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

This is strong evidence favoring a general "pressure matters" thesis. However, we cannot conclude that, if pressure had been placed on otherwise unpressured hospitals (i.e., low-cost hospitals), there could have been substantially more savings in hospitals spending. It is true that Medicare outlays would certainly have been lower in these hospitals if equal pressure had been applied. But there is no evidence that unpressured, low-cost facilities could (or would) cut the rate of expenditure inflation if pressured. There is also no evidence that such facilities do not have as much inefficiency (slack) as others. If pressure had been equalized, would there have been as much pressure on the high-cost hospitals? If not, this literature certainly suggests that not as much would have been saved from these hospitals. Hence, equalization of pressure through some form of hospital-based rate (rather than a national blend) may allow more cost containment, or it may not.

Can we say why high rates of inflation returned? Hadley and coauthors offer who explanations for the resurgence in spending: first, that maximum efficiency had been attained; and second, that the original profit windfall was being expended in subsequent years. There is some evidence, albeit indirect, to support both explanations. Some research suggests that payment pressure may be able to generate cuts in resource use that are sufficient to reduce patient welfare, possibly buttressing the view that maximum efficiency has been reached. Work by Staiger and Gaumer (1990) and Cutler (1991) suggests that patient mortality outcomes in small hospitals and government facilities may be quite sensitive to variations in payment levels. Other types of facilities do not exhibit such sensitivity. This does not imply that PPS is creating a mortality problem, but that such facilities, for whatever reasons of structure and history, are vulnerable to variations in rates. These results, and the econometric work on margins by Cromwell and Burge (1991), emphasize how strongly total margins seem to be related to size (small facilities, low margins), thereby confirming the special vulnerability of small facilities to fixed payment rates. This vulnerability may result from the volatility of volumes within small pools of patients or from the low occupancy rates or limited revenue recovery alternatives these smaller institutions enjoy. At the same time, however, there is no evidence that other classes of institutions have exhausted slack, nor is there evidence for larger institutions of systematic variations in mortality to suggest exhausted slack.

There is some emerging evidence that excess payments may have fueled some of the early spending increases. This evidence also suggests limits to the marginal incentives to retain profits. But it really does not dismiss the role of marginal incentives in limiting losses. The Urban Institute and Georgetown authors, as well as Cromwell and Burge (1991), estimate models showing that profit levels are related to subsequent spending and margins, lending support to the view that the return of high inflation may have been caused by the national rate phase-in, as excess profits may have caused subsequent spending. That is, with a national rate phase, PPS may have had its own built-in self-limiting mechanism. Clearly, much of the windfall early in PPS resulted from overpayment, not rate equalization. Moreover, the initial return of higher rates of spending growth might well have been exacerbated by a pool of windfall profits.(10) The work by Hadley, Zuckerman, and Feder (1989) suggests that 30 cents of every $1 in excess profits will be spent in the subsequent year. This is roughly the order of magnitude of year-to-year profit retention as would be indicated by the Cromwell and Burge (1991) margin model. Unfortunately, there have been to studies of fund balances or investment behavior that would be able to show how retained margins might have been subsequently saved (or spent) apart from operations.