In 2011, Center for Medicare and Medicaid Services (CMS) actuaries made two predictions about the implications of Affordable Care Act (ACA) cuts to the prices Medicare will pay for hospitals services: (1) that they will cause 15% of hospitals to become unprofitable in a decade and (2) that they will be half those of commercial market prices by 2040. Recent work suggests that only one of these predictions is likely to be correct. A review of how hospitals react to Medicare cuts reveals which.
Hospitals might respond to Medicare payment cuts (or, more typically, reductions in their rate of growth) in three ways. They are not mutually exclusive. First, they might shift costs, i.e., raise the prices they charge to private payers (insurers and self-insured employers) in direct, causal response to shortfalls in payments from public payers like Medicare. In a 2011 paper in The Milbank Quarterly, I surveyed the literature on cost shifting, finding evidence that hospitals could offset, at most, about 20% of lost Medicare revenue with this technique.
However, more recent work suggests that hospitals can’t cost shift at all. In fact, studies published since 2011 find the opposite, that there is a price spillover: when Medicare cuts its prices, so do private payers. I summarized this evidence in a commentary in Health Services Research.
In their analysis of cost shifting, Dranove, Garthwaite, and Ody (2013) exploited the downward financial shock of the 2008 market collapse, arguing that hospitals would not differentiate between loss of endowment revenue and a reduction in resources from a public payer. The authors found no evidence of cost shifting by hospitals, on average. [...]
Exploiting exogenous changes in Medicare hospital payment policy from 1995 to 2009, White (2013) found that a 10 percent reduction in the Medicare payment rate was associated with a 7.73 percent reduction in the private rate. This price spillover is the antithesis of cost shifting. Finally, He and Mellor (2012) also found evidence consistent with spillovers. In their analysis of outpatient surgical procedures at Florida hospitals during 1997–2008, they found that Medicare rate cuts were associated with an increase in volume from private insurers that paid fee-for-service prices. This volume shifting is inconsistent with cost shifting and is expected to accompany price spillovers. It suggests hospitals reduce private prices (though still keep them above Medicare rates) in response to lower Medicare ones to attract a larger volume of higher paying patients (Morrisey 1994). [...]
Exploiting exogenous changes in Medicare hospital payment policy [Wu and White (2013)] examined their effect on hospital total revenue, operating expenses, profits, assets, and staffing over the years 1996–2009. Their findings are inconsistent with cost shifting: a $1 reduction in Medicare inpatient revenue is associated with an even larger reduction ($1.55) in total revenue, consistent with price spillovers. [Links added.]
A second way hospitals could respond to Medicare shortfalls is by cutting costs. I discussed this possibility and the consequences in a previous post at The Incidental Economist. Finally, hospitals could cut profit margins. Wu and White (2013) simulated the effect of Medicare cuts of a size expected by the ACA over 10 years and found that the resulting loss of profit would increase hospitals operating at a loss by 15 percentage points.
With these results, we can evaluate the predictions listed at the top of this post. The prediction that over a decade 15% of hospitals will become unprofitable as a result of the ACA’s Medicare cuts is consistent with the results of Wu and White, described above. So, we can give CMS full marks on that prediction, at least based on what we know now.
CMS’s other prediction, that Medicare prices will be half the value of commercial market ones by 2040, isn’t looking so good. It relies on the premise that commercial market prices hold steady when Medicare’s fall. As documented above, recent evidence does not support this premise. Instead, we might more reasonably expect commercial market prices to fall along with Medicare’s, though not necessarily dollar-for-dollar. That this is also consistent with economic theory provides further confidence in rejecting CMS’s prediction.
Though CMS missed price spillovers, at least it did not predict cost shifting. Its actuaries also could not be aware of the price spillover research that had not been published at the time of their work. I’ll grant partial credit.