Better Health: Smart Health Commentary

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The above graph would seem to disprove Ezra’s original thesis, that hospitals continue to participate in Medicare because it is profitable for them to continue to do so.  As you can see, there’s rampant cost shifting, as Medicare pays only 92% of the actual costs of inpatient care whereas the commercial payers are in the high 120s%.  Right?

Well, yes and no.  The lifeline in this case is some very interesting testimony by the head of MedPac regarding a small subset of hospitals (about 12% of all hospitals) who were actually able to eke out a positive margin (0.5%) on Medicare payments in 2004-2006.  The contention is that since these hospitals were able to do so, and with higher quality than the other 88% of hospitals, that the hospital industry in general is inefficient and if they were only able to get their act together Medicare payments would be sufficient to support a viable hospital industry.

The key factor which Ezra glides over is that these hospitals are in the “financially pressured” category.  There doesn’t seem to be a definition or cross-tabs on what exactly “financially pressured” means, but these hospitals actually have a worse operating margin on their non-medicare business (-2.4%).  Given that, it’s fairly safe to conclude that this means hospitals with crummy payer mixes — high medicaid and uninsured, low numbers of commercially insured patients.  This occurs most commonly in rural and inner-city markets — underserved areas in which there is usually one hospital at best.  These undesirable markets do not encourage other providers to enter and compete for customers and so the hospitals there tend to undercapitalize, willfully or no, and offer bare-bones services.  That some fraction of “financially pressured” over-perform on outcomes is not explained in the testimony.   It could be a statistical aberration, or cherry-picked data; giving credit to the integrity of MedPac, it might be due to the exceptional leadership that some of these financially stressed hospitals have developed.  The testimony does not reveal what fraction of “financially pressured” hospitals outperform on quality measures — if less than 50% of “financially pressured” hospitals outperform on quality, it would imply that the under-funding of these facilities harms quality of care more than it helps.  Note that those that outperform have substantially worse margins (0.5% vs 4.2) on Medicare payments, implying that there is some linkage between higher expenditures and better outcomes.

I am gallant, however, and I will concede the key point here: hospitals which are well-funded do tend to be inefficient.  Specifically, areas with enviable payer mixes are generally served by multiple hospitals and those hospitals compete for patients and revenue by over-capitalizing and improving amenities and customer service.  This is just another example of the perversion of the market in which patients do not directly bear the costs of their health care decisions.

Coming back to the original point: if Medicare were such a lousy payer, hospitals would opt out, yet this never occurs.  Interestingly, the well-heeled suburban hospitals who lose the most money on Medicare patients are the least likely to opt out of Medicare.  They have such high margins on their commercial patients that they can view Medicare as their charity contribution to the community.  On the other hand, the financially pressured hospitals do better on Medicare than the rest of their payers, so Medicare is their economic lifeline.  Or, more formally, the value of Medicare patients to a hospital varies inversely with the number of commercial patients in their payer mix.

Ezra’s conclusion here is that we need to cut costs, hospitals are in many cases inefficient, and so we should just reduce payments to them until they feel the pain and dial it way back.  As my old medical director used to say, “We’re building a Buick, not a Cadillac.” But there are many problems with such a strategy.  For one, the hospitals most dependent on Medicare would be harmed most by reductions in payments.  While workarounds could be crafted for financially stressed hospitals, it’s unclear what effect reductions in payments would have in quality, but it would be hard to imagine that quality in general would improve.  And it’s not clear to me that this really addresses the key drivers of cost: wasteful and redundant care, as opposed to more-expensive-than-it-needs-to-be inefficient care.  Given the volume incentive of the fee-for-service game, reductions in compensation usually just drive increases in utilization, not the other way around.

Ultimately on this point, I have to concede ignorance.  I know that the Medicare Professional Fee Schedule for phyicians is woefully inadequate and needs to be increased.  I do not know if the same applies to the hospital fee schedule — I’m just not well-enough versed in the economics of that game.  I should point out that while medicare payments to physicians have been essentially frozen since 2001, the facility fees, unconstrained by the SGR, have risen year over year to keep pace with inflation.  I never did see any disagreement with my original points, by the way, that for professional services, the underfunding of Medicare is leading to decreased access as physicians close their practices to new Medicare patients, and that hospital-based physicians are unable to opt out due to the nature of their relationships with the hospitals who employ them.