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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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18 replies »

  1. 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?

  2. 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 certain area’s. I imagine in hospital the Dr.’s probably run all kind of highly compensated diagnostic test even when they probably don’t need to, but they do it in effect cost-shift from the medicare patient who is at a fixed reimbursement rate.

  3. 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.

  4. @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 total costs, but cover variable costs, it’s not really cost shifting – but it cannot persist in the long term.

    Then there’s something hard to put into an economic model. Because they operate in a political environment, hospitals will always be tempted to say that they lose money on government payers, but will never claim to actually stop serving the patients. The quality of service actually provided will go down, but this will not be admitted.

  5. 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.

  6. 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….

  7. 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.

  8. 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.

  9. 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 articles about the Medicare and Medicaid cuts, and they have all discussed what the health care industry can do in order to make up for lost funds. But, discussing cost shifting from the insurers’ side has brought a new light to the situation. First and foremost, the role of the health care industry is to provide HEALTH CARE. Profits or not, patients are looking to go to the place where they can get the most valuable health care. I understand that health care providers can do a lot of things to improve the value of their services and this interview with the AMA president, Peter Carmel, provides ideas that add value to the health services even with the cuts going on.

    https://ignite.optuminsight.com/archive/improving-the-value-of-health-care/

    Again, there are so many different ways to improve the value of health care, and if cost shifting is actually occurring, the only way it would be beneficial is if it has a valuable effect on the health care provider, which would in turn, have a valuable effect on the patient. Otherwise, cost shifting is risky, and slightly fraudulent.

  10. 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 reimbursement remained primarily charge based. Over the years, outpatient charges were increased dramatically resulting in MRI charges of $3,000. Now virtually ALL payments are fixed so the cost shifting lever is virtually useless. So the uninsured are stuck dealing with the aftermath in the form of ridiculous charges that have no relationship to ANYTHING.

    During the peak of cost shifting, the yield was very high. In the last year that I worked on a budget, we cost shifted our charges up by $5M but only yielded $500K and most of that was to be paid by the uninsured. Mission? I don’t think so.

    Cost accounting in healthcare is dominated by first generation allocation methods that rely on outdated and inaccurate overhead allocation methods. CFOs love the reports though that indicate contribution margins by service line. No other industry would be caught dead using the cost accounting methods preferred by hospital CFOs.

    I still don’t know why hospitals don’t lower their charges since payment sare no longer based on charges. Oh wait, the uninsured still pay based on charges so lets continue to hose them.

  11. 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 Medicaid rates? I don’t think there is. If there isn’t then how are they in business if not for cost shifting?

  12. “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?

  13. 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, as the writer implies.

    I’m also amazed when anyone thinks a non-profit hospital system does not seek to maximize profit. Mission? Please. Most of them have simply baptized their geographic necessity and made it into a “mission”.

    Cost-shifting? As someone who negotiates contracts with payers, I’m puzzled about the question. You get the best deal you can, every time. But the definition of “best deal” has a great many variables in it, and they shift constantly, as Nate points out. Medicaid cut? 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.

    These intangibles cannot possible be captured in a “study”.

  14. “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 and Medicare revenue and you could probably get by with a major austerity program. Reduce staffing, cut salaries, remove any and all frills, and turn our hospitals into eastern European wards and you would keep the doors open. It is the cost shifting to Private insurance that allows all of our citizens and 11+ million non citizens to share some of the best hospitals in the world.

    Why don’t they take field trips in college? A few days outside the ivory walls and this question, in health economics, would be solved….

    “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.”

    How about one reason you should? Pooled risk. The fallacy of your argument is NU and McDonalds are purchasing insurance not financing healthcare. If they were individually financing their healthcare your arguments would make sense. Since they are purchasing insurance, which is multiple customers aggregating risk and sharing cost, your end game must be 100% of needed premium. If you take 5% from one place you must make it up someplace else. Reserves, loses, capital infusion means any one year you could be over or under 100% but big picture long term you must raise needed capital, with insurance.

    “McDonalds would probably threaten to take its insurance business elsewhere.”

    You assume here McDonalds has someplace else to take their insurance. Government over regulation constrains the market for insurance such that employers don’t always have an option to move to and some employers don’t have an option to buy at all.

    “Second, the scenario I have described is inconsistent with profit maximization”

    ….so? profit maximization is a theory used in Academia. While it sounds nice it is seldom found outside of Academia for more reasons than I can list in this comment. To use something that rarely or never exist as an argument on why something else can’t exist doesn’t stand up. Leprechauns can’t be real because the Boogy man would eat them if they were?

    “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.”

    If my company was to write NU tomorrow, even with the 5% discount, then McDonalds was to call the next day I would be far less willing to offer McDonalds a discount then if they had called before NU, let that be a lesson McDonalds, call me! In fact having NU in the bag allows me to be more aggressive and stick it to future clients, I don’t need their business as much as I did before. The cost structure of insurance is also very incremental once you cross certain thresholds, if you have meet your revenue targets you can be more aggressive.

    “We might never expect BC to raise prices to some customers to make up for shortfalls from others,”

    In academia how you do explain customers with negative loss ratios? I can assure you they are real.

    “This calls into question whether the cutbacks will result in any savings for taxpayers and cause any harm to Medicaid beneficiaries.”

    I assume you mean what tax payors save in taxes they will pay that and more in premium and thus have a net increase in cost? Yes, this is not only expected but very common, let me share another case where this happens in a very dastardly manner;

    Medicaid is broke in most states, in order to save money states started passing laws that insurance companies had to cover adults to age 25, 26, 28, and even 30. This wasn’t done because they worried about young health kids out of college, this was done because dependent adults with disabilities were cost them millions. So they pass a law and parents start enrolling their disabled over age kids on employer plans. What sucks is now instead of tax payors footing the bill for these handful of people the 60 people unlucky enough to work with their parents and the business owner eat the whole thing. When government shift cost, they do it every year, private insurance always eats the tab. In this particular case providers actually made out because they were generally compensated at much higher rates, doubly perverse solution to government funding shortage no?

    “Couldn’t they just cost-shift their way out of financial difficulty?”

    This is predicated on there being someone to shift to. Dropping names so you get the point, if I could make all my members go to Metro Health instead of Cleveland Clinic I could drop rates 20%+. That’s great but if I made that part of the plan I would have no members. Metro Health does a good job at amazing price, they still can’t get private insured patients in the door. Without the patients to bill more you can shift the cost.

    “Insurers are far more powerful today than they were back then.”

    Exit the tower and you’ll see this isn’t true. In Cleveland for example you have the choice of BUCA plus MMO plus multiple second tier carriers. You have CC and UH for hospitals. Who holds the power in rate setting? There is an insurance company that as a business model excludes the high cost hospitals, their market share is low single digits.

    “all of the hospitals in Illinois were nonprofits and, as far as I could tell, most placed mission above profits.”

    80s, no. 40s maybe. 80s reimbursement under indemnity policies were lucrative enough and also under the government programs that they didn’t need to shift cost, there mission was never at risk then like it is now under government reimbursement. Remember EMTALA was passed 86. There was a reason Congress passed this.

    “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.”

    How did you account for Market Clout and penetration? Again even though Metro Health might need to pass cost that doesn’t mean they would be nearly as effective at it as Cleveland Clinic. What time frame did you use? I assume you took into consideration when each hospital had their major insurance contracts up for renewal? If Hospital X just signed a 3-5 year deal with their major payor the week before Medicaid cuts while hospital Y inked a new deal the week after that could easily account for all of the difference. There are so many variables I don’t see how a study could even begin to support an argument one way or the other.

    “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.”

    Cost allocation is speculative in the best institutions? Really? I’ve seen some pretty accurate cost projections come out of private hospitals, especially when they are trying to build a new one. They know what the capital cost to build the room, service the debt and all that is. They know how much staffing they need per room and its exact cost. The only thing you don’t really know is the supplies and type of service that will be rendered to the patient in that room on a specific day but that is accounted for in the billing. Seems to me you could get cost right to the dollar, might be off a few cents but there is no great mystery in cost allocation, at least not outside health economics.

    “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.”

    Top reason being it would be darn hard to sell single payor healthcare or Medicare for all if cost shifting was real and you wanted to eliminate the only place to shift cost to? Without cost sifting Medicaid and Medicare blow up within a couple years instead of 20 years. There are great political reasons to question it, no scientific reasons.

  15. 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.

  16. 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 market concentration contributes to differential pricing: http://www.policyprescriptions.org/?p=1954

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