• Behind the Curtain: Industry Cost Shift Calculation Revealed

    Recently I wrote about the September 2009 Health Affairs paper by Dobson et al. “How A New ‘Public Plan’ Could Affect Hospitals’ Finances And Private Insurance Premiums.” In that paper the authors assumed that hospitals would shift 50% of reductions in payment from public payers to private ones. Their conclusion that private premiums would skyrocket follows necessarily from this assumption. It turns out the 50% assumption rests on 14 year-old analysis of 18 year-old data. In this post I follow the paper trail back to the source document.

    As support for the 50% cost shifting assumption, Dobson et al. cite the March 2009 Lewin report by Sheils titled The Health Benefits Simulation Model (HBSM): Methodology and Assumptions. End note 7 of Dobson et al. reads, “Sheils estimates the cost shift at 40 percent, which is roughly consistent with our assumption.” By “roughly” the authors mean that 50% is roughly 40% (a mere 25% difference).

    In the HBSM report Sheils justifies the 40% cost shift assumption as follows, “Our own analysis of hospital data indicates that about 40 percent of the increase in hospital payment shortfalls (i.e., revenues minus costs) in public programs were passed-on to private-payers in the form of the cost shift during the years studied.” A footnote indicates that their “own analysis” is that provided in a December 1995 report and “years studied” means 1991-1992. The 1995 report referenced is one by Sheils and Claxton titled “Potential Cost Shifting Under Proposed Funding Reductions for Medicare and Medicaid: The Budget Reconciliation Act of 1995.”

    If the 1995 Sheils and Claxton paper is online I couldn’t find it. But I am a curious fellow with urgent questions. What analysis in 1995 revealed a 40% cost shift? Why is the document so hard to find, yet so frequently cited (18 hits in a Google search of the title, many to documents written or testimony given within the past few years)? Could I get my hands on this old study? And what would I find when I pulled back the curtain?

    While neither of the authors could provide the report (Claxton, now Vice President of The Henry J. Kaiser Family Foundation returned my e-mails, Sheils did not), I obtained a PDF on request by calling The Lewin Group directly (703-269-5500). Sure enough, it included a calculation that had a 40% bottom line. Better yet, it included enough aggregate hospital cost and revenue data (from the American Hospital Association’s survey of hospitals) to replicate the calculation. (See the “wonk note” below for a summary of the calculation.)

    There is a key assumption embedded in the calculation, that costs are beyond control of hospital managers. Working through the calculation, every additional dollar of cost produces an additional dollar of public to private cost shift. Is it credible that costs drive private revenue and not the other way around (at least in part)?

    Another interesting fact revealed by the data is that that profits increased as the purported cost shifting was taking place. In fact, profit increases represent two-thirds of the increase in payments from private payers. One way to look at it is that when the hospitals were done being forced into increasing charges to private payers due to public shortfalls they were then forced to increase them a lot more to support growing profit.

    If cost shifting exists the approach in the 1995 Lewin report does not make a strong case for it. An assumption of inviolable costs is not reasonable.  Profits increased at the expense of private payers and despite lower public payments, suggesting insufficient pressure to reduce costs. One thing is clear. The document tells us a little bit about how to use early 1990s hospital cost report figures to make it appear as if a 40% cost shift is an inevitable, causal phenomenon. But that’s a poor foundation for the analyses of health reform conducted in 2009 that build upon the 1995 results. Like the Wizard of Oz, what was behind the curtain was rather old and less powerful than suggested.

    Wonk note: The methodology of the 1995 Lewin report that derives a 40% cost shift is as follows. The difference between the 1992 and 1991 non-private (I’ll call it “public”) payer shortfall (revenue less costs) is computed (call this value A).

    Next, the 1992 private payer revenue less its expected value is calculated (call this value B). The expected value of the 1992 private payer revenue is the product of the 1991 revenue-to-cost ratio and the 1992 cost.

    From B a change from expected 1992 profit is subtracted (call the difference C). Expected 1992 profit is the product of the 1991 profit-to-revenue ratio times the 1992 revenue. The cost shift is the ratio C/A which works out to 40% using the actual figures in the report.

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    • Austin, good detective work. I have seen many such “assumptions” in my career and they have amazing persistence. There is a wider and deeper behavioral economics story in how we look at Causality in this. My cynical side does not expect your exposure to have much effect, but at least now when anyone Googles the issue they will find your explanation. So for those who seek the truth they shall find it.

      • @Jim – Thanks. I’m driven by curiosity and, in large part, this blog is a notebook for my thoughts. To the extent there is any wider benefit that’s great, but it isn’t expected. You’re right that there is a hidden causality trap in this. My view is that it stems from 100% supply-side thinking, that costs drive revenue. Well, there is a demand side isn’t there? One can’t view this issue from one side only and expect to get a correct result.

    • Yes, and very timely, I needed an example for class today (I’ll credit you) and if the class sees this note, yes, here is where I got it, and it is perfect for taking them through this discussion and the Dobson et al. paper.