Does prospective payment really contain nursing home costs? - Policy Impact - Statistical Data Included

Health Services Research, April, 2002 by Li-Wu Chen, Dennis G. Shea

With an aging population, American society has faced an increasing demand for nursing home care. Consequently, nursing home expenditures have increased significantly from $20 billion in 1980 to more than $87 billion in 1998 (Levit, Cowan, Lazenby, et al. 2000; Rosko et al. 1995). As a result, the cost of nursing home care has become a key area of public policy concern. To control nursing home expenditures effectively, Medicaid programs in many states have shifted from retrospective cost-based system to prospective payment system (PPS). In addition, the Medicare program has recently implemented a per diem PPS for its beneficiaries who seek skilled nursing facility (SNF) care in nursing homes. The underlying assumption behind recent payment changes for nursing home care is that prospective payments would drive greater efficiency, thus helping to contain the growth of nursing home expenditures. However, the effects of prospective payment in controlling nursing home costs remain unknown.

Although a few previous studies addressed the impact of prospective payment on nursing home costs, most of them do not control for quality variables or output and/or quality endogeneity in their studies. In addition, most of these studies used data prior to 1987, when the Nursing Home Reform Act of the Omnibus Budget Reconciliation Act (OBRA) was passed and nursing homes were required to provide a higher quality of care to their patients. It is unknown how nursing homes responded to the changes in their regulatory environment in terms of their operational efficiency and quality. To fill this gap in the nursing home literature, we investigated the impacts of prospective payment on nursing home costs using more recent national data. Our study also tried to minimize the cost function estimation biases from which the previous studies have suffered.

PREVIOUS RESEARCH

Empirical evidence has shown inconclusive results regarding the effect of prospective payments on nursing home costs. A number of nursing home cost studies indicate that prospective payment has lowered nursing home costs when compared with cost-based reimbursement (Bishop and Dor 1994; Dor 1989; Meiners 1982; Thorpe, Gertler, and Goldman 1991). On the other hand, some studies show that prospective payment either may not lower nursing home costs or may achieve cost savings through reductions in access and quality of care. For instance, Sexton et al. (1989) used Data Envelopment Analysis to estimate the relative efficiencies of nursing homes in Maine before and after the implementation of a PPS. They found nursing homes became less efficient after the introduction of prospective reimbursement. In addition, Coburn et al. (1993) suggested that nursing homes under prospective reimbursement may reduce access of Medicaid patients. Moreover, although finding that the PPS lowers nursing home costs, Cohen and Dubay (19 90) suggested the savings are achieved through decreasing case mix or lowering staff levels by nursing homes.

The inconclusive results regarding the effectiveness of the PPS in previous studies may stem from the difficulty in estimating nursing home cost function. For instance, some studies used capacity measures (e.g., number of beds, occupancy rate) as their output variable. These measures do not really reflect the magnitude of output produced by nursing homes. Although some studies used a better measure, such as number of patients, the great variation in the length of stay among patients still makes this measure inappropriate. Although the use of payment-type (Medicare/Medicaid/private) patient days by Bishop and Dor (1994) and Dor (1989) may correct for output measurement errors by reflecting length of stay as well as the disparity in case mix among different payer types of patients, admission and discharge practices may be based on the patient's payment source. As a result, patient's length of stay may be "manipulated" in nursing homes (Breyer 1987; Frank and Lave 1985; Freiman and Murtaugh 1993; Grannemann, Bro wn, and Pauly 1986; Vitaliano 1987). The ability of nursing homes to manipulate patients' length of stay, based on their payment sources, indicates that payment-type patient days (e.g., Medicare days) should not be considered as exogenous variables in the cost function.

Because nursing homes have some ability to choose their quality level, quality must be regarded as a choice of the firm. As a result, in a cost function, quality cannot be considered as an exogenous variable, either. Gertler and Waldman (1992) suggested that a nursing home cost function that treats quality as exogenous produces misleading estimates of coefficients. Davis and Provan (1996) also suggested that quality orientation is a function of a nursing home's emphasis on cost control or cost consideration. Their argument about quality as a function of cost consideration indicated that quality should not be considered exogenous to cost in the nursing home cost function.

In addition, previous research did not adequately investigate whether the cost reduction of nursing homes, if any, comes from more efficient operation or from other sources. Efficiency would mean the nursing home produces the same output at lower cost. However, nursing homes might lower costs, but also reduce quality. In effect, this is not improved cost efficiency because one output of the nursing home-quality--has been changed. Because most previous studies did not control for quality and/or case-mix variable in their cost functions, their findings on the effect of PPS on cost could be misleading. More importantly, almost none of the previous studies controlled for quality of life or addressed the possible endogeneity of quality variables. Quality of life, in addition to quality of care, is an important construct that needs to be measured and controlled for in the nursing home cost function. Nyman and Geyer (1989) suggested that "nursing home patients are in fact living in these health care institutions and that the quality of their lives within these institutions may be at least as important as the quality of the health care they receive there" (p. 797).