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Hospital 'profits': the effects of reimbursement policies
Insights
Cost-based reimbursement (CBR) incentivizes hospitals to inflate charges to maximize revenue, particularly under the Medicare formula. This study analyzes the impact of CBR on hospital costs and charges, finding evidence of this inflationary effect.
Area of Science:
- Health Economics
- Healthcare Management
- Hospital Administration
Background:
- Previous analyses of cost-based reimbursement (CBR) assumed it paid economic costs plus a small markup, thus not significantly distorting hospital decision-making.
- This paper challenges that assumption, proposing that cost-based reimbursement transforms accounting costs into prices for cost-paying patients, optimizing them for revenue maximization.
Purpose of the Study:
- To theoretically and empirically analyze the impact of cost-based reimbursement (CBR) on hospital costs and charges.
- To investigate how CBR, particularly the Medicare reimbursement formula, creates incentives for hospitals to increase charges beyond single-price, profit-maximizing levels.
Main Methods:
- Theoretical analysis of hospital pricing strategies under dual patient populations (cost-paying and charge-paying).
- Empirical analysis of hospital laboratory costs and charges to test theoretical predictions.
- Comparison of cost and charge levels across different hospital ownership types (for-profit, non-profit, government).
Main Results:
- Hospitals with cost-based reimbursement can set dual price schedules, optimizing accounting costs to maximize revenue rather than reflecting economic profit.
- The Medicare reimbursement formula incentivizes hospitals to raise charges above monopoly levels, demonstrating an inflationary effect.
- Empirical data, especially from hospital laboratories, generally supports the theoretical predictions regarding cost and charge inflation.
Conclusions:
- Cost-based reimbursement creates incentives for hospitals to inflate accounting costs and charges, particularly under formulas like Medicare's.
- Accounting data from hospitals under CBR should be interpreted cautiously, as it reflects pricing incentives rather than true economic efficiency or profitability.
- Evidence suggests minimal cross-subsidy between cost-paying and charge-paying patients, contrary to some assumptions.
Abstract:
This paper provides a theoretical and empirical analysis of the effect of cost-based reimbursement (CBR) on hospital costs and charges. It takes issue with previous analyses which have treated CBR as paying economic costs plus a mark-up, and have concluded that the mark-up is too small to significantly distort hospital decision-making. The basic thesis here is that if reimbursement is based on costs, accounting costs become a price to cost-paying patients, and will be optimized to maximize revenue. A hospital serving both cost and charge-paying (private) patients can set two price schedules. Accounting profits (ratio of charges to costs) are not a measure of economic profit but of relative prices to these two groups of patients. In the absence of constraints from regulation or patient co-payment, the optimum level of accounting costs would be infinite. In practice, the Medicare reimbursement formula links allowable costs to charges received from charge-paying patients. This formula creates incentives for the hospital to raise charges above the single-price, profit-maximizing monopoly level. This inflationary effect of the Medicare formula does not presuppose that Medicare pays less than full cost. The empirical analysis of hospital laboratory costs and charges generally supports the predictions; for other departments, the conclusions are consistent but more tentative because of data limitations. Overall, evidence suggests minimal cross-subsidy between cost and charge-paying patients. Comparisons of cost and charge levels in for-profit, voluntary non-profit and government hospitals are presented, but it is emphasized that inferences about relative efficiency and profitability cannot be drawn from accounting data, given the incentives created by CBR.