Trends in total hospital financial performance under the prospective payment system

Health Care Financing Review, Spring, 1992 by Charles R. Fisher

Introduction

In order to focus on the overall performance of hospitals under the prospective payment system (PPS), I chose to study those hospitals that were under PPS since the inception of that program in October 1983. Thus, data for hospitals in States that had their own cost-control programs during some portion of the PPS period (Maryland, Massachusetts, New Jersey, and New York) are excluded from the study because their specific payment systems could confound the numbers.

Two basic data sources are used for this analysis:

* American Hospital Association (AHA) annual surveys for 1977 through 1989 as reported in the annual publication Hospital Statistics (American Hospital Association, 1977-89).

* Medicare Cost Reports for report years 1985-89. Data and analysis based on Medicare Cost Reports are shown in the Technical note.

This article first examines the "average" hospital's financial performance and total hospital activity in the context of the general economy, using AHA data for report years 1977-89. The study period was divided into four periods:

* From 1977 through 1979, the effective period of the industry's Voluntary Effort (VE) cost-containment program.

* From 1979 through 1983, the pre-PPS period when VE was no longer effective.

* From 1983 through 1985, the initial period of PPS.

* From 1986 through 1989, the later period of PPS.

Each of the four periods displays unique aspects of trends in hospital expenditures.

Key determinants of financial performance are examined:

* A measure of hospital output transaction prices that enables an estimate of hospital real output trends.

* Expenses trends as a function of outputs, total factor productivity rates, and input resource prices.

* Net profit and net revenue trends.

* Trends in nominal and real expenditures and in transaction prices for the hospital industry compared with nominal and real output and prices in the general economy.

The same trends analysis is then applied to Medicare Cost Reports for report years 1985-89.

Key findings of this article are:

* Hospital spending grew less than economywide spending (gross national product, or GNP) in the initial PSS period but resumed historical excess growth in the later PPS period.

* Rising hospital input prices, particularly hospital worker compensation increases in excess of general economy compensation changes, are a primary source for hospital spending rates in excess of general economy spending.

* Hospital inpatient outputs, which declined in the initial PPS period, resumed historical growth patterns in the later PPS period.

* Rapid growth in outpatient outputs characterized the entire PPS period.

* Hospital net profit rates, although declining in the recent PPS period following unprecedented high rates in the initial PPS period, were higher at the end of the study period than at the beginning of the study period.

Trends in revenues and profits

From 1977 through 1989, the average PPS hospital's net revenues quadrupled, reaching nearly $32 million by 1989 (Table 1). Most of these revenues, about 93 percent, were derived from revenues provided by patients or their third-party payers (government or private health insurers) for patient care goods and services provided by the hospital. The remainder represents revenues received by hospitals from sources other than patient care, for example, investments and proceeds from parking lots, gift shops, etc.

During the period 1977-89, the average hospital's net profits fluctuated from a low of $258,000 in 1977 to a high of $1.6 million in 1985, the first full year of PPS implementation. Overall, from 1977 through 1989, the average hospital's net profits increased fivefold, ending with nearly $1.3 million in profits in 1989.

Net profits as a percent of net revenues increased 25 percent during the period, rising from 3.2 percent in 1977 to more than 6 percent in the initial PPS period [TABULAR DATA OMITTED] and subsequently stabilizing at about 4 percent in the late 1980s. During the same time, the number of community hospitals declined steadily from 5,308 to 4,968.

Net revenues and expenses, while decelerating rapidly in the initial period of PPS following rapid growth in pre-PPS periods, began to accelerate again in the later PPS period (Table 1). Net revenues, which had been increasing at double-digit rates prior to PPS, dropped to single-digit increases from 1984 through 1987, but subsequently resumed double-digit growth in 1988.

Outputs and output prices

Hospital outputs are defined here as any good or service appearing on a hospital bill in the form of a billable charge. Specific outputs do not have to be detailed but must be measurable by being included in an aggregate charge. I define a charge for an output as the output "list price" and the cash value of an output as the output "transaction price." The output transaction price represents the list price after discounts are applied.

Two output transaction prices are estimated: a patient care transaction output price, which represents net patient revenues divided by patient care outputs, and a total output transaction price, which represents total net revenues divided by patient care outputs. (Total net revenues are the sum of net patient revenues and non-patient revenues derived from sources other than patient care.)