Wednesday, August 26, 2009

Chicken or the egg? The case of government payment and hospital costs

Hospital_under_constructionAt President Obama’s recent town hall in Montana, there was a question from the audience that went something like this, “Mr. President, my brother is a hospital administrator and he states that Medicare and Medicaid do not pay the costs of providing care and thus, drive up the costs for the rest of us. Why then, should we consider expanding these or adding additional government programs?” This is a good point that has been raised increasingly over the past few weeks and as of yet, no health reform supporter (including the President) has even remotely answered it.

They probably haven’t answered it because there is no short and simple answer to this question. As usual, in health care, nothing is simple. As I have said before, what we have is a system problem – not a people problem. Our health care system encourages waste and hospitals are part of that system. Health care is the only market I can think of where costs are the significant driver of payment. That is like going to Best Buy, having only one or a few brands to choose from and then be told the price for a new computer is $3000 because that is what the manufacturer says it cost to make. Not much efficiency there.

Yes, it is true that government does not pay the full cost for hospital care in the aggregate. What is less clear is whether hospitals cost-shift to other private-payers to make up the difference or whether high margins from private-payers depress the government margin (hence, the chicken or the egg). To gain a better understanding, one has to ask ‘are the costs reasonable?’ or better yet ‘what is driving the costs?’ I can remember one specific instance last year when a Florida hospital spent $350,000 on a groundbreaking ceremony for a new tower complete with expensive champagne and Waterford crystal flutes at the same time it was cutting the hours and pay of its direct care nurses. This same hospital spent hundreds of thousands of dollars on a re-branding campaign and a marketing officer making $200,000 a year. Again, I ask ‘are the costs reasonable?’

Thankfully, the independent Medicare Payment Advisory Commission addressed this question in its annual report to Congress (which apparently few supposedly knowledgeable people have read). From the report:

Despite appearances, record-breaking hospital construction in 2007 and negative Medicare margins in 2007 are not at odds. We note that a third factor—unusually high private-payer profit margins—can lead to more construction, higher hospital costs, and lower Medicare margins. In 2007, hospitals’ non-Medicare profits and total (all payer) profits were at the highest levels in a decade. The data suggest that, when non-Medicare margins are high, hospitals face less pressure to constrain costs, costs rise, and Medicare margins tend to be low. Of course, not all hospitals had high private-payer profits; those with low levels of profit on their non-Medicare business face pressure to keep their costs down. We found that hospitals facing significant financial challenges in recent years (2004 through 2006) tended to have lower costs and hence higher Medicare margins in 2007.

A key question is whether Medicare payments are adequate to cover the costs of efficient providers. To explore this question, we have examined financial outcomes for a set of hospitals that consistently perform well on cost, mortality, and readmission measures. For these relatively efficient hospitals, we found that Medicare payments, on average, roughly equaled their Medicare costs.


As the graphic above shows, spending on hospital construction has nearly doubled over the past eight years as hospitals and insurers compete in a virtual ‘arms race’ through growth and acquisition. On pages 62-64 of the report, the Commission provides some nice empirical evidence to back up their claims and states, ‘While causation may flow in both directions to a degree, the data suggest that the primary reason Medicare margins are inversely related to private-payer profits is that high private-payer profits are followed by high hospital costs.’

MedPAC closes its analysis by stating: ‘In the end, affordable health care will require incentives for health care providers to reduce their rates of cost growth and volume growth.’ To a naysayer, this statement equals rationing, to a realist, this statement means that we have got to get better value for our dollar. ~BAA

Note: For additional information, Maggie Mahar’s Health Beat blog has two excellent posts on whether government programs underpay hospitals and whether waste and inefficiency is rampant in hospitals.