• The Health Care Cost Shifting Myth

    This post originally appeared on The Health Care Blog on 31 August 2009.

    There is a pervasive notion that providers of health care can make up for lower payments received from one set of payers (e.g. Medicare, Medicaid, uncompensated care) by increasing prices charged to other payers (e.g. private insurance companies). To the extent it occurs cost shifting offsets attempts to control overall health care costs through reduced fees paid by public insurers. It makes “bending the cost curve” harder.

    However, it is a myth that providers can fully shift costs. That they could do so violates, in most cases, principles of economics. Moreover, empirical evidence suggests cost shifting, where it occurs, is done so at a minimal level: only a small fraction of decreased payments by public payers shows up as an increase in charges to private payers. Losses associated with one payer are largely not recouped from another.

    Some take price discrimination as evidence of cost shifting. However, price differentials are not necessarily the recouping of losses from one payer by overcharging another. As described in the 2001 Health Affairs paper by Richard Frank “Prescription Drug Prices: Why Do Some Pay More Than Others Do?” price discrimination can be due to unequal bargaining power across classes of purchasers. In other words, in maximizing profits, providers charge different prices to different market segments. In such cases, by definition, profits cannot be further increased by cost shifting. (Uwe Reinhardt makes a similar argument on the Health Affairs Blog.)

    It’s true that cost shifting could theoretically occur under specific conditions. One case is when a provider has monopoly power that it has not fully exploited, for instance charging private insurers less than it could. More fully exploiting its monopoly power with respect to those payers, such a provider can recoup losses. Still, there is a limit to how much of the lost revenue can be recouped. The monopoly profit-maximizing price level imposes a ceiling.

    Another instance in which cost shifting could occur is in a more competitive market in which all providers have roughly the same level of undercompensated care. All competitors in such a market might choose to increase charges to private insurers by the same amount, maintaining their relative competitive positions. However, if one competitor elects to reduce costs or reduce its burden of undercompensated care, it might be able to charge private insurers less then others, thereby increasing its market share. So, cost shifting may not be a stable equilibrium.

    The literature provides estimates of the extent of cost shifting in cases where it is theoretically possible. The March 2009 MedPAC Report to Congress: Medicare Payment Policy (Chapter 2A) includes a summary of such evidence. It concludes that the dominant dynamic in the market is that hospitals with strong market power have abundant financial resources. In turn they have a high cost structure (perhaps due to provision of relatively higher quality care) that causes lower or negative Medicare margins. In contrast, hospitals that are forced to run efficiently are adequately funded by Medicare payments. That is, Medicare payments are sufficient to cover costs but some hospitals run inefficiently and make it appear otherwise. Therefore, MedPAC has concluded that increased Medicare payments to hospitals would not reduce rates charged to private insurers. The primary effect would be to induce lower cost operations.

    The MedPAC report cites mixed evidence from the literature on the level of cost shifting, as does the December 2008 CBO report Key Issues in Analyzing Major Health Insurance Proposals. A few studies from the 1980s found evidence of cost shifting at a rate of up to fifty cents on the dollar. However, conditions in the 1990s were less conducive to cost shifting and the rates were found to be on the order of a 0.4 to 1.7 percent increase in private payments in response to a 10 percent reduction in Medicare and Medicaid fees. In a 2005 study of geographic variation in health costs of the Federal Employees Health Benefits Program, the GAO concluded that the considerable variation it found was not due to variations in payments from other payers.

    In conclusion, cost shifting is not as large and widespread a phenomenon as some would believe. Under some market conditions it is inconsistent with economic theory. And, while it can occur under other market conditions it is far from a dollar-for-dollar shift in costs. The most recent studies of the phenomenon find little evidence of cost shifting or very low levels of it. Claims that reductions in public payments for health care will necessarily show up as commensurate increases in private payments are unfounded.

    • Austin,

      On UR’s quote:

      If that is true, however, then one may ask the following question: If the private plans cannot resist increased prices as a result of this particular cost shift, how then can they resists any price increases justified to them by any cost, whatever its origin? How, for example, could they resist picking up the tab for the so-called medical arms race by which hospitals compete? I find this an intriguing question and invite comments thereon.

      I always wondered the same thing; not that hospitals would raise this point, but why doesnt Congress, or MCO’s?

      Also, your quote:

      However, if one competitor elects to reduce costs or reduce its burden of undercompensated care, it might be able to charge private insurers less then others, thereby increasing its market share. So, cost shifting may not be a stable equilibrium.

      Would this hold true only in a rational market? Given the asymmetries/dysfxn in health marketplace, would this not be a less or even rare phenomena?


    • @Brad – First I tend to fall back on the notion of market power. In a market in which the providers have substantial power relative to the insurers, the insurers are commensurately at their mercy. This is a real problem. I think those who really understand health care markets know it. But it is not politically expedient to beat up on providers now. The focus is, incorrectly, on insurers. In fact, they’re not the big source of the cost problem.

      There are many sources of market failure in health care. But I don’t have any basis upon which to believe hospitals behave irrationally with respect to competition (happy for someone to cite something to the contrary). Why would a hospital not reduce its cost if it could gain market share by doing so?

      Bottom line: cost shifting is a rare and small phenomenon. The only folks I’ve seen claim otherwise have a major conflict of interest. I do not. I don’t profit by this claim or the contrary one.

    • In my neck of the woods (NYC), hospitals running 90+% capacity, no point in lowering prices for greater market share. I can see though, in certain areas lowering prices would have beneficial effects.


      ps–see healthbeat blog, 9/24. your post gets a citation

      • @Brad – 90+% capacity with privately insured patients? Or is that counting Medicare and Medicaid? Suppose it is some of each. I don’t know to what extent a hospital can control its payer mix. But charging a bit less to the private insurers in order to gain more market share in that sector is what I was thinking.

        Thanks for the heads up on the Health Beat blog.