The Sobering Implications Of Health Care Reform

by Lanhee J. Chen, Julius L. Chen
Tuesday, February 18, 2020

The recent conversation over health care reform, particularly in progressive policy circles, has shifted away from discussions about the efficacy of the Affordable Care Act (ACA) to efforts to more fundamentally alter the U.S. health care system.  Proposed ideas, such as Medicare for All or the creation of a government-administered public option that would compete with private plans, would bring significant changes to many aspects of how health care is currently delivered and paid for.

In particular, either a Medicare for All system, or a robust public option, would likely alter the way that health care providers are reimbursed for services.  Today, physicians and hospitals are paid at different levels depending on the type of insurance that a patient has.  For a given service, providers are generally paid the least for Medicaid patients, more for Medicare patients, and the most for privately insured patients.  Providers often use the revenues generated from higher-paying privately insured patients to support the provision of less profitable services, including care for Medicaid and uninsured patients – a practice known as cross-subsidization.

Proposals to enact a fully government-run system, like Medicare for All, or to create a public option to compete with private plans, generally assume that the government would set reimbursement rates to providers for medical services rendered.  And, in the case of public option proposals, government scorekeepers like the Congressional Budget Office have explicitly assumed that hospital and physician reimbursement rates would be close to Medicare levels.

Thus, transitioning to an alternative system, where providers generally receive Medicare-level payment rates and higher private rates are eliminated, would constitute a major shift and lead to significant changes throughout the health care industry.  In particular, hospitals would need to adapt to these new reimbursement levels.  How well they will be able to adapt is unknown, but there will likely be significant variation in the impact across different hospitals.  While some hospitals could see their revenues increase, it is likely that more hospitals could find this model financially challenging, as cross-subsidization would no longer be possible.

 

The Current Financing System

In the current provider-reimbursement system, two practices widely occur.  First, under price discrimination, providers charge different prices to different payers for the same service.  Price discrimination is pervasive in health care markets, and an extensive literature finds that the prices paid for both hospital and physician services in the commercial market (i.e., private insurance coverage for beneficiaries under age 65) are consistently higher than those paid by Medicare and Medicaid. 

Recent work by researchers at RAND quantifies the wide and growing gap between private insurer and Medicare payments for hospital care.  The authors analyze 2015-2017 insurance claims data for enrollees in employer-sponsored health plans, capturing services delivered by 1,598 hospitals in 25 states.  They estimate that in 2017, case mix-adjusted private prices were 241 percent of Medicare prices, on average, and relative prices varied widely across states.  These findings, along with those from earlier studies, suggest that a provider’s payer mix, or the percentage of patients seen from each insurer category, can have a significant impact on its financial success and profitability.

Second, price discrimination enables providers to cross-subsidize.  This is a practice whereby providers use the revenues earned from more profitable patients and services to support the delivery of less profitable services, including care for less profitable patients.  At least for hospitals, cross-subsidization is a pervasive strategy.  In particular, hospitals often rely on higher payments from private insurers to cover their costs.

A third concept, known as cost-shifting, is the subject of considerably more debate in the academic literature.  Under cost-shifting, providers increase the prices charged to privately insured patients, in response to the government lowering Medicare and/or Medicaid rates.  A review of the evidence on cost-shifting explains it this way: “In cost shifting, if one payer (Medicare, say) pays less relative to costs, another (a private insurer, say) will necessarily pay more.”  Cost-shifting, unlike price discrimination, suggests that there is a causal link between different payers’ prices.  While there is some evidence that cost-shifting occurred in earlier time periods, more updated research suggests that cost-shifting is rare; some studies even find that private payment rates declined following reductions in public rates (a so-called “price spillover” effect).  Still others argue that providers respond to public payers’ lower reimbursement rates not by cost-shifting, but rather by cost-cutting.

 

What Might Happen Under Broad Medicare-Level Reimbursement?

If provider reimbursement transitions to a system where services are reimbursed at Medicare-level rates, providers would see significant changes to their revenues.  In turn, hospitals would need to adapt by adjusting their cost structure and operations. 

Two extremes have been discussed: Medicare-level rates would be catastrophic and lead to hospital closures, or they would generate significant cost savings as hospitals are forced to become more efficient and inefficient players are driven out of the market.  The reality is likely somewhere in between, although hospitals would certainly need to respond to these changes.  Moreover, it is crucial to acknowledge that how well providers will be able to adapt is unknown ex ante, and there will likely be significant variation in the impact across different providers.

How might this variation play out?  For the smaller subset of hospitals (such as safety-net or some rural hospitals) that primarily treat uninsured or Medicaid patients, revenues could actually increase.  This is because Medicaid rates would increase to Medicare levels, and as the uninsured gain coverage through other components of Medicare for All proposals, the amount of uncompensated care would decrease. 

For the larger subset of hospitals that treat many privately insured patients, revenues would likely decline.  In general, these hospitals have been reliant on the current system of higher payments from self-insured employers and private payers to support their operations.  Thus, broad-based reimbursement at Medicare levels would constitute a major change, as they would no longer be able to price-discriminate or cross-subsidize, and likely lead to significant financial pressure.  Stanford professors Kevin Schulman and Arnold Milstein estimate that if the current Medicare fee schedule were universally applied to all patients, the net effect on hospitals would be an almost 16 percent decline in revenue (or a loss of $151 billion across the roughly 5,200 community hospitals in the United States).

Yet even among this larger subset of hospitals, there may be variation in effects.  Some have argued that because private prices are artificially inflated, switching to Medicare-level reimbursement could drive efficiency gains and encourage hospitals to exercise greater discipline in controlling their costs. 

In contrast, others have raised concern about the potential side-effects of hospitals’ cost-cutting strategies.  Beyond a certain point, these strategies (like reducing staffing levels, lowering capacity, or eliminating low-margin service lines) could lead to deleterious effects (like lower quality of care, reduced access to needed services, or negative labor market outcomes).  For example, Schulman and Milstein argue that cost reductions at hospitals would be most easily carried out through workforce reductions, estimating that “1.5 million hospital clinical and administrative jobs could be lost if hospitals reduced labor costs to compensate for the entire revenue shortfall” associated with universal application of current Medicare reimbursement rates.  Lower overall reimbursement might also lead to unwanted behavioral responses, such as providers shifting their efforts toward higher-margin procedures or increasing overall procedure volume.

 

Discussion

There is little doubt that a move toward Medicare for All, or even the creation of a robust government-administered public option, would represent a significant departure from existing financial arrangements in the health care system.  In particular, physicians and hospitals would be subject to government-determined reimbursement rates to a far greater extent than is currently the case.  But are these types of changes politically sustainable over time?

Historical evidence suggests that they may not be, as such changes will undoubtedly face stiff political opposition.  In fact, one need look no further than provider-reimbursement rates within the Medicare program to see the degree to which political influence can impact the levels at which providers are compensated. 

In 1997, Congress created the Sustainable Growth Rate (SGR) formula in an effort to restrain spending on physician services within the Medicare program, by setting a global spending target that resulted in automatic payment cuts to providers when overall program expenditures exceeded a specified target.  Because of the SGR, in 2002, Medicare payments to physicians were cut by 4.8 percent.  The following year, physicians objected and lobbied Congress, which responded by passing special legislation to increase payments to physicians by almost 2 percent.  Each year through 2015, Congress passed what became known as “doc fixes,” either to raise payments (as was the case in eight of 13 years) or keep them constant.  The SGR was ultimately repealed in 2015 under the Medicare Access and CHIP Reauthorization Act (MACRA), which introduced a new physician payment scheme.

Thus, the widespread adoption of a public option or, more dramatically, a shift to Medicare for All, would require policymakers to make difficult choices about provider compensation levels.  On the one hand, they could defy the provider lobbying that would come with efforts to more broadly apply Medicare-level reimbursement rates.  Or, they could increase reimbursement rates to something closer to private payer levels, though this would create enormous fiscal challenges, increasing deficits and the debt over time.

 

Conclusion

While it is easy for policymakers to propose broad-based health reforms, such as the creation of a government-administered public option or Medicare for All, the implications of such changes would be substantial and profound. 

Notably, universal (or more widespread) application of Medicare-level reimbursement rates would likely have a significant impact on providers’ financial outlook.  Some uncertainty exists around the magnitude and scope of the financial impact on providers and—more importantly—how they would respond to this marked departure from the current financing system.  But before making such large-scale changes, policymakers should seriously consider the potential for variation in effects across providers—as well as the possibility of downside effects—on the access to services and the quality of care provided to patients across America.

 

Lanhee J. Chen is David and Diane Steffy Fellow in American Public Policy Studies at the Hoover Institution and Director of Domestic Policy Studies in the Public Policy Program at Stanford University. 

Julius L. Chen is Assistant Professor of Health Policy and Management at Columbia University and an Affiliate of the Columbia Population Research Center.