Will Hospital Cost-Shifting Blunt the Impact of Medicare Payment Reform?

Ask any policy wonk to rattle off the most powerful ways to improve performance in the U.S. health care system and you’ll likely hear them mention payment reform. You’ll hear them talk about how the U.S. health care system has historically paid for quantity, not quality and these policy wonks will argue that successful health care reform must include introducing so-called pay-for-performance programs that link payments to outcomes.

These policy wonks are, of course, absolutely correct. As a former health secretary, who shall remain nameless, once remarked in a closed door meeting, the best way to get a message to doctors and to have them change their behavior is to write the message on a check. That is, altering the financial incentives for doctors can have a huge effect on what they actually do.

Because financial incentives are so important, many of us were encouraged that one of the most prominent elements in the recent Affordable Care Act was payment reforms introduced into Medicare. The bill set out plans to begin to 1) slow the rate of growth in Medicare payments, 2) more closely link payment to performance, and 3) stop paying for undesirable outcomes, like unwarranted hospital readmissions.

The challenge, however, is understanding how payment reform works when there are multiple payers. The impact of pay-for-performance programs and broader changes in payment schemes are fairly easy to predict in health systems where there is only one payer, like the British National Health Service.  In contrast, when there is more than one payer, as is clearly the case in the US, predicting the impact of payment system reforms becomes quite a bit more complicated.

One concept that has been a source of perennial debate in the U.S. is the question of whether or not cost shifting has a major effect on hospital prices. Cost shifting occurs when changes in the prices charged to one payer leads to commensurate changes in the prices charged by another payer.  The most readily cited example of cost shifting would be hospitals raising their prices for privately funded care in the face of reductions in the price of Medicare-funded services.

If cost shifting in hospitals was a frequent phenomenon in the U.S., it would have profound policy implications. In the absence of cost shifting, reductions in the Medicare reimbursement rate would lower overall health care spending, and hospitals would absorb the loss in revenue. On aggregate, this would mean a reduction in overall health care spending.

However, if hospitals were able to cost shift and raise the prices they charged to privately funded patients in the face of reductions in the price Medicare paid for services, then public patients would be free riding on the back of the privately insured. In that scenario, private insurance premiums would likely rise and the privately insured would be paying a de facto tax to subsidize Medicare and Medicaid enrollees.

More importantly, if cost shifting occurred in the U.S., then the government’s efforts to reduce Medicare spending would actually have no effect on overall spending. In essence, the impact of compressing Medicare spending on overall spending would be a bit like squeezing down on a balloon: you’d pinch one side but the other side would expand and the net volume of the balloon would remain the same – i.e., overall health care spending would remain the same.

So, is cost shifting a major concern in the U.S., or is it a straw man used by private providers to argue for higher government reimbursement rates?

Well, the answer is far from certain and it depends who you ask.

U.S. trends in gains from different payers certainly suggest that cost shifting might be real. An exhibit in a Health Affairs article on Medicare payment illustrates that most hospitals generally take a loss on Medicare and Medicaid patients, but tend to recoup that loss by making gains on privately insured patients (1). Indeed, as public prices went down in the 1990s, private prices actually increased.
However, as the old saying goes, correlation does not mean causation.

It turns out that the empirical evidence on the presence of cost shifting is far from certain.  The economics literature has not consistently found that cost shifting exists, and when it is discovered, the rate of shifting tends to be far lower than a dollar for dollar transfer from loss-making public prices to profit making private prices. What’s more, as I’ll discuss, the theory about cost shifting is often equally ambiguous.

Ask an economist who doesn’t work frequently in the health care arena about whether cost shifting is possible and their gut reaction will be a resounding no. That is because they assume that hospitals are profit maximizers. What they mean by that is that profit maximizing hospitals will charge the highest prices they can to privately insured patients, irrespective of changes in Medicare payment rates. Framed differently, these profit maximizers will not wait for reductions in Medicare prices to raise the prices they charge for private payers; they will have been charging high rates to private payers all along.

Two conditions need to be met for hospitals to cost shift in the face of reductions in public reimbursement rates. First, hospitals need to have sufficient market power (i.e., approach monopoly power) to raise prices and second, they must not have used all of that power prior to the change in public reimbursement rates. And, many U.S. health care analysts have argued that those conditions are met in the U.S., where many hospitals operate in monopoly markets and where a majority of hospitals operate as not-for-profits.

While it is certainly possible that not-for-profit providers are profit maximizers and will behave just like other private companies, some not-for-profits might have other priorities.  In economics jargon, these not-for-profit providers might be utility maximizers, not profit maximizers. Here, not-for-profits might seek to maximize the quality of their services and the volume of care they provide, rather than maximizing their profits. In this latter scenario, cost shifting is a real possibility.

So what are we to make of the threat of cost shifting? What do we make of the theoretical uncertainty and the ambiguous findings in the academic literature?

My hunch is that the threat of cost shifting is real, and I think this is one area where traditional economics doesn’t capture real world hospital behavior particularly well. I believe that hospitals and the doctors working in them have complex motivations and that while raising profits is certainly one motivation, it is not the only motivation. As a result, it is unlikely that hospitals, at present, are fully exploiting their market power and are currently charging private payers the highest prices possible. Further, this means that there is scope for hospitals to raise the prices they charge to private patients in the face of reductions to the reimbursement rate they receive for public patients.

This means that as we seek to alter the way Medicare and Medicaid fund care in the U.S., we need to remain aware of the knock on impacts it could have for those with private insurance. While it’s doubtful that there’s dollar for dollar shifting between public and private payers, we need to endeavor to get more precise empirical estimates of the size and scale of cost shifting and keep the prospect of cost shifting in mind as we press ahead with much needed payment reform.


  1. Lee, J. S., Berensen, R. A., Mayes, R., & Gauthier, A. K. (2003).  Medicare payment policy: Does cost shifting matter? Health Affairs, w484, Exhibit 3. Retrieved from http://content.healthaffairs.org/content/early/2003/10/08/hlthaff.w3.480.full.pdf



Columnist Zack Cooper is a health economist working at the Centre for Economic Performance at the London School of Economics. His column for the Health Policy Forum considers health policy and politics, often from the international perspective. Columnists are regular contributors to the Health Policy Forum who pose their own opinions and policy positions in the realm of health care and health policy. As a leading nonprofit health care research and consulting institute dedicated to improving human health, Altarum encourages open discussion and debate about the many challenges in health care today. All postings to the Health Policy Forum (whether from employees or those outside the Institute) represent the views of the individual authors and/or organizations and do not necessarily represent the position, interests, strategy, or opinions of Altarum Institute. Altarum is a nonprofit, nonpartisan organization. No posting should be considered an endorsement by Altarum of individual candidates, political parties, opinions, or policy positions.

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