13 October 2009

Health Care and Cost-shifting

Ezra has blogged skeptically about this more than once, and he's not the only one.  To explain, health care providers have been arguing for years that Medicare is underfunded -- that the reimbursements from Medicare do not cover the cost of providing the services.  Medicaid reimbursement is even worse.  Providers claim that this has forced us to charge privately insured patients more to offset the low reimbursement from the public programs.  Understand that "providers" include both physicians as well as hospitals.

There's some logic to the skepticism: Keith Hennessy summarized it nicely:
If you believe that a hospital will raise the prices it charges privately insured patients in reaction to cuts in reimbursement rates from government programs, you must believe (1) the hospital has pricing power and (2) it has until now charged less than it could. (1) is quite plausible in some circumstances. I find (2) incredible. If someone has pricing power, I generally believe they will exert it. Are we to believe that providers of medical care were charging privately insured patients less than they could have before the cuts in government payment rates?
From a theoretical economic point of view, this is accurate.  If health care providers were perfectly rational actors operating in a vacuum where their only goal was to maximize revenue, it would make sense.  You take what you can get.

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

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

It's true that the "rational" thing to do would be to maximize the revenue from the private insurers every single year.  But in the real world it turns out that it's not so easy.  Providers have limited leverage, and it is a bilateral negotiation with a very powerful opponent.  You can't fight a scorched-earth battle every year, and with every insurer.  The only real threat we have is to drop out of an insurer's network -- which is the "nuclear option" in the health care contracting world.  You make that threat every year, and soon enough the insurers stop believing it.  You follow through on the threat, and it is a massive war, with media attention and angry patients and the risk of losing money if patients leave and don't come back.  Worse, you could go to war and lose -- you bear the cost of the war in PR and lost revenue and wind up with lower reimbursement anyway.  There are real risks and costs of taking the hardest possible line in negotiating reimbursement rates with the private insurers. The analogy I use is that most insurers and providers live in a state of perpetual détente.  We edge to the brink and back, over and over again.

(I should also point out that when we are at the negotiation table, there are human beings on the other side of it.  They may be "the enemy" and they may be motivated to minimize their costs, but they are also emotional and irrational at times.  As an ER doc, I am shameless about playing the "uninsured and Medicaid" card in negotiating.  This does evoke a sympathetic reaction.  It's not huge -- we don't all break out into tears and hug one another.  They know the realities of the situation, and they hate it, but it has an effect on the interpersonal dynamics.  Economists can argue the whether there is a causal relationship of cost-shifting, but there is a clear tactical relationship between the under-insured and increased private insurance compensation.)

So when do we go to the mat?  When do we pull the trigger?  When the budget crisis hits.  That can be caused by a drop in government funding, or the inciting factor could be anything else -- a change in the number of the uninsured, wage escalation, etc.   And I agree with the assertion that the pass-though is not 100%.   If nothing else, the insurers are not willing to give you 100% of your goal in every negotiation.  But the idea that there is no causal relationship is absurd.

So, yes, I would say to Dr Hennessy, there are times that health care providers do leave their leverage un-utilized.  I think of it as "keeping the powder dry," or "picking your battles carefully." 

There is, as the skeptics would note, an alternative to cost-shifting.  It's to accept the loss of revenue.  It's to cut back on services (or amenities), to cut back on staffing, to accept lower physician reimbursement.  That happens, too.  In fact, that is one of the big reasons for the problems in primary care -- physician income has been flat-to-negative and doctors don't want to do it anymore.   For many reformers, this is not a bug but a feature of the public option -- that it places pressure on hospitals and physicians to make less money, on the theory that we'll find ways to deliver the same care for cheaper.   I'm apprehensive about this, because it's such a blunt instrument.   This is why I'm not a single payer fan.  The strategy of just turning the screws on healthcare providers and leaving it to them to figure out how to eliminate excess costs seems simplistic and unlikely to succeed. 


  1. The strategy of just turning the screws on healthcare providers and leaving it to them to figure out how to eliminate excess costs seems simplistic and unlikely to succeed.

    Just wondering - did you feel the same way about the CAFE standards for autos?

  2. In countries with universal healthcare, the government sets all rates for all services. In exchange for the working conditions in France, Germany, Japan -- no medical school debt, piddling malprractice rates and close to zero administrative costs -- would U.S. doctors be willing to accept reduced compensation?

  3. Evinx:

    Great point, but there is a point of diminishing returns, and I would argue that healthcare is at that point. You can dial CAFE standards up to the point where they exceed what is possible (or what the market will support) and eventually something's going to give. Healthcare is an industry where the average profit margin for a hospital in a good year is 4% and more typically is somewhere between 2% and -2%. It's not like hospitals aren't already under significant financial pressure. Which is why I am dubious that another turn of the proverbial screw will accomplish much.

  4. ASP --

    Interesting hypothetical. My gut feeling is that the answer is "no," meaning that US docs would not willingly accept reduced compensation.

    On the other hand, we may be in the worse position of being obligated to accept reduced compensation without any of the lovely offsets you describe. Pity.

  5. ASP:
    Your hypothetical would only lead to under-the-table payments. Japan, for example, is known for drs getting special favors from patients/families to accelerate surgery dates or tests. This is the inevitable result when you have price controls.

    NYC has price controls on many residential rents. Try getting an apt w/o a bribe. Impossible.

    The lesson to be learned is not to control markets (people); rather to create conditions for greater competition.

    I appreciate healthcare is at a breaking point - but we need principles. You have intimate knowledge about healthcare but in all liklihood, limited knowledge about autos (choose your industry). We need to have a set of principles to determine when and how we should regulate -- and it definitely should not be based on politics - which is where we are now for healthcare, autos, and so much more.

    When drs and hospitals allowed the govt to determine their fees, etc (thru medicare/medicaid) they made a deal with the devil - ie, a political process. Now it is coming back to bite big time.

  6. I was reviewing the outlines of the pending health care bill today, and found myself wondering aloud whether the bill's proponents in congress were stupid or brilliant.

    Anyone who believes that piling on community rating and guaranteed issue while putting caps on out of pocket expenses, leaving barriers to a national insurance market in place, imposing additional taxes and fees on the industry *cough* consumers* cough, tossing in more government subsidies, and maximizing adverse selection with a $750 fine that's assessed after EIGHT years without coverage is smoking a thousand pound brick of crack through a 5,000 psi air compressor. Insane.

    On the flip side, anyone who wants to set-off a cost spiral that's virtually guaranteed to end a centrally administered price fixing scheme would have a hard time constructing a more foolproof mechanism than this bill.

    The only redeeming feature of this plan that I can see will be watching all of the economically illiterate but well intentioned physicians who let their empathetic sides trump their analytical capabilities wail, moan, and suffer under a regime where they are forced between the pincers of clinical judgment and unconstrained liability on one side, compliance with "voluntary" algorithmic cost containment rules laid down by the government on the other, all while laboring under increasingly onerous schemes to limit their compensation.

    The cost shifting is coming, and once the consumer is well and truly tapped out, it's going to land heavily on your shoulders, docs. Enjoy the BOHICA.



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