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Chapter
5Factors Affecting the Supply and Prices of Health Care Services
The ultimate effects of proposals on access, spending, prices, and the amount of care received would depend not only on factors that affect the demand for health care services, such as the number of people who are insured and the scope of their coverage, but also on factors that affect the supply of those services. The methods of setting prices and paying for services affect the supply of health care services by influencing the decisions that providers make about how many patients to serve and which treatments their patients will receive. Because of the central role that doctors and hospitals play in providing health care, it is important to consider the incentives they face when making those decisions and whether a proposal would alter those incentives. In the longer term, those rates of payment also affect the number of doctors and hospitals.
To provide a basis for analyzing those issues, this chapter first presents an overview of factors that affect the supply of doctors, nurses, and hospitals in the United States. It then considers:
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The methods insurers use for paying providers—including fee-for-service payment, bundled or episode-based payment, capitated payment, and salary payment—and how the financial incentives stemming from those payment methods may affect the provision of health care services and spending per enrollee.
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How payment rates, or prices for services, are set (generally, by negotiation in the private sector and through administrative pricing for Medicare and Medicaid) and the relationship between how the rates are set and the level at which they are set.
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How providers, in response to changes in their payment rates or the demand for their services, might adjust the number or type of services they supply.
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Whether and to what extent the relatively low payment rates of public programs or the costs of providing uncompensated care for the uninsured yields higher payment rates for private insurers—a process known as cost shifting.
Although the focus of the analysis in this chapter is on doctors and hospitals, many other types of providers also deliver health care services. Those providers include dentists and other medical professionals as well as home health agencies, rehabilitation centers, and other types of facilities. Substantial shares of spending for health care also go to purchase goods, such as prescription drugs, medical devices, and durable and nondurable medical equipment. In some cases, the factors affecting supply, the methods of payment and rate setting, and the issues that arise are similar to those for doctors and hospitals. A full consideration of the supply and pricing issues involved in each of those sectors, however, is beyond the scope of this report.
Background on the Supply of Health Care Providers
Health care services are delivered to individuals by a combination of health care personnel (such as doctors, nurses, technicians, and aides) and facilities (such as hospitals, outpatient clinics, and clinical laboratories). Before considering the ways in which insurers pay providers for those services—or how changes in payments or in the demand for care affect the supply of services—it is useful to examine the supply of those providers.
In 2006, the health care industry in the United States employed about 14 million people, making health care the nation’s largest industry, by employment.1 That figure includes various types of health aides, therapists, and medical technicians as well as administrative and other support personnel employed at facilities where health care is provided. Although all may contribute to delivering services, focusing on the supply of physicians and nurses is useful because of the central role they play in determining the nature and amount of health care delivered. That focus also reflects the lead times that can be involved in changing the supply of practitioners—and concerns about current or projected shortages that have arisen—and highlights the increasing role played by physicians and nurses trained in other countries. Similarly, the hospital sector warrants particular attention because of its major role in treating patients and because of the large share of spending and employment in the health sector for which it accounts.
The process of educating and training new physicians can be lengthy, reflecting the complexity of medical care. After obtaining a four-year college degree (usually with a "pre-med" or related major), prospective physicians generally spend four years training in medical schools and then enroll in residency programs that can last from three to seven years, depending on the medical specialty they are pursuing. U.S. medical schools graduate about 16,000 doctors of medicine per year, a figure that has held relatively steady over the past 20 years.2 First-year residents numbered about 24,000 in 2006, up from about 18,000 in 1990 and about 22,000 in the late 1990s. Almost three-quarters of the residency slots are filled by graduates of U.S. medical schools, and the rest go to graduates of foreign medical schools.
One important factor affecting the number of doctors in training is the subsidies that Medicare has provided for residency programs. Those subsidies have been estimated to exceed $70,000 per resident per year.3 Before Medicare’s creation, the federal government had also begun giving matching grants to medical schools to build or expand their capacity. Those policies—combined with the increase in demand for doctors brought on by Medicare’s provision of near-universal coverage to the elderly—resulted in a doubling of the number of U.S.-trained medical school graduates between 1965 and 1985 and a substantial increase in the number of residency slots. Since 1997, however, Medicare has essentially capped the number of slots it subsidizes.
Roughly 800,000 physicians were practicing in the United States in 2006, up from about 560,000 in 1990. The number of doctors is expected to continue growing, but the rate of growth may slow until it is more in line with overall population growth. Reflecting that assessment, some organizations—including the Council on Graduate Medical Education, an advisory body to the Congress and the Department of Health and Human Services—have forecast that shortages of doctors will develop relative to the heightened demand for care of an aging society.4 Whether those shortages materialize depends in part on whether changes are made to expand the domestic "pipeline" of new physicians, which can involve a lengthy process of approval and certification by provider associations.
Such projections of shortages raise a number of issues. One limitation is that such projections are based on assumptions about a required number of physicians per capita, with some adjustment for population characteristics such as age. In turn, those assumptions may be based on historical patterns in the use of services or on ratios of doctors to patients that are observed in an existing health plan that is treated as a model of efficient use. Whether historic ratios need to be maintained, however, or whether the ratios chosen by one health plan are the correct ones for the entire health sector in the future is not clear. Furthermore, any shortages that arise could be addressed not only by changes in the number of domestically trained physicians but also by changes in the number of hours that doctors work, in the use of ancillary personnel, in the productivity of existing doctors, or by other changes in medical practice. Moreover, to the extent that domestic training slots are limited, the supply of physicians could be augmented by having more foreign-trained doctors enter practice in the United States (which depends partly on immigration policy, because some graduates of foreign medical schools who seek to enter this country are foreign citizens). Finally, projections of requirements for the health workforce generally do not consider the role of prices or fees in determining the demand for or supply of physicians’ services.
Nurses constitute the largest health care profession; about 2.4 million registered nurses were employed in the United States in 2005.5 A license to practice as a registered nurse can be obtained in several ways, including traditional four-year baccalaureate programs, accelerated programs for individuals who have related college degrees, and two-year associate’s degree programs open to high school graduates. A small share of registered nurses has obtained additional education to become nurse practitioners, and recent reports indicate growing interest in that option. Nurse practitioners generally work with physicians in providing primary care, and in many states they have the authority to practice independently (for example, in most states they may diagnose patients’ conditions, and they may also write prescriptions with the collaboration of a physician).
Concerns have arisen in recent years about shortages of nurses. One approach to address those shortages has been to recruit foreign-trained nurses. According to one study, about 14 percent of newly licensed registered nurses in the United States in 2003 were trained abroad, up from about 9 percent in 1995 and from a recent low of 5 percent in 1998.6 Overall, the number of registered nurses practicing in the United States has increased steadily over the past few decades, but some analysts project that the nursing workforce will cease growing within the next 10 years, in part because of projected retirements—raising the prospect of nursing shortages.7 Even without an inflow of foreign-trained nurses, however, it is not clear why a shortage of nurses would persist. If wages for nurses are free to adjust to market pressures, then short-term shortages would cause those wages to rise. That development would limit demand for nurses’ services and would also increase supply—encouraging some nurses to work more hours and others to reenter the practice of nursing (for those who had been trained as nurses but had left the profession) and enticing new people to enter the field. In principle, those adjustments should continue until a wage is reached at which supply equals demand.8
Health care facilities vary widely in their size and scope, ranging from small medical clinics to large hospital complexes. Although hospitals retain a primary role in delivering care—accounting for about one-third of spending on health care services and about 40 percent of health care employment—changes in medical practice have allowed more services to be performed on an outpatient basis and have shortened recovery times from some surgeries, which in turn has reduced the need for lengthy hospitalizations and a large inpatient capacity. Even within the hospital sector, the share of revenue accounted for by inpatient care has fallen from 77 percent in 1990 to 62 percent in 2006 (with the remainder coming from the outpatient care that hospitals provide).
Reflecting those developments, the total number of hospitals in the United States dropped from 6,649 in 1990 to 5,764 in 2003—a 13 percent decline—and has remained at about that level since then. Hospital capacity, as measured by the total number of beds, decreased by about 20 percent during the same period. Community hospitals, which are open to the general public and provide acute care and which constitute the vast majority of hospitals, saw a somewhat smaller decline; the total number of those hospitals and of beds in them fell by about 12 percent during that period. Since 1990, hospitals’ average occupancy rates have generally ranged between 65 percent and 70 percent (with slightly lower rates seen among community hospitals).
Payment Methods and Providers’ Incentives
Health insurance plans pay doctors, hospitals, and other providers of health care in various ways. Common methods include fee-for-service payment, bundled payments for defined medical episodes, and "capitated" payment—a fixed amount for all services that a patient receives over a specified period. Some health plans, such as staff-model health maintenance organizations, own the hospitals that serve their enrollees and employ doctors as salaried workers. Providers’ financial incentives vary greatly among those approaches, so a health plan’s choice of payment method can exert a significant influence on the use of medical care and spending per enrollee.
Proposals could seek to change payment methods directly or indirectly. An example of a direct approach would be to require changes in how payments are made in the Medicare program. The effects of such changes would depend on their breadth and design (a full analysis of which is beyond the scope of this report). By contrast, an indirect approach would encourage shifts in enrollment toward private health insurance plans that use lower-cost payment methods. For example, if enrollees were required to pay the full additional cost of joining a more expensive health plan (an approach discussed in Chapter 4), they might join a plan that uses a less expensive payment method.
More generally, fee-for-service payments can give providers an incentive to deliver additional services and thus may yield greater levels of spending and higher premiums. Payment methods that give providers stronger incentives to control spending on health care would tend to yield lower premiums (holding other factors equal) but would also raise concerns about the degree of financial risk that providers face and about their incentives to limit the use of beneficial services. Some enrollees would be reluctant to switch to plans that use such methods, and the challenges involved in changing payment systems would be substantial both for a private health plan and for the Medicare program.
As the name implies, fee-for-service systems make separate payments to providers for each service they deliver, whether it is a medical procedure, an office visit, or an ancillary service (such as an X-ray). Fee schedules specify payment amounts for a broad set of clinical tasks. After seeing a patient, the provider is paid an amount that reflects all services performed, with each individual service adding to the total.
Compared with other methods, fee-for-service payments generally reward all efforts to provide care and create no financial incentive to limit the use of beneficial services. If the fees for the services exceed the costs of providing them, however, such payments can encourage providers to perform a greater number or more expensive mix of services, even though the clinical value of those services may be slight. For their part, cost-sharing requirements for insured patients generally cover only a portion of the providers’ fees, so patients have incentives to receive services as long as the expected benefit exceeds the portion they have to pay.
In the United States, most care provided by doctors is paid for on a fee-for-service basis. The Medicare program pays doctors in that way and has established more than 7,000 different billing codes for the specific services that physicians provide. Fee-for-service payment is also common among private health plans. Preferred provider organizations, which are the most popular type of private plan, generally use that method. In addition, many health maintenance organizations contract with a network of independent doctors and pay them on a fee-for-service basis—at least for specialty care and, in many cases, for primary care too.
Bundled or Episode-Based Payment
An alternative approach is to make a single fixed payment for a bundle of related services or for an episode of care, such as a hospital admission. The most prominent example of that approach is the prospective payment system that Medicare adopted in 1983 to pay hospitals for acute inpatient care. Under that system, most hospitals generally receive a fixed amount per admission that is based either on the patient’s diagnosis or on the treatment he or she receives. Several hundred payment rates (one for each diagnosis-related group, as they are known) have been established. If treatment costs are less than the payment, the hospital keeps the difference; if treatment costs exceed the payment, the hospital incurs a loss, though in certain cases Medicare makes additional payments for high-cost "outlier" patients. (Private health plans typically pay hospitals a fixed amount per admission or per day.)
Because a fixed payment shifts some financial risk from the insurer to the provider, episode-based payments can create a strong incentive for providers to economize on care for a given health episode. After the prospective payment system was implemented, the number of days that Medicare enrollees spent in the hospital declined sharply—reflecting the fact that hospitals were no longer being paid more for longer stays. The number of hospital admissions also fell, reversing the trend before 1983 when hospitals were paid on the basis of their reported costs.
Although fixed payments can encourage hospitals to limit the costs of a given admission, Medicare’s system is not designed to encourage savings in other ways (such as taking steps to avoid or prevent hospital admissions). In addition, for more than 40 percent of the payment groupings, Medicare’s payment depends not just on the diagnosis (for example, a heart attack) but also on what procedure is performed (for example, a bypass operation).9 In those cases, hospitals may still have incentives to provide more expensive treatments during an admission—because they would be paid more—but would retain incentives to control other costs associated with that admission.
Bundled or episode-based payment is mainly used for financing hospital care and postoperative care, perhaps because it is relatively easy to define medical episodes that involve those services. Under Medicare, for example, skilled nursing facilities (which provide postoperative rehabilitation services) generally receive a fixed payment per day, and agencies that provide home health care generally receive a fixed payment for each 60-day episode of care. In both cases, the payment amounts are adjusted to reflect the severity of each patient’s condition.
In principle, episode-based payment could be used more broadly to cover all of the services involved in treating a given health problem—including those performed by physicians, hospitals, and other providers and facilities. In practice, however, assigning control over a patient’s care or allocating payments across settings may be difficult, particularly when the providers are not otherwise linked. Even in the case of hospital admissions, Medicare pays doctors separately for the services they provide during a patient’s hospital stay; that is, the payments for physicians and hospitals are not bundled. Determining what services are part of an episode may also be challenging, particularly if patients have multiple health problems.
Capitated payment is similar in concept to bundled or episode-based payment but is far broader in scope. Unlike an episode-based payment, which covers costs arising from a specific health event, a capitated payment generally covers all of a patient’s care for any health problems over a specified period. In capitated payment arrangements, insurers typically pay providers (or provider groups) fixed monthly amounts in exchange for an agreement to treat any health problems that arise during a patient’s period of enrollment.
Capitated payment creates especially strong incentives for providers to limit the use of costly services and thus can yield substantial savings. Capitated payments may also encourage providers to invest in types of care that reduce the likelihood that a patient will need costlier treatments in the future. In order to take such steps, however, providers would have to expect to have long-term relationships with their patients; if turnover among patients is rapid, providers may find it unprofitable to devote resources to such services under capitation because they would not be able to capture the financial benefits.
Although capitation can provide strong incentives to control costs, it raises concerns about the possible underprovision of needed care. Capitation may also encourage providers to avoid treating very sick patients if payments are not sufficient to cover those patients’ higher expected costs. In principle, "risk-adjusted" payments—higher capitated payments for sicker, costlier patients—can minimize providers’ incentive to "cherry-pick" healthier enrollees. In practice, however, risk-adjustment methods have some limitations (as discussed in Chapter 4). As in the case of risk-adjusted payments to health plans, the key question is whether doctors could systematically predict the expected costs of potential patients more accurately than the risk-adjustment models and whether that information could be used in ways that affect the range of patients that doctors see.
Another concern that arises with capitated payments is that they effectively make providers of clinical care the primary bearers of financial risk—a role traditionally played by insurers. In comparison with insurers or large provider groups, smaller provider groups would face greater variability in their patients’ expected costs just because of random fluctuations that are beyond the doctors’ control. Some private health plans adopted capitated payment methods in the 1990s, but anecdotal evidence indicates that physicians had difficulty managing the financial risks involved and that the use of capitation has subsequently declined.
To mitigate potential problems, some health plans blend capitated payment—typically for primary care—with other methods, such as fee-for-service payment, for specialty care. Blended models have also been proposed for Medicare as a way to help balance the differing incentives that fee-for-service and capitated payments provide.10 Even so, a challenge for those approaches is to find an organizational unit that would receive and distribute the blended payment when various providers that treat Medicare patients are not linked financially. The effects could also differ substantially depending on whether participation by doctors was made voluntary or mandatory. (A related approach, in which a patient’s primary care provider would serve as a "medical home" and coordinate his or her care—possibly in return for a capitated payment or other financial incentives to limit the use of specialty care—is discussed in Chapter 7.)
Some plans employ providers, including physicians, as salaried workers. In those settings, providers’ incentives are like those of salaried workers in other fields. Monitoring aspects of a physician’s performance, including quality of care and cost control, are management functions of the employing organization. Compensation may consist simply of a salary, or it may include bonus payments for good performance (as discussed below). Organizations that employ salaried physicians include staff-model HMOs and the Veterans Health Administration.
In general, determining the effects of various payment systems on expenditure levels can be problematic because of the difficulties that arise in accounting for other factors that might affect comparisons between different private health plans or between private health plans and Medicare. In the case of salary payments, however, a useful comparison comes from the RAND Health Insurance Experiment, a large study conducted from 1974 to 1982 to test the effects of various health insurance designs by randomly assigning participants to different plans. The RAND study included a staff-model HMO plan and estimated that total expenditures for its enrollees were about 30 percent lower than those for enrollees in a comparable plan using fee-for-service payment.11 In addition, various comparisons of enrollees’ health did not show systematic differences, although the ability of statistical methods to detect differences in health among participants in the experiment may be limited.
One important factor that limits the applicability of the RAND comparison, however, is that the plans it analyzed do not resemble current offerings in other respects. In particular, neither the HMO nor the fee-for-service plan required any cost sharing, and the fee-for-service plan did not use any of the cost-management techniques commonly employed by health plans today (see Chapter 3 for a discussion of those techniques and their impact).
Some health plans offer financial incentives to providers to encourage desired performance. For example, they may give bonuses to providers that meet targets for quality (such as performing appropriate tests on patients with diabetes) or reduce payments to providers that do not. Those arrangements, known as "pay for performance" initiatives, could be incorporated into fee-for-service systems in an effort to encourage doctors to provide only treatments that are deemed appropriate; they could also be used with capitation or salary arrangements to encourage providers not to stint on care.
Designing an incentive system can be challenging, however, especially when the system is implemented outside a staff-model setting. (In such a setting, providers’ actions may be more easily observed or supervised.) In particular, developing valid and meaningful measures of performance quality can be difficult because of the complexity of medical care. Medical outcomes such as mortality or avoidance of acute health problems are relatively easy to measure, but conclusions about quality of care that are based on those measures can be misleading if they do not properly account for differences in the severity of patients’ illnesses or if the provider being measured does not perform a given procedure often enough to make a reliable comparison.
Reflecting those difficulties in assessing outcomes, many attempts to gauge performance focus on "process" measures for treating specific conditions. For example, providers may be required to report whether they have followed several widely accepted treatment guidelines, such as prescribing medicines called beta blockers for patients who have had a heart attack. The value of such approaches depends on whether a provider’s performance on those metrics is correlated with the overall quality of the care he or she delivers. Determining an optimal structure of bonuses or penalties may also be difficult.
Payment systems determine what is being paid for, but the financial incentives created by different payment systems—and the spending levels they yield—also depend on the level at which payment rates (or the prices for services) are set.12 How those rates are set also plays a role in determining their level.
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Payment rates in the private sector are generally set by negotiation, reflecting the underlying costs of the services and the relative bargaining power of providers and health plans; in turn, bargaining power depends on factors such as the number of competing providers (or provider groups of a particular type or specialty) within a local market area.
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Fee-for-service payment rates in Medicare and Medicaid are set administratively. Although a common goal of administered pricing systems is to set rates that cover the costs of an efficient provider, keeping payments in line with providers’ costs for each specific service can be difficult. In addition, annual updates to those prices may reflect statutory formulas or legislative responses to budgetary and other pressures that may deviate from the changes in providers’ costs.
The level of administratively set prices and mechanisms for setting them are particularly important considerations for proposals that would expand their use. For example, proposals for a single-payer system could establish a government entity that would set payment rates, perhaps using methods similar to those employed in the traditional fee-for-service portion of the Medicare program. Alternatively, some proposals would create a new public program similar to Medicare as an additional option for the general population. The new program would compete against privately run plans and could use administered pricing to set its payment rates. Still other proposals might expand the role of Medicaid or shift Medicaid enrollees to private health plans. The available evidence indicates that payment rates for Medicare and Medicaid are, on average, lower than those of private payers—in some cases, substantially lower—but the difference is much smaller in some areas of the country than in others.
Determining Rates in the Private Sector
In general, payment rates and fees in the private sector are set through some process of negotiation between health plans and providers. In the case of large hospitals or physician groups, those negotiations may be explicit, involving face-to-face bargaining. In other cases, the bargaining may be tacit, with health plans setting a payment rate schedule and adjusting it as necessary so that a sufficient number of providers are willing to accept the terms.
Partly to enhance their bargaining leverage, private health plans generally establish a network of providers from which enrollees are encouraged or required to obtain covered services. For example, preferred provider organizations usually charge relatively small copayments for visits to providers within the plan’s network but have much higher cost-sharing requirements for visits to other providers. HMO plans generally require enrollees to obtain services within the plan’s network in order to receive coverage. Faced with the threat of being excluded from the network and thus seeing fewer patients, many providers are willing to accept lower fees. (Plans may seek to exclude certain providers for other reasons, such as having a particularly high-cost practice style or performing poorly on quality measures.)
The effect of establishing a network of providers on payment rates depends on local market conditions. Other factors held equal, large health plans can probably negotiate lower prices than small plans because large plans can have a greater effect on the number of patients a provider sees (although providers would not be willing to accept payments that were lower than their costs for providing services). Hospitals or physician groups with few local competitors, however, are better able to resist demands for price concessions.
Medicare’s Approach to Setting Payment Rates
The process used to set payment rates in the Medicare program exemplifies the workings of and challenges facing an administered pricing system. Medicare generally pays doctors and hospitals a fixed amount per service or per admission. Although the scope of the payments differs substantially between those two payment systems, the mechanisms for setting payment rates have many similarities. In both cases, a base or average payment amount is multiplied by a factor that is designed to capture differences in the resources needed to provide various services or to treat different types of patients. The base payment amount is updated annually according to statutory formulas, but that update may be—and often is—modified by legislation.
For inpatient hospital care, Medicare pays a flat rate for each stay. That rate depends on the diagnosis-related group to which the stay is assigned (which is determined by the patient’s diagnoses and whether or not certain surgical procedures were performed). Each group is assigned a weight that is intended to represent the expected costliness of stays in that group relative to the national average. Medicare’s payment for a given stay is thus determined by multiplying the group’s weight by the base payment rate.13 The Centers for Medicare and Medicaid Services, the agency that administers Medicare, reviews the definitions of all groups annually to ensure that they continue to include cases with clinically similar conditions requiring comparable amounts of inpatient resources. The base payment rate’s initial value reflects the historical costs used in constructing the rate in 1983 (when the prospective payment system was adopted) plus annual updates that have been made since then. In the absence of legislative changes, the annual update is based on projected increases in hospitals’ input costs (such as staff wages and the prices of medical supplies), but the update has frequently been altered by legislation in response to budgetary pressures or other considerations.
For physicians’ services, Medicare uses a fee schedule that is based on an assessment of the relative resources needed to provide those services (including the time, skill, and training required of the doctor). The payment rate for a particular service is determined by multiplying the relative value or weight that has been established for that service by a base payment amount, known as the "conversion factor." As with inpatient hospital care, the base payment amount for physicians’ services reflects the average level of historical spending per service at the time the fee schedule was adopted and subsequent annual updates to that amount. The fee schedule’s relative weights are also updated at least every five years, with input from the American Medical Association and physicians’ specialty societies; the list of service codes and the conversion factor are updated annually.
Under current law, the annual update for physicians’ payments is determined by the "sustainable growth rate" mechanism, which entails target levels of expenditures and a method for adjusting payment rates in an attempt to bring actual expenditures in line with the targets over time. In essence, the targets are set so that spending per Medicare enrollee will grow at about the same rate as per capita gross domestic product.14 If expenditures on physicians’ services are equal to the targets, the conversion factor is updated by the projected change in the average price of inputs—such as the costs of office space and support staff—that are used to produce those services; the update is then adjusted to reflect expected improvements in productivity. In recent years, however, spending per enrollee on physicians’ services has grown more quickly than the economy as a whole—consistent with long-term trends in health care spending—and Medicare’s expenditures have exceeded the targets.
That outcome would have led to cuts in physicians’ payment rates, but legislation has generally prevented those reductions from taking effect. The most recent intervention canceled a 10.6 percent reduction in Medicare’s payment rates that was scheduled to go into effect on July 1, 2008. Instead, the legislation froze those payment rates for the remainder of the year and will increase them by 1.1 percent in January 2009. In the absence of further legislation, however, future payment rates will revert to the levels that were specified under prior law, necessitating a 21 percent reduction in payment rates under the physicians’ fee schedule in 2010 and additional cuts in later years.
Determining whether Medicare’s payment rates are adequate is difficult, in part because of the challenges involved in estimating providers’ costs. Among the relevant issues are questions like how to:
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Allocate overhead costs or account for the costs of equipment or facilities that are shared with the production of other services,
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Set payment rates for new treatments and technologies.
In the view of some experts, updates to administered price schedules tend to lag behind changes in medical technology and practice techniques that affect the costs of services and treatments, and such lags may in turn affect the pace of technological advance.15 Accounting for the value of the services that enrollees receive or the quality of different providers may also be difficult.
Despite those challenges, the Medicare Payment Advisory Commission (MedPAC) assesses the program’s rates and makes recommendations each year to the Congress about the update factor that should be applied for hospital and physicians’ services. MedPAC’s analysis seeks to determine whether payments are sufficient to cover the costs of efficient providers and takes into account available data on access to services by enrollees and the financial condition of providers. In its most recent report, MedPAC recommended that payments to hospitals and physicians receive a full update for inflation in input prices in 2009 (with an adjustment to the update for physicians’ payments that is in line with productivity gains for workers observed in the economy as a whole).16
For both inpatient care and physicians’ services, the Medicare program also faces a considerable challenge in setting payment weights that accurately reflect the relative costs of providing different services, particularly given the changes over time in medical practice and providers’ productivity. Evidence indicates that because of limitations in the available data on providers’ costs, the weights have unintentionally resulted in some types of inpatient admissions (such as those for cardiac surgery) and some types of physicians’ services (such as imaging) being more profitable than others.17 Such differences—which can also arise for private payments—create incentives that can cause providers to deliver too much of some types of care and too little of others; they also encourage investments in some types of facilities and equipment that would not have otherwise been made.
Comparison of Public and Private Payment Rates
Many private insurers and states’ Medicaid programs pay for physicians’ services using payment rates that are based on Medicare’s fee schedule. In many cases, their rates differ substantially from Medicare’s rates, however, because they use different conversion factors. In the case of private plans, those differences are negotiated to reflect local market conditions and may vary for different specialties.
How large are the differences? An analysis by MedPAC indicates that Medicare’s payment rates for physicians were, on average, nearly 20 percent lower than private insurers’ rates in 2006.18 As for Medicaid, one study concluded that the program’s rates for physicians in 2003 were about 30 percent lower than Medicare’s rates.19 Charges for physicians’ services, which are the amounts that uninsured patients are expected to pay unless they make arrangements to receive charity care, were about 125 percent higher than Medicare’s rates, on average.
Private insurers and public programs also vary in how they pay for inpatient hospital care, but comparing their payment rates is more difficult. Data compiled by the American Hospital Association (a trade group representing hospitals) indicate that Medicare’s average payment rates for inpatient care were about 30 percent lower than those of private insurers in 2006, and that the payments by Medicaid were about 5 percent lower than those of Medicare.20 Those calculations are not direct comparisons; rather, they reflect the relative "payment-to-cost" ratios that hospitals reported for each insurer and thus depend on how fixed costs are allocated to different types of patients. In particular, they reflect a calculation that, on average, Medicare’s payments were about 9 percent below the costs of serving Medicare patients, whereas private payments were about 30 percent above costs. Alternatively, if a greater share of hospitals’ fixed costs was allocated to private patients, then the payment-to-cost ratio would fall for private insurers and rise for Medicare.
The relationship between Medicare’s payment rates and those of private insurers varies geographically. Medicare’s rates are established nationally and are adjusted to account for geographic variation in providers’ input costs. The rates that private insurers are able to negotiate also depend to some extent on the relative negotiating leverage of providers and insurers in local market areas. Private rates are noticeably higher than Medicare’s rates in areas with less competition among providers, such as small cities and rural areas. According to one study, the rates paid to physicians by private insurance plans are an average of 30 percent higher than Medicare’s rates in small metropolitan areas and rural areas, 10 percent higher in medium-sized metropolitan areas, and 1 percent higher in large metropolitan areas.21 Proposals that would shift payments from private rates to Medicare’s rates would therefore lead to a much greater reduction in payment rates in rural areas than in large metropolitan areas.
Responses to Changes in Payment Rates or Demand for Services
Changes in payment rates would clearly have a direct effect on health care spending and insurance premiums, but they could also have an indirect effect by changing the number of services that providers would be willing to supply. Similarly, the effects of covering currently uninsured individuals would depend not only on the resulting increase in their demand for care but also on how that increase would affect the supply and prices of services.
Whether and to what extent supply might be constrained depends on several factors, including the size of the increase in demand and the amount of time available for adjustments to occur. CBO’s analysis indicates that providing coverage to the uninsured population that is similar to coverage under current employment-based health plans would initially increase total demand for physicians’ services and hospital care by 2 percent to 5 percent (see Chapter 3). Although supply constraints could cause the total use of services to increase by a smaller percentage, the extent to which those constraints would arise is not clear.
Responses to Changes in Payment Rates
A decline in the amount that a provider is paid would generally be expected to result in fewer services being delivered. That type of response has been observed in skilled nursing facilities and home health agencies, and there is some evidence that it occurs in hospitals.22
In the case of physicians, however, payment cuts could lead them to increase the amount of services they provide to offset the effect of lower rates on their income. That possibility arises because doctors play a major role in determining how much and what types of care their patients receive—a situation that does not apply to most producers of goods or services. Doctors thus have some ability to induce demand for additional services, and the capacity of insurers to monitor such actions is limited. Researchers attempting to analyze such effects typically assume that doctors incur some "psychic" costs when they induce demand, but those costs are balanced against the gains from increasing their income.23 Doctors could also respond to fee cuts by increasing the reported number or types of the services they provide, without actually increasing their activities, but many physicians might be unwilling to engage in such "up-coding," and others would be deterred from doing so by the risk of detection.
Previous studies of the effects of changes in Medicare’s payment rates on the number and types of services that physicians provide yield mixed evidence of a behavioral response. Some studies have found that doctors respond according to the standard economic model, increasing their supply of services when payments rise and decreasing them when payments fall.24 Other studies have found that physicians respond to reductions in payment rates by increasing the volume of their services so as to offset between 20 percent and 40 percent of the rate cut’s impact on their total payments.25 An analysis of Medicare payments conducted by CBO in 2007 is consistent with the latter studies; it found that physicians responded to recent reductions in those payment rates by increasing the reported volume and intensity of the services they deliver.26 In particular, that study concluded that the response of physicians offsets about a quarter of the reduction in spending that would otherwise occur. The extent to which that response represented increases in the actual services provided or changes in the reporting of existing services could not be determined because it is not observable.
On the basis of that study, CBO would expect responses of that magnitude to changes in payments to physicians when those payments are in the range of Medicare’s current rates. Substantially lower rates, however, such as those paid by Medicaid, may not be sufficient to cover some providers’ costs. If that was the case, doctors would not have an incentive to induce demand for services because they would lose money on the added services; indeed, they might choose not to accept patients who were candidates for those services. Furthermore, over a prolonged period of time, lower average payment rates would be expected to yield fewer practicing physicians than otherwise.
More substantial changes in payment rates could have broader effects on the supply of health care services, depending on the share of patients involved. In particular, adopting Medicare’s current rates under a single-payer proposal would cause a significant reduction in payments for the services provided to a substantial fraction of physicians’ patients—particularly for physicians who practice in geographic areas with limited competition among providers. Such changes in payment rates could diminish the supply of physicians in areas that experienced more substantial declines in rates, which in turn could reduce access to care in those areas. Moreover, lowering payment rates for hospital services to the level of Medicare’s rates could cause a significant decline in the financial condition of some hospitals, which over time could reduce access to hospital services in some geographic areas and lower the quality of care that those hospitals deliver.
Responses to Changes in Demand for Services
Proposals that expanded health insurance coverage would tend to increase the demand for health care services, but the extent to which the use of services and spending on them would increase is less clear. Particularly in the short run, the supply of U.S.-trained health care providers is largely fixed. Substantially expanding the capacity of medical schools and teaching hospitals can take many years, partly because of institutional barriers such as the need for approval and certification from various provider associations. Even if the capacity to train practitioners in the United States is changed, the training time required for new providers is substantial, especially for physicians.
In the interim, those constraints could be alleviated by changing the number of hours that providers work, improving their productivity, shifting responsibilities among providers, or increasing the flow of practitioners from other countries. Any remaining shortages in the supply of services would result in higher prices or greater difficulty in obtaining access to a provider (for example, longer lags in scheduling appointments).27 Studies of how large-scale insurance expansions—both in the United States and in other countries—affect the use of services provide some evidence about the extent to which use of services and spending would increase as a result in the near term. Even so, determining in advance whether and how the impact of a particular proposal would be affected by supply considerations is difficult.
Potential Responses in the Near Term. If policy changes resulted in greater demand for health care services, the textbook response would involve some combination of a larger quantity supplied and higher payment rates to bring supply and demand back into balance. Supply might increase more quickly if payment rates were allowed to adjust; such adjustments would tend to be more rapid with negotiated payment rates than with administered prices. (Whether and how quickly demand adjusted to the new rates would also depend on how those rates affected patients’ cost-sharing requirements.)
In the short run, one adjustment that could be made to expand the supply of services would be an increase in the hours worked by providers who are currently in practice. Physicians may be relatively unresponsive to changes in payment rates, however, either in terms of changing their total hours worked or their decisions about retirement. Some studies (including one by CBO) have suggested that when doctors receive higher fees, they actually tend to reduce the number or complexity of the services they provide.28 Nevertheless, CBO’s analysis also found that, after accounting for physicians’ responses to changes in the level of Medicare fees, the average volume and intensity of physicians’ services provided to each Medicare beneficiary has grown by about 4 percent annually in recent years—indicating that providing more services is feasible even if the number of providers or their work hours are relatively fixed.
Other adjustments that could be made include improving the productivity of physicians or shifting some of their responsibilities to nurses and other providers, thereby allowing more services to be provided without increasing doctors’ hours. For example, steps such as using nurse "help lines" to triage medical problems, outsourcing other activities typically conducted in the physician’s office, or opening primary care clinics at pharmacies and retail stores could enable the delivery of greater quantities (or different kinds) of medical services by a given number of health professionals. Other shifts in responsibility could require additional training. For example, registered nurses can obtain advanced training (typically two years are required) to become nurse practitioners or certified nurse midwives, so that they can perform many tasks performed by physicians. Lags in implementing new proposals would allow such adjustments in supply to begin in anticipation of the changes in demand. To the extent that additional services could be produced using lower-cost staff, the effect on payment rates and spending would also tend to be smaller.
Finally, graduates of foreign medical schools provide additional flexibility in the physicians’ workforce. The share of practicing physicians who were trained abroad is currently about 25 percent, up from about 20 percent in 1985. Although several thousand graduates of foreign medical schools enter residency programs in the United States each year, options for increasing the supply of physicians through that route could be constrained by the number of residency slots. Alternatively, doctors who have completed residency programs or equivalent training abroad may also be able to enter directly into practice in this country, depending in part on the credentialing rules used in their state. The extent to which they would do so in response to greater demand for health care services in the United States depends on the attractiveness of their opportunities abroad and, for those who are not U.S. citizens, on immigration policy.
Evidence from Previous Insurance Expansions. Analyses of several relatively large-scale insurance expansions may shed light on how providers’ responses would interact with changes in demand for services to determine the ultimate effect on health care spending. (Studies examining how smaller-scale coverage expansions, which are less likely to raise issues about supply, affect the demand for care by the formerly uninsured are examined in Chapter 3.) One limitation of such analyses, however, is that several factors—including payment mechanisms and rates—may have been changed at the same time, making it difficult to isolate the effects of each element.
One study examined the impact that Medicare’s creation had on subsequent hospital admissions and spending in the United States.29 Before 1965, about 25 percent of seniors had private health insurance coverage that was comparable with Medicare, and seniors accounted for about 10 percent of the total U.S. population; therefore, about 7.5 percent of the population gained extensive coverage because of Medicare. The resulting increase in the use of services by the elderly was found to be consistent with the impact that would be predicted using the findings of the RAND Health Insurance Experiment. Overall, however, the effect on hospital admissions—for the elderly and nonelderly combined—was several times larger than that, and by 1970, Medicare’s introduction had led to an increase in hospital admissions of 30 percent to 45 percent. The author attributed that effect to the broader adoption of treatments and methods of providing care (such as those used in dedicated cardiac care units) that also had a dramatic impact on care for the nonelderly.
Those findings suggest that the supply of services can respond rather rapidly to an expansion of insurancecoverage. Indeed, the results indicate that the overall effect on the use of services could be much larger than the increase in the use of services for people who had gained coverage under the new program. One factor that may have contributed to that response, however, was the relatively generous payment system that Medicare adopted. Following the common practice of private insurers at the time, Medicare initially paid hospitals on the basis of their incurred costs—an approach that gave hospitals little incentive to control those costs. The increase in hospital spending that resulted from Medicare’s creation could well have been smaller under a less generous payment system.
Another example comes from the province of Quebec, which implemented Canada’s universal health insurance plan for physicians’ services in late 1970. That plan covered all costs for services that doctors provided in their offices, in clinics or hospitals, or during house calls. When researchers compared the use of physicians’ services shortly before the change and two years later, they found that the number of office visits (which were covered) rose sharply but that the number of telephone contacts doctors had with patients (which were not reimbursed) declined. Overall, the number of face-to-face contacts in all settings increased modestly.30
The study also found that the average hours doctors worked fell by about 15 percent, primarily because of a decline in the average amount of time spent on each office visit. The study did not seek to account for the effects of any changes in physicians’ payment rates that came with the adoption of a uniform fee schedule or for the impact on health care spending of the changing mix of doctors’ activities. A survey of patients did find that waiting times to schedule an appointment roughly doubled, indicating that the supply of services did not increase as much as patients would have wanted when care became free to them. Moreover, total contacts with patients rose for lower-income families (whose demand for care increased most sharply) but fell for higher-income families—indicating that the overall supply of services was constrained, at least in the short run.
A more recent example comes from Taiwan, which implemented universal health insurance in 1995. One study examined the effects on services used by adults and found that among the one-quarter who were previously uninsured, the number of visits to physicians increased by about 70 percent and the number of hospital admissions more than doubled; use rates for people who had been insured previously were largely unchanged.31 Another analysis found that the overall rate of hospital admissions in Taiwan grew by about 10 percent between 1994 and 1996.32 Those figures would suggest that Taiwan’s health care system was able to accommodate the increase in demand, but another factor was that payments to physicians working in primary care clinics were raised by about 20 percent. That change helps explain why the number of physicians working in such clinics, which had been increasing by about 5 percent per year, grew by 10 percent in 1995. (Whether those doctors shifted from the hospital sector, which accounted for about 60 percent of physicians’ employment, or came from another source is not clear.)
Uncompensated Care and Cost Shifting
Another issue that arises when analyzing providers’ payments is whether relatively low payments by public programs or the costs of providing uncompensated care to the uninsured result in higher payment rates for private insurers—a process known as cost shifting. In many cases, uninsured individuals pay much less than the costs of the care they receive, so doctors and hospitals might seek to make up those losses by charging more to private health plans. Similar pressures to raise private payment rates could occur if payments from public programs did not cover the average costs of their patients (which could be termed "undercompensated" care). To the extent that costs are being shifted, proposals that reduced the uninsured population or switched enrollees from public to private insurance plans would have ripple effects on private payment rates and thus on private insurance premiums.
The evidence indicating that private payment rates are higher than public rates—and that they also appear to exceed the costs of treating privately insured patients—is sometimes taken as proof of cost shifting. There are, however, other explanations. In general, a firm that has some monopoly power will be more profitable if it charges different prices to different sets of purchasers that reflect differences in the groups’ willingness to pay (a practice known as price discrimination). The fact that hospitals receive different payment rates from public and private insurers may reflect that same behavior. Differences in payment rates across different types of insurers do not, however, mean that costs have been shifted from one type to another. The key question about cost shifting is whether an increase in the rates paid on behalf of some patients (including people who used to receive charity care but would now have insurance) would cause a decline in the rates paid by others (such as private insurers).
Whether and how such cost shifting would occur depends on several other factors, including the amount of uncompensated care that is provided, the adequacy of public payment rates, and the degree of competition facing hospitals and doctors. Recent estimates (discussed below) indicate that hospitals provided about $35 billion in uncompensated care in 2008, but the available evidence suggests that less than half of those costs—and probably much less—were shifted to private insurers. Estimates of uncompensated care provided by doctors are considerably smaller, and cost shifting does not appear to be a substantial factor affecting payment rates for physicians. Although assessing the adequacy of Medicare’s payments to doctors and hospitals is more difficult, MedPAC’s analysis indicates that those payments are sufficient to cover the costs of efficient providers in 2008; that finding suggests that Medicare’s payments do not generate cost shifting in competitive markets. Medicaid’s payment rates for doctors and hospitals probably fall below the costs of treating that program’s enrollees, but whether the costs of those shortfalls are shifted is not clear.
The Potential for Cost Shifting
Cost shifting could occur only under certain conditions, so it is useful to review them carefully. There are two basic scenarios: one that involves a provider market with limited competition, and one that involves a competitive provider market.
An extreme example of limited competition would be an isolated community that is served by a single hospital. Because of its monopoly power, such a hospital could negotiate payment rates from private insurers that exceed its costs for those patients. In response to a reduction in payments from public insurance programs or an increase in the amount of uncompensated care that it provides, that hospital might be able to secure higher payments from private insurers to offset its losses. In order for such cost shifting to occur, however, the hospital would have to have been charging private insurers less than it could have; that is, the hospital would have to have had monopoly power that it had refrained from using fully.33
Whether some hospitals have market power that they have failed to exploit is unclear. One reason that many hospitals might not have fully used their market power is that most of them are nonprofit organizations. As a result, their goals of serving the community and the corresponding makeup of their governing boards may lead them to charge private insurers less than the profit-maximizing price (that is, the price a monopolist would charge).34 In other respects, however, the behavior of nonprofit and for-profit hospitals can be difficult to distinguish. For example, a recent study by CBO found that nonprofit and for-profit hospitals provided similar amounts of uncompensated care.35 Whether a hospital’s goal is to maximize profits, serve the community, or some combination of the two, the key questions remain: Would hospitals (and other providers) that have market power lower private payment rates if proposals either reduced uncompensated care or raised the payments that providers receive for enrollees in public programs? Or would hospitals still seek to charge private insurers a profit-maximizing price, either as an end in itself or as a means of financing other efforts to serve their community?
Cost shifting could also occur in a competitive provider market in order to offset the costs of uncompensated care or to make up for losses that might arise from relatively low public payment rates. Why would they accept those rates in the first place? In general, providers have some operating costs that do not vary with their patient load (fixed costs) and some that do (variable costs). If public payment rates were high enough to cover the variable costs of serving those patients—but contributed little or nothing toward covering providers’ fixed costs—it would still be worthwhile for providers to accept those payments, at least in the short run. Providers could try to make up for losses from undercompensated care by charging more to private insurers. If competing providers had roughly comparable burdens of uncompensated and undercompensated care, then those higher private rates could probably be sustained in a competitive market.36
Providers facing shortfalls in payments would also have alternatives, however, including the option of reducing their costs. That approach would yield higher payment-to-cost ratios and could reduce the quality of care that patients receive, but it would not raise private payment rates. Indeed, with a lower cost structure, hospitals may reduce their rates for private insurers. By the same token, a decline in uncompensated or undercompensated care might allow providers to offer care of higher quality (at a higher cost), but it might not yield a corresponding reduction in private payment rates and could even cause private rates to increase.
Estimates of Uncompensated Care and the Adequacy of Public Payments
Estimates of how much uncompensated care the uninsured receive vary depending on the data sources used and on how the concept is defined and measured. Analysts generally define uncompensated care as care for which the provider is not paid in full by the patient or a third party.37 It includes both charity care (for which little or no payment is expected) and bad debt (for cases in which payment is sought but not collected). Studies differ, however, in how they define "full" payment, with some comparing the payments that are received to the list prices that providers post. A more useful comparison, however, is to the total payments that providers would receive for the same service when treating a privately insured patient, because that amount (which is generally much lower than the list price) more closely resembles their costs.
A recent study by Hadley and others, which used that analytic approach, examined a sample of medical claims for uninsured individuals and projected that they would receive about $28 billion in uncompensated care in 2008.38 That study also examined cost reports from hospitals and a survey of doctors and generated a different estimate: The gross costs of providing uncompensated care would be about $43 billion in 2008, of which $35 billion would come from hospitals and $8 billion from doctors. Total spending on hospital care in 2008 is estimated to be about $750 billion, so those figures would imply that uncompensated care accounts for about 5 percent of hospital revenues, on average. Those findings are consistent with CBO’s analysis of uncompensated hospital care (cited above), which found that a sample of for-profit and nonprofit hospitals incurred costs for such care that averaged between 4 percent and 5 percent of their operating revenues.
Another point on which analysts disagree is whether to consider only the gross costs of providing uncompensated care or to net out offsetting payments that providers receive from sources other than insurers. As the Hadley study noted, about half of hospitals’ aggregate costs for uncompensated care may be offset by added payments under Medicare and Medicaid to hospitals that treat a disproportionate share of low-income patients.39 Whether hospitals seek to recoup from private payers the gross costs they incur for providing uncompensated care or their net costs after accounting for those offsetting payments is not clear; the answer depends in part on how well the offsetting payments are targeted toward hospitals that provide uncompensated care.
As for physicians, the figures cited above indicate that they provide a relatively small amount of uncompensated care—representing about 1 percent of the roughly $500 billion spent on physicians’ and clinical services in 2008. Another study found that, on net, uncompensated care provided by office-based physicians was close to zero after the higher payments made by some uninsured individuals were taken into account.40 That study also found that if those offsetting payments were ignored, the gross amount of uncompensated care provided by physicians was about $3 billion per year in the 2004–2005 period. Either way, the uncompensated care that physicians provide seems unlikely to have a substantial effect on private payment rates.
As with estimates of uncompensated care, assessments of the adequacy of payments from Medicare and Medicaid vary depending on the data and the points of comparison that are used. The data from hospitals’ cost reports compiled by the American Hospital Association indicate that Medicare’s payments covered about 91 percent of costs for those patients in 2006 (whereas private payments were reported to average about 130 percent of the costs of treating those patients).41 Correspondingly, the AHA estimated a shortfall in Medicare’s payments to hospitals of about $19 billion in 2006. As noted above, however, those calculations depend partly on how hospitals’ fixed costs are allocated.
MedPAC’s most recent analysis indicates that Medicare’s payments are sufficient to cover the costs of efficient hospitals. That assessment took into account hospitals’ reported losses on Medicare patients, although MedPAC’s calculations used a slightly different approach and found a smaller gap between payments and costs (about 5 percent in 2006, compared with AHA’s estimate of 9 percent). That analysis also considered other indicators of whether payments were adequate, including beneficiaries’ access to care, the volume of services provided to them, and hospitals’ plans for expansion (a measure of financial health). Indeed, MedPAC’s analysis suggests an alternative explanation: Instead of low Medicare payment rates causing private rates to be higher, high private payment rates at some hospitals may be leading them to relax their efforts to control costs. In turn, that tendency may have pushed up per-patient costs and thus caused payment-to-cost ratios for Medicare (and private) patients at those hospitals to be lower than they would be at hospitals that have lower per-patient costs.
As for Medicaid, AHA’s analysis of hospitals’ cost reports indicates that the program’s payments covered about 86 percent of costs, on average, in 2006 (with the added Medicaid payments to hospitals that treat a disproportionate share of low-income patients included in that analysis). That calculation translates into an estimated shortfall in payments of about $11 billion. Medicaid’s payment rates appear to be lower than Medicare’s, so even if AHA’s calculation overstates the shortfall, it seems likely that Medicaid’s payment rates fall somewhat below hospitals’ average costs for those patients.
Because physician markets are generally competitive, individual doctors or group practices would be able to shift costs to private payers only to the extent that Medicare and Medicaid payments did not cover their costs (which can be difficult to estimate). Even so, MedPAC’s conclusion that Medicare’s 2008 rates for doctors are adequate indicates that little scope for cost shifting exists in that sector. As for Medicaid, the available evidence indicates that many doctors do not accept Medicaid patients, which implies that those payments, in many cases, fail to cover doctors’ costs. The extent to which doctors who accept Medicaid payments are able to shift costs to private payers depends in part on whether their competitors have comparable numbers of Medicaid patients.
How much cost shifting actually occurs? Differences in public and private payment rates are sometimes taken as proof that costs are being shifted, but those differences reflect several factors, and it is not obvious whether or to what extent private payment rates would change as a result of changes in uncompensated care or public payment rates. Researchers who have attempted to evaluate whether hospitals shift costs to private payers have generally focused not on payment levels but on changes in the prices paid by private insurers following increases or (more commonly) reductions in Medicare or Medicaid fees.
Those studies have produced varied results, depending on the period studied and the methods used. The evidence that some cost shifting had occurred was relatively strong when researchers examined periods of less vigorous competition in the medical marketplace, such as the early 1980s. For example, a 1988 study that examined how hospitals in Illinois responded to cuts in Medicaid payments found that hospitals raised private prices to offset about half of the revenue from Medicaid that had been lost.42 Other studies from that period suggest that financial pressures led to a limited amount of cost shifting and also encouraged hospitals to adopt cost-containment measures.43 The early 1980s were conducive to cost shifting because private insurers usually paid hospitals on the basis of their charges and engaged in little price negotiation or selective contracting. In such an environment, it may have been relatively easy for hospitals that faced a revenue shortfall on other patients to raise prices for private insurers.
After the mid-1980s, however, competitive pressures on hospitals intensified as private insurers became more aggressive in negotiating payments and establishing networks of preferred hospitals. Accordingly, the evidence of cost shifting generally became weaker.44 For example, a study examining data from hospitals in California for the 1993–2001 period indicated that cost shifting in response to a 10 percent reduction in Medicare and Medicaid’s fees increased the ratio of private payments to costs by 1.7 percent and 0.4 percent, respectively; that response for Medicare was generally lower than the effect that was estimated by applying a similar analytic approach to data from the 1980s.45 In fact, one study suggested that cuts in public payment rates prompted hospitals with high numbers of Medicaid patients to decrease prices to private payers in an effort to attract more private patients.46
Overall, the impact of cost shifting on payment rates and premiums for private insurance seems likely to be relatively small. The available evidence indicates that hospitals shift less than half of the costs of reductions in public payment rates to private insurers—and in all probability, substantially less. Studies have not examined changes in uncompensated care as closely, but it seems reasonable to conclude that those costs are shifted to a comparable degree. Developments since the late 1990s—particularly consolidation of hospitals and pressure on private insurers to broaden their provider networks—appear to have strengthened hospitals’ bargaining position, raising the possibility that more cost shifting will occur than was observed in the 1990s. Although payment-to-cost ratios for private insurers rose sharply between 2001 and 2004, it remains unclear whether hospitals have taken full advantage of their strengthened position or still have the degree of untapped market power that is necessary for cost shifting to occur in markets with limited competition.
Unless specified otherwise, data used in this section on health care employment and facilities come from National Center for Health Statistics, Health, United States, 2007 (Hyattsville, Md., 2007), www.cdc.gov/nchs/hus.htm.
In addition, U.S. schools of osteopathic medicine produced nearly 3,000 doctors of osteopathy in 2005. Those doctors generally enter residency programs in the United States.
See Sean Nicholson and David Song, "The Incentive Effects of the Medicare Indirect Medical Education Policy," Journal of Health Economics, vol. 20, no. 6 (November 2001), pp. 909–933; and Congressional Budget Office, Medicare and Graduate Medical Education (September 1995).
The Council on Graduate Medical Education had forecast excesses of physicians in the 1980s and 1990s, partly on the basis of projections that the spread of managed care plans during that period would reduce demand for all physicians (and for specialists in particular).
That figure does not include about 700,000 licensed practical nurses and licensed vocational nurses, who have less training and responsibility than registered nurses.
See Barbara L. Brush, Julie Sochalski, and Anne M. Berger, "Imported Care: Recruiting Foreign Nurses to U.S. Health Care Facilities," Health Affairs, vol. 23, no. 3 (May/June 2004), pp. 78–87. That study found that the overall share of the nursing workforce that was trained abroad was below 5 percent but was rising because of the recent influx of foreign-trained nurses.
David I. Auerbach, Peter I. Buerhaus, and Douglas O. Staiger, "Better Late Than Never: Workforce Supply Implications of Later Entry Into Nursing," Health Affairs, vol. 26, no. 1 (January/February 2007), pp. 178–185.
For additional discussion of issues regarding nursing shortages, see Charles E. Phelps, Health Economics, 3rd ed. (Boston: Addison Wesley, 2003), pp. 308–311.
Mark McClellan, "Hospital Reimbursement Incentives: An Empirical Analysis," Journal of Economics and Management Strategy, vol. 6, no. 6 (Spring 1997), pp. 91–128.
For a specific proposal, see Elliott S. Fisher and others, "Creating Accountable Care Organizations: The Extended Hospital Medical Staff," Health Affairs, Web Exclusive (December 5, 2006), pp. W44–W57. For a more general discussion, see Joseph P. Newhouse, Pricing the Priceless: A Health Care Conundrum (Cambridge, Mass.: MIT Press, September 2002).
See Joseph P. Newhouse and the Insurance Experiment Group, Free for All? Lessons from the RAND Health Insurance Experiment (Cambridge, Mass.: Harvard University Press, 1993). The RAND analysts did not have data on actual spending per enrollee in the HMO, which can be difficult to calculate for staff-model plans because a separate payment is not made for each service provided. Instead, analysts had data on the use of services by HMO enrollees and imputed their spending. Thus, the difference in spending between the HMO and other plans did not generally reflect differences in the prices paid for or average costs of specific services.
The discussion in this section primarily describes issues regarding fee-for-service or episode-based payment rates, but many of the same considerations would apply in setting capitation rates or salary levels.
The payment amounts are adjusted to reflect geographic variation in hospitals’ input prices and to account for the presence of other health problems (known as comorbidities) or complicationsthat arise during treatment; additional payments are made for extraordinarily costly "outlier" cases. A variety of other adjustments are also made; for example, payments are modified for rural hospitals and for teaching hospitals.
For additional information, see Congressional Budget Office, The Sustainable Growth Rate Formula for Setting Medicare’s Physician Payment Rates, Issue Brief (September 6, 2006).
For example, see Joseph P. Newhouse, Pricing the Priceless; or Newhouse, "An Iconoclastic View of Health Cost Containment," Health Affairs, vol. 12 (Supplement 1993), pp. 153–171.
See Medicare Payment Advisory Commission, Report to the Congress: Medicare Payment Policy (March 2008). The commission also recommended adopting a payment incentive program for hospitals to encourage higher quality of care and a process for measuring and reporting physicians’ use of resources on a confidential basis.
See Kevin J. Hayes, Julian Pettengill, and Jeffrey Stensland, "Getting the Price Right: Medicare Payment Rates for Cardiovascular Services," Health Affairs, vol. 26, no. 1 (January/February 2007), pp. 124–136; and Paul B. Ginsburg and Joy M. Grossman, "When the Price Isn’t Right: How Inadvertent Payment Incentives Drive Medical Care," Health Affairs, Web Exclusive (August 9, 2005), pp. W5-376 to W5-384.
See Medicare Payment Advisory Commission, Report to the Congress, p. 89.
See Stephen Zuckerman and others, "Changes in Medicaid Physician Fees, 1998–2003: Implications for Physician Participation," Health Affairs, Web Exclusive (June 23, 2004), pp. W4-374 to W4-384.
See Appendix 4 of American Hospital Association, Trendwatch Chartbook 2008: Trends Affecting Hospitals and Health Systems (prepared by Avalere Health for the American Hospital Association, Spring 2008), p. A-35, www.aha.org.
Dyckman & Associates, Survey of Health Plans Concerning Physician Fees and Payment Methodology (report prepared for the Medicare Payment Advisory Commission, August 2003).
Congressional Budget Office, The Impact of Medicare’s Payment Rates on the Volume of Services Provided by Skilled Nursing Facilities, Background Paper (July 2007).
For a discussion of the economic principles involved, see Thomas G. McGuire and Mark V. Pauly, "Physician Response to Fee Changes with Multiple Payers," Journal of Health Economics, vol. 10, no. 4 (1991), pp. 385–410.
See, for example, Jack Hadley and James D. Reschovsky, "Medicare Fees and Physicians’ Medicare Service Volume: Beneficiaries Treated and Services per Beneficiary," International Journal of Health Care Finance Economics, vol. 6, no. 2 (June 2006), pp. 131–150.
See, for example, Nguyen Xuan Nguyen and Frederick William Derrick, "Physician Behavioral Response to a Medicare Price Reduction," Health Services Research, vol. 32, no. 3 (August 1997), pp. 283–298.
Congressional Budget Office, Factors Underlying the Growth in Medicare’s Spending for Physicians’ Services, Background Paper (June 2007). "Intensity" refers to the complexity of services used in delivering patient care. For example, use of a computerized axial tomography (CAT) scan rather than an X-ray would represent an increase in intensity—and would result in a higher payment from Medicare to reflect the greater cost of providing the more complex service.
According to press reports, the recent expansion of insurance coverage in Massachusetts has caused demand for visits to primary care physicians to exceed supply, making it difficult to obtain appointments. For a discussion of the key features of that expansion, see Chapter 2.
Congressional Budget Office, Factors Underlying the Growth in Medicare’s Spending for Physicians’ Services.
Amy Finkelstein, "The Aggregate Effects of Health Insurance: Evidence from the Introduction of Medicare," Quarterly Journal of Economics, vol. 122, no. 1 (February 2007), pp. 1–37.
See Philip E. Enterline and others, "Effects of ‘Free’ Medical Care on Medical Practice—The Quebec Experience," New England Journal of Medicine, vol. 288, no. 2 (May 31, 1973), pp. 1152–1155; Philip E. Enterline and others, "The Distribution of Medical Services Before and After ‘Free’ Medical Care—The Quebec Experience," New England Journal of Medicine, vol. 289, no. 22 (November 29, 1973), pp. 1174–1178; and the discussion of the results of those studies in Thomas C. Buchmueller and others, "The Effect of Health Insurance on Medical Care Utilization and Implications for Insurance Expansion: A Review of the Literature," Medical Care Research and Review, vol. 62, no. 1 (February 2005), pp. 3–30.
Shou-Hsia Cheng and Tung-Liang Chiang, "The Effect of Universal Health Insurance on Health Care Utilization in Taiwan: Results from a Natural Experiment," Journal of the American Medical Association, vol. 278, no. 2 (July 9, 1997), pp. 89–93.
Jui-Fen Rachel Lu and William C. Hsiao, "Does Universal Health Insurance Make Health Care Unaffordable? Lessons from Taiwan," Health Affairs, vol. 22, no. 3 (May/June 2003), pp. 77–88. That study also found that subsequent efforts by the government to institute a global budget for health care services helped control the growth of spending in that country. For a discussion of such global budgets, see Chapter 8 of this report.
To the extent that a hospital with market power charges prices that exceed its costs, the question of why competing hospitals have not entered those markets arises. The apparent persistence of limited competition among hospitals in many areas, however, indicates that some barriers to entering the market exist, at least in some areas of the country.
See Paul B. Ginsburg, "Can Hospitals and Physicians Shift the Effects of Cuts in Medicare Reimbursement to Private Payers?" Health Affairs, Web Exclusive (October 8, 2003), pp. W3-472 to W3-479.
See Congressional Budget Office, Nonprofit Hospitals and the Provision of Community Benefits (December 2006).
In the strict sense of the term, such markets might not be considered fully competitive because hospitals would have to feel compelled to continue serving patients for which they were undercompensated. Without that constraint, some hospitals would probably stop accepting those patients; those hospitals could then lower their fees to private payers and take private business away from competing hospitals (to the extent that they had sufficient capacity). Hospitals that continued to be undercompensated would suffer financial losses and would either have to receive outside assistance or eventually exit the market.
By definition, no payments are received from insurers, but some care provided to uninsured individuals is paid for by other third-party sources, such as workers’ compensation programs (for on-the-job injuries) or veterans’ benefits.
Jack Hadley and others, "Covering the Uninsured in 2008: Current Costs, Sources of Payment, and Incremental Costs," Health Affairs, Web Exclusive (August 25, 2008), pp. W399–W415. As discussed in Chapter 1, that study estimated that people who are uninsured for all of 2008 receive about $540 in uncompensated care, on average, and that people who are uninsured for part of that year receive about $150 in uncompensated care.
Conversely, a reduction in uncompensated care could provide a policy rationale to reduce those payments from Medicare and Medicaid.
Jonathan Gruber and David Rodriguez, How Much Uncompensated Care Do Doctors Provide? Working Paper No. 13585 (Cambridge, Mass.: National Bureau of Economic Research, November 2007).
American Hospital Association, Trendwatch Chartbook 2008.
See David Dranove, "Pricing by Non-Profit Institutions: The Case of Hospital Cost-Shifting," Journal of Health Economics, vol. 7, no. 1 (1988), pp. 47–57.
Stephen Zuckerman, "Commercial Insurers and All-Payer Regulation: Evidence on Hospitals’ Responses to Financial Need," Journal of Health Economics, vol. 6, no. 3 (September 1987), pp. 165–187, and Jack Hadley and Judith Feder, "Hospital Cost Shifting and Care for the Uninsured," Health Affairs, vol. 4, no. 3 (Fall 1985), pp. 67–80.
Michael A. Morrisey, Cost Shifting in Health Care: Separating Evidence from Rhetoric (Washington, D.C.: AEI Press, 1994); and Jack Hadley, Stephen Zuckerman, and Lisa I. Iezzoni, "Financial Pressure and Competition: Changes in Hospital Efficiency and Cost-Shifting Behavior," Medical Care, vol. 34, no. 3 (1996), pp. 205–219.
See Jack Zwanziger, Glenn A. Melnick, and Anil Bamezai, "Can Cost Shifting Continue in a Price Competitive Environment?" Health Economics, vol. 9, no. 3 (April 2000), pp. 211–226; and Jack Zwanziger and Anil Bamezai, "Evidence of Cost Shifting in California Hospitals," Health Affairs, vol. 25, no. 1 (January/February 2006), pp. 197–203. Although Zwanziger and colleagues concluded that the strength of cost shifting had not diminished by 1991, the 2006 paper generally finds less cost shifting in the more recent period. The estimated effect of a cut in Medicaid’s fees was low in both periods.
See David Dranove and William D. White, "Medicaid-Dependent Hospitals and Their Patients: How Have They Fared?" Health Services Research, vol. 33, no. 2, pt. 1 (June 1998), pp. 163–185.
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