen Dobson The Lewin Group, Financial
Performance of Academic Health Center Hospitals,
1994 2000, prepared for The Commonwealth Fund,
September 2002.
32
As have Academic Health Center Hospital Margins
Source Allen Dobson The Lewin Group, Financial
Performance of Academic Health Center Hospitals,
1994 2000, prepared for The Commonwealth Fund,
September 2002.
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Implications of Cost Shifting for Medicare
Policymaking

• We have known almost from day oneand I can say
  we, ProPAC and I think Congressthat teaching
  hospitals, on a purely cost basis, were being
  paid more than they could really justify on a
  cost basis for teaching. What held me back, and
  I think other members of ProPAC back, was that we
  also looked at teaching hospitals total margins.
  
• We then looked at the total margins of other
  hospitals and said, My God, if we really forced
  the teaching adjustment down to what technically
  the regression equation suggests we should pay
  them, we could force teaching hospitals into very
  serious financial shape. And we count on them to
  provide a disproportionate amount of
  uncompensated care. We count on them, one way or
  another, to really be subsidizing teaching and
  education in different sorts of ways. Quite
  frankly, were a little afraid of finding out how
  far we can push it.
• - Stuart Altman Quoted from The Policymakers
  Perspective How Has Current Policy Developed and
  How Can the Past Inform the Future? When Public
  Payment Declines Does Cost-Shifting Occur?
  Hospital and Physician Responses, Symposium
  Sponsored by Changes in Health Care Financing and
  Organization (HCFO), Washington, D.C., (November
  13, 2002).

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Implications of Cost Shifting for Medicare
Policymaking

• Ultimate Question So what should Medicare pay
  providers?
• (Stock) Answer A fair amount, which produces
  rough justice.
• (Real) Answer
• The issue is just What can the political market
  bear for Medicare payment grossly in any given
  year? And then how does that play out to all of
  the individual payments? And with all due
  respect to the great work that ProPAC, PPRC, and
  ultimately MedPAC have done over the years, very
  little analysis actually plays through to that
  ultimate decision. The ultimate decision on
  payment policy is a political decision made in
  the marketplace. As a public policy decision,
  public purpose is a piece of it. But special
  interests get involved and whether its the
  people that are pushing DSH payments or indirect
  medical education, they sort of push and if they
  push hard enough and theyre smart enough, they
  affect the ultimate whole. And I would argue
  that at the end of the day it has very little to
  do with the market price. It just has to do with
  what the government can bear.
• At the end of the day for the hospital
  administrator, they look at that and say, Gee,
  how much do I have to make? And what can the
  market bear in the real marketplace with retail
  prices and these negotiated payments? Then they
  just sort of work it out and pray that it all
  comes together at the end of the day and that
  they have enough to meet their operating costs
  and make some margin for future purposes.
• - Chip Kahn, President of the Federation of
  American Hospitals (FAH)

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Conclusion

• Perhaps cost shifting is best thought of as a
  lubricant within a massive series of financial
  feedback loops between
• - government (Medicare, Medicaid),
• - providers (hospitals, physicians), and
• - private payers (insurance companies,
• employers, individuals).

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Future Concerns I

• The ultimate cost shift is both prevalent and
  increasing in scope and degree employers passing
  on a larger and larger share of their increased
  health care costs to their employees in the form
  of higher monthly wage deductions and/or
  increased co-payments, deductibles, and
  out-of-pocket costs (especially for employees
  dependents).
• Beyond this strategy, more and more employers
  have simply stopped offering health insurance
  (15 of the U.S. population is uninsured 42.6
  million individuals or the aggregate population
  of 24 states, 2002)

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Future Concerns II

• Increased segmentation of medical provision
  private, independent physician-owned surgical and
  delivery centers (e.g., cardiac, orthopedic,
  radiological services)
• These centers skim off the best paying patients
  who ordinarily subsidize many hospitals
  loss-making departments makes cost shifting more
  difficult because there are fewer patients over
  whom a hospital can spread its risk and costs.
• Exit Question What do providers do when every
  payer only wants to pay the marginal cost? How
  do we finance the entire health care system?