Government And Commercial Insurer Payment Rates to Hospitals: A Commentary on Priselac

Editor’s Note: This perspective was originally published on Health Affairs Forefront on September 25, 2023.

This article is the latest in the Health Affairs Forefront series, Provider Prices in the Commercial Sector, featuring analysis and discussion of physician, hospital, and other health care provider prices in the private-sector markets and their contribution to overall spending therein. Additional articles will be published throughout 2023. Readers are encouraged to review the Call for Submissions for this series. We are grateful to Arnold Ventures for their support of this work.

Thomas Priselac’s article in Forefront today raises important concerns that low payment rates from Medicare and state Medicaid programs, together with the growing percentage of patients funded by these programs, will undermine the delivery system’s ability to “support policy goals regarding affordability, equity, quality, and a healthier population.” He believes that the presence of “the hospital cost shift” has so far enabled hospitals to avoid consequences of low rates by public payers by getting private insurers to pay higher rates. But he foresees threats to hospital financial viability arising from either further reduction in rates from public payers or from possible new regulatory constraints on what hospitals can charge private payers.

I believe Priselac overstates the magnitude of possible hospital cost shifting. While cost shifting is possible for those hospitals with outstanding reputations for their ability to deliver highly specialized services of high quality, such as Cedars-Sinai, and for those with great leverage with insurers based on substantial monopoly power, the research literature consistently shows that hospital cost shifting is not an important market phenomenon (see below). Paradoxically, overstating the extent of cost shifting detracts from the urgency of concerns about the consequences for the financial viability of many hospitals of public payers being unable to pay higher rates.

More fundamentally, however, I believe that in framing cost shifting as a necessary and rational response to low government payment rates, Priselac gives short shrift to the enormous societal problem of excessive health care spending due to limited attention to efficiency or value.

In this piece, which Health Affairs editors asked me to write as a companion to Priselac’s, I address both of these key issues in the cost shifting “debate.” I discuss how much cost shifting actually takes place and whether there is a way through the debate to focus on the need for cost control and the best way to pursue it.

Hospital cost shifting

Cost shifting describes how payment rates that hospitals negotiate with private insurers might change in response to changes in rates paid by Medicare and Medicaid. This should not be confused with hospitals negotiating higher rates for private insurers than they receive from government payers, which economists call “price discrimination.” In my several decades as a researcher interviewing hospital and insurance executives, I have been struck by the broad agreement about a simple model of cost shifting—private payer rates increase to fully offset reductions in public payer rates.

Economists have long been skeptical about the reality of this perception, with their skepticism having grown over time as additional research has been published. They pose this question: If a hospital is able to negotiate higher payment rates with private payers, why did it wait for cuts by public payers? In other words, why has the hospital not obtained rates that maximized its revenue in the past?

Perhaps separating myself from other economists who have focused on this issue, I can envision some situations in which a hospital might choose not to maximize revenue during some periods and would therefore be in a position to raise private payer rates in response to cuts by public payers. Specifically, hospitals that have achieved “must have” status in private insurance networks, either from a stellar reputation for being cutting edge or from strong monopoly power, such as by being the only provider in a geographic area, might be able to accomplish their missions without continuously maximizing revenue. Other factors ameliorating revenue maximization for these hospitals can include the social mission of nonprofit hospitals and their boards often including various community stakeholders with concerns about constraining health insurance premium increases in their community.

But the reality is that most hospitals must maximize revenue—and they struggle to obtain private insurance payment rates that they perceive to be adequate to support their viability. The negotiating positions of many good but not uniquely positioned hospitals in metropolitan areas reflect having other good hospitals nearby, undermining the need to include them in an insurance network. It’s not clear how hospitals having limited leverage with insurers could simply raise their commercial rates in response to changes in government rates. In fact, most hospitals’ limited negotiating leverage is consistent with the finding of Austin Frakt’s 2017 literature review that “it’s been nearly two decades since any rigorous study has found evidence of substantial cost shifting.”

What happens in the majority of hospitals that are constrained in what they can charge private insurers when public payers cut their rates? According to the literature, they reduce their costs to protect their profit margins for Medicare patients and may cut their rates to private insurers to be included in more networks so that they can attract more privately insured patients. Research published in Health Affairs by Chapin White found the opposite of cost shifting: A 10 percent reduction in Medicare payments was associated with an 8 percent reduction in prices charged to private insurers.

A Medicare Payment Advisory Commission (MedPAC) analysis shows that the 25 percent of hospitals earning the lowest profit margins from non-Medicare services had the lowest Medicare costs (8 percent lower than the national median) and, as a result, the highest Medicare profit margins (4 percent, which is 9 percentage points above the national median). The hospitals with the least financial pressure had the highest Medicare costs and the lowest Medicare margins.

Michael Chernew’s recent article in Health Affairs provides evidence of how the growing trend of hospital consolidation provides a distinct mechanism through which cost shifting can occur. What he labels “consolidation-induced cost shifting” occurs where reduced rates from public payers lead some hospitals to close or seek to be acquired by larger systems. But the Chernew results add support to economists’ skepticism about the importance of cost shifting by showing that for those hospitals unable to reduce costs, negotiating higher rates with insurers was not possible.

Priselac finds the abovementioned research irrelevant because it is based on “retrospective data.” But the data underlying this research indeed come from the “real world” and are reliable because they are systematic, rather than reflecting the experiences of any single hospital system’s negotiations.

Need to address the cost problem

A key finding from the research on hospital cost shifting is that costs per admission or per service are not outside of the control of hospitals. Indeed, throughout the economy, businesses’ success in controlling their costs is critical to whether they thrive or fail due to competition. Historically, health care in general and hospitals in particular have not faced substantial competitive pressure to constrain costs. Other than a few places such as Maryland, where an effective all-payer rate review approach has been in place since the 1970s, the only regulatory pressure on hospitals has been Medicare and Medicaid payment rates. With little competitive pressure on costs, it is not a surprise that hospital executives believe public payment rates are too low and don’t cover their costs.

The most important factor behind the lack of competitive pressure is the very large role of third-party payment. With patients paying only a small part of the bill, incentives on the part of providers to be efficient are highly diluted. With quality variable but difficult to measure objectively, patients are even less likely to shun relatively expensive providers with a good “brand.” The tax treatment of employer-sponsored health insurance also undermines competition across health care providers by fostering richer insurance benefits and broader provider networks than employees might choose if they had to pay the full after-tax cost. Although efforts by employers to get consumers to have more “skin in the game,” for example, through high deductibles, have made some more sensitive to price, their aggregate impact likely has been overwhelmed by the powerful trend toward consolidation among hospitals and medical practices.

This combination of little competitive pressure on hospitals and price-limiting regulation applying only to Medicare and Medicaid has led to very high costs, seen most strikingly through international comparisons. For decades, the Organization for Economic Cooperation and Development (OECD) has been measuring health spending per capita across its member countries. The United States has always been an outlier, and the differences have tended to increase over time. In the most recent OECD data (2019), after adjustment for purchasing power, US health care spending was twice as high as the average across the other high-income countries in the G7. Research has indicated that these spending differences predominantly reflect price differences (as memorably captured by the late Uwe Reinhardt in his classic study “It’s the Prices, Stupid” and recently updated by his coauthors) with the higher prices received by providers in part leading to higher earnings for physicians and others working in health care.

With health spending in the United States continuing to increase as a percentage of national income, federal and state governments are being asked to provide or subsidize insurance coverage for more people, making existing commitments for Medicare, Medicaid, and subsidies to individual purchasers of insurance more challenging to fund, especially given the enormous revenue losses associated with the tax treatment of employer-sponsored coverage. It is certainly true as Priselac states, that more patients have public coverage now. But we must bear in mind that expansions of public coverage are a response to cost increases making private coverage unaffordable for more people.

Resistance to tax increases means that higher health spending is either crowding out other government priorities or, for the federal government but not states, increasing budget deficits, which are now becoming more expensive to fund due to the double-whammy of increasing levels of debt and rising interest rates. For these reasons, outside of the COVID-19 pandemic, when the federal government provided substantial temporary assistance to health care providers to maintain the viability of the delivery system, governments have been appropriately reluctant to provide additional payment increases.

Priselac is right to point out the challenges to remain financially viable facing hospitals that mostly serve publicly insured patients. Increased public payment, especially to hospitals disproportionately meeting social needs while facing the greatest reimbursement challenges, should be high on the policy agenda. As one example of such a policy reform, in its March 2023 Report to Congress, MedPAC recommends redistributing payments for disproportionate share hospitals (DSH) and uncompensated care payments according to a Medicare Safety-Net Index (MSNI), better targeting these payments to hospitals with more challenging patient mixes. MSNI payments would be an add on to Medicare payment rates rather than the lump sum per hospital used under DSH, so the program would send payments for Medicare Advantage patients directly to the hospital.

Pursuing a two-pronged strategy

For decades, policy thinkers and policy makers have argued about whether competition or regulation should be the approach to constrain health care spending to what society can afford. By having chosen neither, our nation now finds itself with a much larger challenge. The magnitude of our health care affordability problem cries out for pursuing both competition and regulation.

Two trends critically limit what greater competition might accomplish. As previously discussed, the rapid increase in provider consolidation undercuts the efficacy of competition. Although policies to restrain further consolidation should certainly be pursued, I believe provider consolidation has already progressed to a point where even increased consumer incentives—such as through higher cost sharing—will have limited impact on the increasing number of the providers with substantial leverage with private insurers. This will diminish the impact on overall health care costs from low payment rates from public payers.

The second confounding trend is that a major driver of health care spending is advancing technology that produces possibly more effective but extremely expensive therapies. Relying on cost sharing large enough to impact use of expensive technologies would increasingly undermine access not only for those with lower incomes but also for those with middle incomes, making the strategy less attractive.

With opportunities for constraints on cost through competition shrinking, several states are starting to pursue regulatory measures to constrain prices, whether through actual limits on spending growth or on prices, public (insurance) options, or review of contracts between insurers and providers. Price transparency initiatives and pioneering research by economists at the RAND Corporation have led to greater understanding about the enormous variation in ratios of negotiated prices and costs, opening up the motivation and ability to target restrictions to those providers with the greatest immunity from the forces of competition. Perhaps after all these years, the United States may slowly join the rest of the world’s high-income countries in having a public entity limit payment rates from all payers. Failing to adopt this step will continue the escalation of health care costs, distorting government spending and the economy. Debating whether or not hospitals can cost shift should not distract us from this profound challenge.

Author’s Note

The author wishes to thank Steven Lieberman and Jeffrey Stensland for helpful comments and to acknowledge support from Arnold Ventures through a grant to the USC Schaeffer Center. Ginsburg’s employer, the University of Southern California, includes a major academic medical center. He served as a commissioner and vice chair of the Medicare Payment Advisory Commission from 2016 to 2022. The Commission has taken positions on a number of issues discussed in this article.

Ginsburg, P. B. (2023). Government And Commercial Insurer Payment Rates To Hospitals: A Commentary On Priselac. Health Affairs Forefront.

DOI: 10.1377/forefront.20230922.208319

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