Case-mix specialization in the market for hospital services

Historically, cost-based reimbursement encouraged hospitals to compete on the basis of quality, leading to duplication of services and other inefficient behavior. More recently, prospective payment, selective contracting, and other innovations in reimbursement have strengthened incentives for more efficient hospital operations. In principle, hospitals may be able to reduce their costs by limiting the array of services they provide, but there has been little empirical evidence that U.S. hospitals are moving toward greater specialization or that specialization leads to cost savings. This article explores recent changes in case-mix specialization and the relationship of these changes to hospital costs. It first describes an index of specialization derived from Information Theory and shows that this index provides intuitively reasonable results in characterizing patterns of specialization across hospitals. The analysis then demonstrates that specialization, as measured by this index, in fact increased from 1980 through 1985; that specialization can indeed lower hospital costs; and that increases in specialization have been largest in those hospitals with the greatest incentives to reduce costs.