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Do Hospitals Cost-Shift?

This blog continues my exploration of the great mysteries of health economics.

Northwestern University is one of Blue Cross of Illinois’ largest customers. Suppose that premiums for all BC plans are expected to increase by 10 percent, but NU is able to force Blue Cross to accept a 5 percent increase. Would you expect Blue Cross stick McDonalds with a 15 percent increase in order to cover the shortfall from NU?

I wouldn’t, for two reasons. First, McDonalds would probably threaten to take its insurance business elsewhere. Second, the scenario I have described is inconsistent with profit maximization by Blue Cross. After all, BC’s ability to stick McDonalds with a 15 percent increase surely does not depend on the price paid by NU. Any negotiator whose willingness to stick it to McDonalds is conditional on the price charged to NU is leaving money on the table and probably would have been fired a long time ago.

We might never expect BC to raise prices to some customers to make up for shortfalls from others, so why do we believe that hospitals do this all the time? It is impossible to discuss Medicare and Medicaid payments without someone invoking the mantra of cost-shifting. The theory of cost-shifting is deeply ingrained in the minds of healthcare decision makers and the policy implications of the theory are profound. Consider that if hospitals cost shift, then the burden of Medicaid cutbacks falls on privately insured patients, not on Medicaid patients and the hospitals that serve them. This calls into question whether the cutbacks will result in any savings for taxpayers and cause any harm to Medicaid beneficiaries. It also makes you wonder why hospitals that serve low income communities struggle to survive. Couldn’t they just cost-shift their way out of financial difficulty? A cost-shifting zealot would conclude that the managers of these hospitals are incompetent.

I must confess that I perpetrated one of the best cited papers providing evidence of cost-shifting. I studied what happened at hospitals in Illinois in the early 1980s after a substantial cut in Medicaid fees, finding that hospitals did raise prices to privately insured patients by enough to make up about half the Medicaid shortfall. But things were different back then, and I don’t believe that evidence can be used to describe what happens today. For one thing, there was essentially no managed care in Illinois, so insurers had to accept the prices set by hospitals. Insurers are far more powerful today than they were back then. Second, all of the hospitals in Illinois were nonprofits and, as far as I could tell, most placed mission above profits. So it is possible to believe that prior to the Medicaid cutbacks, hospitals really were leaving private sector money on the table. With all the empire building that hospitals are engaged in today, it is hard to believe they would ever leave insurer money on the table. This makes it equally hard to believe that they would need the excuse of government cutbacks before sticking it to insurers.

Cost-shifting may be a flawed theory, but there may still be a disconnect between theory and practice. Hospitals might cost shift because, well, that is what they think they are supposed to do. So what does the modern evidence show? Will White and I published another paper about a decade ago that tracked what happened at hospitals in California after large Medicaid cutbacks. We found that hospitals that experienced large Medicaid cuts also experienced relatively slower increases in private sector payments, the opposite of what would have occurred under cost shifting. There are quite a few other studies showing that the quality of care delivered to Medicaid and Medicare patients suffers when government payments fall. This would not occur if hospitals could cost-shift.

Unfortunately, there are a lot of more stylized analyses that seem to show that cost shifting is alive and well. The typical analysis finds that profits from privately insured patients are negatively correlated with profits from government-insured patients both in the cross-section and over time. This is cited as conclusive evidence of cost-shifting.

There is alternative explanation that, unfortunately for the cost-shifting zealots, is quite consistent with the institutional facts. To motivate the explanation, consider an industry in which all firms earn zero profits, but the firms’ accounting systems are somewhat arbitrary and assign costs to different customer groups in a somewhat haphazard fashion. If a firm in this industry has two groups of customers, it may appear to be profiting from one group due to the way it allocates costs. Because the firm earns zero profits overall, it must appear to lose money from the other group. Thus, reported profits will be negatively correlated between customer groups.

Now suppose that one group of customers got its act together and demands lower prices. This would have no impact on the price paid by the other group in the short run. In the long run there would be exit, because some firms were losing money. This would drive up prices and again create a negative correlation in pricing both in the cross-section and over time. But this would not be cost-shifting as it is commonly discussed. (Nor would it require arbitrary cost-accounting.)

If we relax the assumption of zero profits but instead suppose that profits are constrained to a fairly narrow band, then we would still get the same negative correlation in both the cross-section and over time, provided there is a fair degree of arbitrariness to cost allocation. And this, I believe, pretty well describes the hospital sector, where most hospitals have profits in a range of plus or minus 5 percent, and cost allocation is speculative even in the best institutions.

So I can explain away the stylized evidence without invoking the mantra of cost-shifting. But that does not make my explanation correct. Cost-shifting is so deeply engrained that CFOs might do it even though it is not profit maximizing. I think I could even construct a game theoretic model in which hospital CFOs use government cutbacks as a kind of focal point for passing along tacitly collusive price increases, so that cost-shifting is profit-maximizing in a strategic sense. My point is not to deny cost-shifting so much as to point out that there are good reasons to question both the theory and evidence. Whether or not hospitals cost-shift remains one of the great mysteries of health economics.

David Dranove, PhD, is the Walter McNerney Distinguished Professor of Health Industry Management at Northwestern University’s Kellogg Graduate School of Management, where he is also Professor of Management and Strategy and Director of the Health Enterprise Management Program. He has published over 80 research articles and book chapters and written five books, including “The Economic Evolution of American Healthcare and Code Red.”

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Ian CameronJon PersonJohn R. GrahamJohn McAshtinHealth Insurance Recent comment authors
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Ian Cameron
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Ian Cameron

I’m no expert, but last year my insurance company reimbursed my outpatient provider $560.00 for a fabric knee brace with Velcro straps. My copayment – $125.00. And wow, guess what, I went online and could have ordered the exact knee brace for……$125.00. So what are my premiums paying for again?

Jon Person
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Jon Person

I think the cost shifting occurs by targeting specific highly compensated procedures or services. For instance, I work at a company durable medical equipment provider. Were non-profit. In fact, when reimbursement was good the company was a bit sloppy. Bad inventory management, etc… Now that medicare has reduced reimbursement the company has tightened up its operation. According to higher management we make next to nothing on certain services, but do it only to sell other more profitable services. Oxygen delivery is not profitable, but CPAP (sleep disorders) is very profitable. So now they focus very intently on increasing business in… Read more »

John R. Graham
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@Mike Fox: You write that your hospital used to raise charges for services that were price sensitive and lower charges for services that were price insensitive. That cannot make sense. Might you have gotten it upside down? With respect to cost shifting. One reason why the issue is so muddy is that idenfitying fixed versus variable hospital costs is very difficult for outsiders. There is no rational way to allocate fixed costs (i.e. Ramsey pricing) so we can expect that hospitals can charge less to Medicaid that to private payers without losing money. Or, even if they lose money on… Read more »

nate ogden
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nate ogden

regardless if it is variable or fixed cost when the spread is as wide as it is that doesn’t matter. How can treating a private insured cost 50% more then treating a Medicaid insured? The gap is so huge the pennies we are trying to allocate don’t matter.

John McAshtin
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John McAshtin

I work for a local PPO, contracting for physician and hospital services. Last week I was negotiating with a hospital in north central Illinois when the person I was working with said “I have to get a 6% increase in our rates from you, my CFO said our Medicaid business is expected to grow next year and a 6% increase will help cover the lost revenue from Medicaid”.

If that isn’t cost shifting….

nate ogden
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nate ogden

in the academic world that is an invalid opinion. Now if you read a paper written by someone who interviewed a person who studied what you did then it would be scientific and have value.

nate ogden
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nate ogden

If your one of the PPOs we use DON’T GIVE IN!

Health Insurance
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Thank you very much for sharing your thoughts on cost shifting in the hospital industry. Thank you also to the other commenters here who shared additional valuable knowledge and points of views. This subject has been weighing on my mind lately due to some personal reasons and this article really helped me get some perspective, so I thank the author greatly for that.

Jennifer N
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Jennifer N

Even though insurance does not have to do with the actual value of the health care service, charging people more or less because of their insurance policy they decided to go with makes patients feel the value of their personal well being is worth more/less. This now crosses the line in terms of treating all patients equal. Your role in society should not determine your copay. Treating people differently because of the company that is tied to their insurance policy is poor customer service and does not add value to any health care service. I have been reading so many… Read more »

Mike Fox
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Mike Fox

I worked many years in hospital finance and year after year we would increase revenue by selectively increasing the charges for items that had a payer mix with a high level of price sensitivity. We’d lower our prices on those that had little or no price sensitivity. We’d arrive at a weighted overall increase of 5% but we’d jack the prices of the highly sensitive items as much as 20% and offset it by lowering the least sensitive. After inpatient services were converted by all commercial payers to a fixed fee payment, the shifting was concentrated on outpatient services where… Read more »

nate ogden
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nate ogden

I work in the Midwest and West mainly but see hospital contracts from all over the country. Not only do I see rental PPOs but we also administer a lot of business under fully insured high deductible plans. Capitated rates with or without stop loss provisions are the exceptions. We just don’t see per diems any more. Everything is comming across % off billed charges.I can count on one hand the PPOs with majority per diem contracts and they are hospital owned. They are also some of the best networks to work with.

tim
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tim

I’m another person who works in health care who is constantly amused by what the Academics debate. That said, Nate, you are confusing “cost allocation” with “cost projection”. Large institutions can very easily show differing profit numbers for different service lines or patient populations, just by the internal choices they make in allocating costs. The oldest trick in the book, for example, is to allocate fixed costs to a business line and claim it is losing you money. So, yes, hospitals can and do project costs quite accurately, as you say, but they also manipulate profit figures for external consumption,… Read more »

nate ogden
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nate ogden

“Do I ask for more money from a private payer because of a recent Medicaid cut? No, I would have asked for it anyway. But the leverage I have to work with has changed, and I hope the other party does not know it.”

Wait what was that Tim, you don’t need more money from me? What else haven’t you been upfront about? This isn’t really the best deal your giving anyone else either is it?

nate ogden
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nate ogden

in regards to cost allocation/projection; Assume hospital has a total margin of 5%. Medicaid reimburses 50% of private insurance, Medicare 75% of Private insurance. 30% of their market is Medicaid and 30% Medicare. Assume they can break even on Medicare which most can and should. The key then is private money to offset Medicaid business if there is cost shifting. If you take the 40% of Private business and reduce those reimbursements 50% it doesn’t matter how you allocate the expenses your losing money, no your bleeding money. Is there a single hospital in the US that could survive at… Read more »

nate ogden
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nate ogden

“Whether or not hospitals cost-shift remains one of the great mysteries of health economics.” Only in health economics is this a question, let alone a great question. I’m sure places in Academia still debate rather the earth is flat. It doesn’t take much research or effort to look at a hospital’s balance sheet, reduce all revenue to a level compensated by Medicaid and see they would be out of business. When you’re upside down 20-40% it’s no longer a question of where you account for the cost and obviously an issue of insufficient revenue period. Do a mix of Medicaid… Read more »

youdeals.us
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Health care and health insurance are always in debate.Cost shifts should be kept at bay to enable suffering patients who are very poor to bear more medical bills in this falling economy.

in-home caregivers
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I totally agree with the above comment.

Cedric
Guest

I disagree with the initial comparison of Blue Cross cost-shifting to hospitals cost-shifting. Blue Cross doesn’t have to accept any customer that want to purchase insurance (yet); hospitals have to take on anyone seeking service through their emergency departments. Nevertheless, hospitals get paid different amounts for the SAME thing depending on who pays. Do you feel the differential pricing for payers is a result of DISCOUNTS hospitals give to larger groups (Medicare > Medicaid > private insurance > self-pay patients)? Or is it the traditional “COST-SHIFTING”? Or, are they just the same thing with different names? Recent data suggests that… Read more »