Medicare's prospective payment system: a critical appraisal - Cost-Containment Issues, Methods, and Experiences

Health Care Financing Review, Annual, 1991 by Robert F. Coulam, Gary L. Gaumer

The bifurcation of PPS margins may be a telling fact about the cost-containment success of PPS. As Coelen's (1991) graphic analysis indicates (Figure 1), the hospitals entering PPS with the highest base-year costs per case reduced costs more than the lowest cost hospitals and experienced virtually no increase in PPS revenues per case through the phase-in period. (Coelen uses a threshold of 20 percentage points above the mean to define the high-cost group; the low-cost group has a threshold 20 percentage points below the mean.) The more rigorous econometric work on the early years of PPS by other researchers from the Urban Institute and Georgetown first pointed to the fact that hospitals pressured by payment rates under PPS (i.e., high-cost hospitals) exhibited more aggressive responses to improve financial performances, in terms of cutting LOS, reducing rates of inflation in expenditures, and avoiding larger reductions in admission volumes (Feder, Hadley, and Zuckerman, 1987; Hadley and Swartz, 1989; Hadley, Zuckerman, and Feder, 1989). Examining the first 2 years of PPS, these researches also found that these differences in response, coupled with the regional rate blend, led to significant differences in margin trends between pressured and not-pressured hospitals. Changes in profit margins were favoring the latter group of facilities, which were taking less aggressive action to improve financial performance. This pattern of evidence suggests that pressure drives discretionary behavior, but profits accrue as windfalls on past cost level, or to other facility and market characteristics. The pattern has been widely confirmed in every study that has examined differential hospital performance resulting from differential pressure.(8) Across these various pressure indicators and studies using varied data sets,(9) there is a consistent pattern of findings.

These findings and their implications have become something of a literature themselves (see sources cited above, plus Lave, 1990; Oday and Dobson, 1990; Guterman, Altman, and Young, 1990). Can we say that only (or mainly) through - rather than managerial incentives to accrue profit - do administered prices work to reduce hospital cost inflation? The work by Hadley, Zuckerman, and Feder (1989) makes the strongest case for this view. They find large initial effects, followed by diminished effects in the next year and concluded that these early effects are apparently the result of a large (one-time) fall in LOS, creating a large spending effect beyond the effects of TEFRA. (The expenditure effects of TEFRA incentives have been estimated to be about one-half as large as the first-year PPS effects [Hadley and Swartz, 1989].) Hadley, Zuckerman, and Feder also show that hospitals responded to changes in levels of pressure, whether they occurred in the first or second year of PPS, and regardless of the level of prior-year pressure. They conclude that "the initial, rather than the continuing, opportunity for profit has the bigger impact" and that "the slowdown in cost containment - or resurgence in cost increases - after hospitals' initial year on PPS raises questions about the system's long-term effectiveness."