Price discrimination and hospital market competition

James Robinson has published two papers recently on hospital prices and market competition. They use similar data, though examine slightly different questions. Last week I posted on his paper that appeared in the American Journal of Managed Care. It examined how private insurance payments to hospitals vary by degree of hospital market competition.

In this post, I consider his other, related paper that appeared in Health Affairs. It examines Medicare and private insurer hospital payments and contribution margins,* stratified by hospital market competition. The key issue Robinson seeks to illuminate is that hospitals can respond to shortfalls in Medicare payments in two ways: cost cutting and cost shifting. Data are from

30,514 patients admitted to any of sixty-one hospitals for total knee replacement, total hip replacement, lumbar spine fusion, cervical spine fusion, coronary angioplasty with drug-eluting stent, insertion of cardiac pacemaker, or insertion of implantable cardioverter defibrillator. […] They are distributed across twenty-seven local hospital markets in eight states.

Some findings and key points:

  • Private plans pay more relative to cost than Medicare. “All procedures yielded positive contribution margins for Medicare patients, but the margins on privately insured patients were higher by a factor of ten or more. [… A]verage costs were 5.4 percent higher for Medicare than for privately insured patients. Average payments were 68 percent higher, and contribution margins, 831 percent higher, for privately insured than for Medicare patients.”
  • Hospital margins from private insurance payments are higher in concentrated markets. “The market-related difference in contribution margin was 82 percent for knee replacement, 137 percent for hip replacement, 64 percent for lumbar fusion, 119 percent for cervical fusion, 106 percent for angioplasty, 77 percent for pacemaker insertion, and 48 percent for defibrillator insertion.”
  • In contrast, hospital margins from Medicare payments are higher in competitive markets. “Medicare margins were negative and were lower in concentrated than in competitive markets by $1,890 (knee replacement) and $1,326 (hip replacement). For the cardiac device insertion procedures, Medicare margins were positive but were still lower in concentrated than in competitive markets by $2,222 (pacemaker) and $4,670 (defibrillator). Medicare margins did not vary significantly between concentrated and competitive markets for lumbar and cervical fusion procedures and for coronary angioplasty with stent.”

Let me emphasize the important point  here: hospital market concentration has the opposite association** with margins generated by private insurance payment as it does with margins generated by Medicare payment. More concentrated markets are associated with higher private margins and lower Medicare margins. What does this mean?

Robinson says it reveals two hospital strategies in the presence of Medicare shortfalls: cost shifting and cost cutting. Hospitals earn higher margins from privately insured patients relative to their Medicare patients. To Robinson, that’s “cost shifting.” However, he points out that he is not using that term in the sense that private payments rise causally (in response to) shortfalls in public payments. Rather, he’s focusing on price discrimination, a static phenomenon. It’s the difference between association and causation. Price discrimination is evidence of the former, not the latter. That is, we cannot use his results to predict how hospitals will respond to future changes in Medicare payment policy.

Robinson’s results also show that Medicare margins are higher in competitive markets. This is consistent with a hypothesis promoted by MedPAC: in competition, hospitals have less market power relative to insurers. Therefore, in bargaining with those insurers, they negotiate lower payment. To stay afloat, they must commensurately reduce costs. When costs come down, Medicare margins rise. Thus, this is cost cutting in action. But note, it is not cost cutting in response to Medicare, but in response to the nature of the market vis-a-vis insurers.

The paper wraps up with an astute observation, one I’ve also made. Current Medicare policy will reduce hospital payments and promote hospital-led provider integration. In such an environment of decreasing public payment and increasing hospital market power, cost shifting is more likely to occur. It will if hospitals exploit their new levels of market clout to extract greater payments from private insurers. Theoretically, an alternative could arise: integration and other Medicare payment incentives could cause hospitals to become more efficient and cut costs.

Public policy seeks both to restrain Medicare spending and encourage provider coordination. Whether these two strategies lead to a lowering of overall cost trends or an accelerating shift in costs from public to private insurers is the question that remains open.

That lower costs will occur is the hope. But I don’t see why we should expect hospitals to share lower costs with private payers. If they were so inclined, why do they exploit their market power to charge higher prices now, as Robinson showed they do?

* Contribution margin is defined as “the difference between the revenue obtained by the hospital from the patient’s insurer (Medicare or a private insurer) and the direct costs expended by the hospital in the care of that patient.”

** Yes, I am talking associations here only. The approach in the paper does not permit causal inference.

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