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Putting Hospitals on a Diet


Shadowfax makes the case for the existence of "cost-shifting" between public programs and private insurers:

[T]he cost of providing health care -- especially for a hospital -- is relatively inelastic on a year-to-year basis. The number of nurses, the payroll costs, the capital expenditures. All of these are not quite fixed costs, but there is very limited ability to make drastic changes in them. Yes, you can decide not to build the $300 million cancer center, or to build a less-opulent version of the cancer center for only $200 million -- there is long-range elasticity in the cost of providing care. But once the buildings are in place, the scanners and equipment are purchased, and the staff is hired, the need to meet this year's operating budget becomes imperative.

Government-funded revenue is completely fixed. It's inelastic. There's no negotiation possible -- the rates are set and providers can take them or leave them. But prices with private payers are negotiable. When you are looking at a budget shortfall, or in the case of physicians, declining physician compensation, and you need more money, there's only one place to go -- to the insurers. It's the only variable source of funding.

Well, that and volume, but we don't want hospitals making up their margins by doing more MRIs. To be clear on my position here, I think there's probably some level of cost-shifting that's between the zero percent that some advocates would like and the 100 percent that the insurance industry suggests. The Lewin Group estimated (pdf) 40 percent, and that sounds reasonable enough to me, though I'd be open to further evidence.

But as Austin Frakt says, the simple fact that public insurers pay less than private insurers is not evidence of cost shifting. It's evidence of a price differential, and the question is how much of that differential represents a shift. Indeed, there are two questions here: The first is how much of the price differential represents cost-shifting. The second is whether hospitals can live on less revenue than they're currently projected to receive. The answer to the first question is probably "some, but not all." The answer to the second is "over time, they're going to have to."

It's true that a hospital's costs are relatively inelastic on a year-to-year basis, but they're more elastic over time: if they had to adjust to less revenue than they'd like, they'd make certain changes to the way they do business. There's some evidence from MedPAC that these changes can mean more efficient hospitals. They can also mean that there will be only one neo-natal unit in town rather than two, or that the building will be renovated five years later than would otherwise be the case, or that there will be longer waits for elective procedures. But whatever it means, hospitals are currently projected to receive enough revenue that the country will go bankrupt, and we're going to have to figure out how to get them to live on less money than that.

Photo credit: AP Photo/Lynne Sladky.

By Ezra Klein  |  October 14, 2009; 10:18 AM ET
Categories:  Health Economics  
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As the Dartmouth Atlas analysis makes clear, health care is one industry in which supply drives demand. The "field of dreams" notion that if you build it, they will come, holds up even though higher utilization (more hospital stays, more doctor visits) does not tend to produce better results (mortality, morbidity), just more spending. But there's the rub: those health insurance "expenses" are some health care provider's income, and no provider looks forward to less income next year than this. It is possible that "pay for performance" adjustments can bend the curve -- but that's what the per-episode payment system was supposed to do, too.

Posted by: bill0465 | October 14, 2009 10:38 AM | Report abuse

Medicare prices are negotiable, but that negotiating happens at the lobbyist and congressional level.

Posted by: Drew_Miller_Hates_IDs_That_Dont_Allow_Spaces | October 14, 2009 10:43 AM | Report abuse

Now we're getting somewhere. Cost shifting does exist. Solutions to reducing total payments to hospitals are challenging, to say the least. 2 possible solutions: close some hospitals OR pay docs less - would seem to be political non-starters.

Also, you've hit on something very interesting with this comment, "They can also mean that there will be only one neo-natal unit in town rather than two" or perhaps only one robotic surgery device in a city instead of two. But the hospital with a NICU or robotic surgery device will get profitable referrals and hospital without these things will lose out out. A bit of game theory here. It may be optimum for only 1 hospital to have these things, but then that hospital will capture all the gains....

BTW: you say, "but we don't want hospitals making up their margins by doing more MRIs..." This already happens. Talk to the insurers. Hospitals have been losing customers as the unemployment rate has increased and they are ordering more exams, follow-up visits, etc. from a smaller paying population to make up for lost revenue.

Posted by: mbp3 | October 14, 2009 10:44 AM | Report abuse

aw come on why diet when some can circumvent the laws meant to protect consumers and gorge themselves on the American insured public. Bayonne Medical Center was glorified (and BCBS demonized)by the WAPO a week or so ago because of their practices that have caused insurance rates in NJ to skyrocket over the last 6 months. BMC is seeing many less patients but getting much more money. Who is happy? Their private equity owners that's who. Whose not? BCBS Policyholders that are now getting 2-30% rate increases at minimum. Let's hope the idiots in Trenton get their act together and stop this.

Laws that were put in place to protect consumers are now being circumvented to make some unscrupulous hospitals rich. And its all done under the guise of patient care. And how many people will be pushed to the ranks of the uninsured in NJ because of the profiteering of this hospital??

Posted by: visionbrkr | October 14, 2009 10:46 AM | Report abuse

"But once the buildings are in place, the scanners and equipment are purchased, and the staff is hired, the need to meet this year's operating budget becomes imperative."

He says that like that's unusual for a business. I'd say most businesses consider making their operating budget projections imperative.


Posted by: roquelaure_79 | October 14, 2009 10:46 AM | Report abuse

Well, that and volume, but we don't want hospitals making up their margins by doing more MRIs.


I'd be interested to see statistics over the last several years to see the number of MRI's done in hospitals in comparison to free standing facilities. I'd expect the number done in hospitals are falling and growing outside of them. Hospitals in urban areas seem to be more and more about inpatient care and less and less outpatient services (now done by docs outside). It saves the doctor on admitting priviliges costs and as well if they own a stake in the o/p surgery facility they get a nice little kick too. See how we can turn a nice profit there. Double dipping is good!! Wait, TRIPLE DIPPING. They don't join an insurance network so they can harass a patient for their deductible on out of network services (assuming they have out of network benefits). And in most states the out of network reimbursement is much greater than an in network contract. QUADRUPLE DIPPING!!!!

(please note sarcasm)

Posted by: visionbrkr | October 14, 2009 10:56 AM | Report abuse

Its been my experience that hospital system contracts with private insurers indeed cost shift. They tell the insurer that they must cost shift to make up for government programs, of which I am skeptical, when I see not for profit hospitals with double digit profit margins. The insurer, who has customers that they must satisfy won't/can't walk away from a deal as long as they believe that they are not at a competitive disadvantage. The government can do what the insurer can not, name their price. As for where the volume of Radiology is being done look to who owns the facility....where is a good Stark law when you need one.

Posted by: reddog3 | October 14, 2009 1:09 PM | Report abuse

Let's not forget some of the other huge components of healthcare costs in our current system:

-- Doctor's Pay

-- Pharmaceutical companies' marketing and profits

-- Administrative costs that are far higher for our fragmented current system than for Medicare, which is, in fact, single payer universal government insurance for seniors, that they love.

-- Very high expenses by insurance companies to evaluate the likelihood that a customer will get sick, and if they do to find a way to avoid paying.

Let's consider doctors pay. If pricing power by the government forced those cardiac surgeons who make $2 million per year to make only $1 million per year, would that really affect the quality of those who go into that field much? There are many countries that pay specialty doctors much less and have as high or higher quality healthcare than we do.

And the savings could go into something that does far more for the effectiveness of medical care, basic medical research. Ezra has an outstanding post on this at:

Posted by: RichardHSerlin | October 14, 2009 4:17 PM | Report abuse

I also recommend a post by Nobel Prize winning economist Paul Krugman, "Why markets can’t cure healthcare" at:

Posted by: RichardHSerlin | October 14, 2009 4:20 PM | Report abuse

I should add that the issue of doctors pay is complex. You can't rely on the pure free market to get it right because of enormous asymmetric information and externalities, to name just two well established in economics market problems. And these problems also exist in the alternatives to more doctor's pay, like more basic medical research. As Nobel Prize winning economist Joseph Stiglitz said recently, Norman Borlaug, the key creator of the green revolution in food production, made very modest money as a university basic researcher, and "Absurdly generous compensation in the financial sector induced some of our best minds to go into banking. Who knows how many Borlaugs there might have been among those enticed by the riches of Wall Street and the City of London? If we lost even one, our world was made immeasurably poorer."

For doctors, I'd like to add, though, if you have multi-million dollar compensation, you can draw in people largely motivated by money, rather than a desire to heal. This can be quite harmful in a field where a patient (customer) has little idea of whether a doctor is prescribing a sub-optimal treatment because it makes more profit (and there are many examples of this). Thus, it's possible that lowering the highest compensation, at least to some extent, via government pricing power, could actually increase the overall quality of doctors.

Posted by: RichardHSerlin | October 14, 2009 4:42 PM | Report abuse

Mr. Klein,
You may want to check the Lewin Group's references before relying upon their data. They are owned by United HealthCare.

Posted by: boscobobb | October 15, 2009 1:51 AM | Report abuse

CBO says cost shifting increases private insurance premiums 1%. The AHIP report says 2%. What are we arguing about again???

Posted by: bmull | October 15, 2009 6:37 AM | Report abuse

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