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Hospital Competition and Reimbursement. Econ 737.01 3/1/11. Outline. I. Competition under a cost-based reimbursement system II. Competition under a prospective payment system III. Competition under managed care. I. Competition under a cost-based reimbursement system.

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outline
Outline
  • I. Competition under a cost-based reimbursement system
  • II. Competition under a prospective payment system
  • III. Competition under managed care
i competition under a cost based reimbursement system
I. Competition under a cost-based reimbursement system
  • Hospital reimbursement was cost-based through the early 1980s => little incentive to keep costs down
  • Physicians and patients made the decisions about which hospital to choose, yet insurance paid most of the bill => price competition ineffective
  • How would you therefore expect hospitals to compete with each other?
i competition under a cost based reimbursement system1
I. Competition under a cost-based reimbursement system
  • During this period, hospitals tended to compete by continually trying to “one-up” each other in terms of quality
  • Ways to do this included investing in the latest technology (regardless of its cost-effectiveness), hiring more staff, and improving amenities
  • This phenomenon is known as the “medical arms race” (MAR)
i competition under a cost based reimbursement system2
I. Competition under a cost-based reimbursement system
  • Example: Two hospitals are deciding whether to purchase the latest MRI machine, which costs $2.5 M. If neither or both purchase it, they keep their existing market shares. If only one purchases it, it will steal $5 M of business from the one that does not.
i competition under a cost based reimbursement system3
I. Competition under a cost-based reimbursement system
  • Nash equilibrium: both hospitals will purchase the machine and each lose $2.5 M
  • Cooperative outcome: neither purchase it
  • The hospitals are therefore trapped in a prisoner’s dilemma that will lead to excessive investment.
  • This simple example ignores other factors such as patient utility and potentially higher reimbursement rates.
  • However, it is sufficient to illustrate the idea that competition could actually increase hospital costs
i competition under a cost based reimbursement system4
I. Competition under a cost-based reimbursement system
  • Empirical evidence on the MAR
    • Robinson and Luft (1985): More competing hospitals within 15 miles => higher costs per admission
    • Robinson et al. (1988, 1987, and 1986): More competing hospitals => higher employee/patient ratio and more of a variety of specialty services
    • Zwanziger and Melnick (1988): Competition increased hospital costs in CA in 1983 but not 1985; they attributed this to increased managed care
    • Conner et al. (1997): Found evidence of non-price competition in 1986 that shifted to price competition by 1994
    • Dranove et al. (1992): More thorough set of control variables; competition only increased supply of 2 of 13 specialty services in CA in 1983
ii competition under a prospective payment system
II. Competition under a prospective payment system
  • Medicare Prospective Payment System (PPS) (1983)
    • Switched from cost-based to diagnostic related group-based reimbursement.
    • Theoretical effect on incentives
      • Incentive to undertreat?
      • Shleifer(1985): incentive to select most efficient production tecnhology
      • Dranove (1987): incentive to dump sickest patients within a DRG onto local public hospital
      • Allen and Gertler (1991): model showing that hospitals would undertreat relatively ill patients and overtreat relatively healthy patients within a DRG; mixed reimbursement scheme based partially on DRG and partially on cost is needed
      • Other papers support finding that mixed scheme needed to optimally balance cost and quality
ii competition under a prospective payment system1
II. Competition under a prospective payment system
  • Empirical evidence
    • Ellis and McGuire (1996): New Hampshire Medicaid switching from cost-based reimbursement to PPS in 1989 reduced length of inpatient stays for psychiatric patients
    • Newhouse (1989): hospitals more likely to admit patients in profitable Medicare DRGs, but do not transfer unprofitable patients to other hospitals after admission
    • Cutler (1995): Changes in reimbursement levels after implementation of Medicare DRG system negatively correlated with inpatient mortality
ii competition under a prospective payment system2
II. Competition under a prospective payment system
  • Utilization review (UR)
    • When a health insurance company reviews a request for treatment (either proactively or retroactively) to determine if it is appropriate
    • Along with the PPS, Medicare implemented UR through Peer Review Organizations (PROs).
    • Many private insurers also began implementing UR in the 1980s, almost all did by late 1990s.
ii competition under a prospective payment system3
II. Competition under a prospective payment system
  • UR
    • Positives
      • Addresses moral hazard problem created by third party payers (like a supervisor)
      • Addresses asymmetric information issue between doctors and patients
      • Helps spread information from medical outcomes research to physicians
      • Empirical evidence suggests it does reduce inpatient utilization
    • Negatives
      • Extra layer of bureaucracy
      • Are the services being eliminated actually the wasteful ones?
ii competition under a prospective payment system4
II. Competition under a prospective payment system
  • Cost-shifting
    • When hospitals respond to reduction in prices from one payer (i.e. Medicare or Medicaid) by raising prices for another payer (i.e. private insurance)
    • Would not make sense for a for-profit hospital but might in a non-profit (Dranove, 1988)
    • In order to cost-shift, hospitals would need to have the power to change prices for privately-insured patients (which is hard with managed care)
    • The most credible empirical evidence suggests that hospitals used to cost-shift but don’t anymore, probably because of the rise of managed care
iii competition under managed care
III. Competition under managed care
  • Managed care is essentially the result of private insurers trying to exercise control over prices and utilization the same way public insurers did
  • Payers created organizations that contracted with providers to obtain discounted prices
  • Patients given strong financial incentives to use these “in-network” providers
  • Payer essentially acts as the “shopper” on behalf of the patient
  • Providers are willing to offer these discounted prices because of the large volume of patients the managed care organization brings
iii competition under managed care1
III. Competition under managed care
  • Theoretically, we would expect managed care to increase the price elasticity of demand and therefore bring competition back to the price dimension instead of just the quality dimension
  • Empirical test: what is the effect of market concentration on price?
    • Lower concentration (more competition) increasing price: consistent with quality competition (MAR)
    • Lower concentration (more competition) decreasing price: consistent with price competition
  • The most credible empirical evidence (Dranove et al., 1993) suggests that lower concentration switched from increasing price in the early 1980s to decreasing price in the late 1980s, consistent with a switch from quality to price competition caused by the penetration of managed care
  • This has obvious antitrust implications.