The Hospital

Eric Jacobson

Health Economics

First Hospitals

• The word hospital was first used in 12th century to refer to a facility run by the church that housed and cared for the sick, the disabled and the insane, as well as providing lodging for pilgrims and other travelers, orphans, and the poor.

• Only those with no homes stayed in the hospital.• Turn of century brought scientific advance in

antiseptics, anesthesia, anatomy, physiology and invention of X-ray

First U.S. Hospital…which state?• Pennsylvania hospital - 1751• Created by a bill passed by the Assembly with the

support of Benjamin Franklin• Obligated governor to provide 2,000 to match

2,000 in public donations for construction. • Six outstanding physicians worked twice a week

without pay.• Major expenditure category of 18th and 19th

century hospital? . . . FOOD

Community Hospital RevenuesAvg Total Rev (1995) $60m

Insurance33%

Medicaid12%

Medicare43%

Self-pay4%

Other8%

Three very different categories of financial success

• Basket-case institutions held together by bailing wire and disproportionate share funding (“Dish payments” from CMS). Often in the inner city, often in deep financial trouble from their heavy loads of uncompensated care.

– Disproportionate share hospital payments: additional reimbursement payments received by states from the federal government to defer the high cost of providing medical care to a large number of low-income individuals.

Three very different categories of financial success

• Teetering on the edge. Mostly nonprofits but including almost all for-profits. Damaged but not destroyed by managed care. Downsized in mid-1990s fearing capitation. Today, this group is surviving but not thriving. Vulnerable to the reduction in funding of the Balanced Budget Act of 1997, which eroded Medicare margins.

Three very different categories of financial success

• Monopolists. Organizations tend to be found in affluent suburban, low unemployment areas. During the late 1990s, operating margins in these top-tier financial performers often exceeded 10% - more than twice the national average.

Hospitals obtain revenues in a variety of ways

• Charges - “list prices” vs. “discounted charges”• PPS/DRGs - Medicare’s DRG system has been

adopted by many other payers.• Per Diem - per day payment of services, favored in

managed care contracts. • Capitation – still relatively rare in hospitals.

Stalling rather than proliferating.• Global budgets - getting a fixed grant for all of its

costs (VA hospitals, Canada, England)• Philanthropy and Grants (2%)

Hospitals differ from the standard firm in 3 significant ways:

• Medical care largely controlled by docs who neither pay nor receive any money from the hospital. Since doctors are the dominant voice in hospital operations, they often take on the role of “employees” and “owners.”

• Patients do not pay, due to insurance or charity.

• Ownership is usually unclear due to nonprofit structure of the organization.

Who gets the “profits” from a nonprofit hospital (NFP)?

• Medical staff?

• Administrative staff?

• Patients?

• Community?

NFPs & Quality of Care

• Why would we expect more quality from NFPs?

• Evidence from medical records for Medicare beneficiaries--no difference

• Other evidence mixed--psychiatric hospitals complaints favor NFP; others show no difference; LTC complaints favor NFP

• Adoption of new technology: no difference

Cost Shifting

• This is the process of charging one group (e.g., commercially insured patients) more to cover the loss due to undercharging another group (indigent patients or Medicaid).

• The pervasiveness of cost shifting and insurance coverage gives managers far more room to raise revenues and little incentives to find efficiencies that would reduce costs.

Dr. Solomon’s Dilemma – After Reading Dranove

1. Many hospital networks, such as the Beth Israel Deaconess Medical Center, are created from the merger of previously independent hospitals. List several reasons why you think so many hospitals have merged.

2. Beth Israel Deaconess has been a big money loser. What factors might account for this? What recommendations would you suggest to turn the bottom line around? Explain.

New Developments

• Systems/ Networks – Dranove?

• PHOs

• Joint Ventures / IDS

From Dranove, Ch 5:

“The emergence of managed care changed everything. Now hospitals and other providers must successfully compete within their local markets, which is why the merger wave of the 1990s is local. Whether to cut costs, boost prices, or both, providers are partnering.”

“A wealth of economic research from many industries generates two basic facts about mergers: the risks are great, and the savings are usually smaller than anticipated.”

“Perhaps the 1990s mergers were less about saving money and more about creating market power.”

What economic principle suggests provider networks will create

efficiencies?

• Economies of scale?• Economies of scope? What?• E of Scale – situations in which the LRAC of a

provider decline as output increases. Some studies suggest E-of-S and D-of-S, with efficient scale ~250 beds).

• E of Scope – situations in which an organization can jointly produce two or more goods (or services) more cheaply than under separate production of the goods.

Physician Hospital Organization (PHO)

Joint ventures between physicians, hospitals, and other providers. At a minimum negotiate with third party

payers.

Physicians originate 70 -80% of hospital’s financial decisions.

PSOs: New health care plans run by doctors & hospitals

• By the mid-1990s when the PSO trend reached its zenith, nearly 40 percent of all new HMOs, were being started by doctors and hospitals.

• Becoming underwriters, providers thought, would put decisions about how to treat patients back in their own hands.

New health care plans run by doctors & hospitals are a sickly bunch

Most plans that have run into trouble seem to have a hard time cracking down on the overutilization of medical services.

Why?

New health care plans run by doctors & hospitals are a sickly bunch. Why?

1. More difficult to cut hospital utilization.

Hospitals with their own health plans often wound up using them to funnel patients to their beds.

But a managed-care plan makes money by keeping people out of the hospital.

New health care plans run by doctors & hospitals are a sickly bunch

2. More difficult to demand lower physician fees or impose capitation payments.

Squeezing physician pay doesn't come naturally to plans owned by doctors and hospitals. Hospitals rely on the goodwill of doctors to bring patients to the hospital, so their health plans don't have a lot of leverage.

New health care plans run by doctors & hospitals are a sickly bunch

3. More difficult to limit enrollment of bad risks. Hospitals and doctors also have tended to enroll patients

they see often as the core membership of their health plans, forgetting that the profits in health insurance come from healthy people who pay their premiums but don't utilize services.

4. Short actuarial experience, scale, and capital (for marketing and $$$$ computer systems).

5. Plus bad market timing. (1995-99: years of falling profits due largely to more competition and the federal government's tightening grip on Medicare reimbursements.)

Definition of an Integrated System

A single economic entity offering the entire continuum of care, from

outpatient to inpatient to home care, in a single contract. Involves both horizontal and vertical integration.

What economic principle suggests IDS will create efficiencies?

• Economies of scale?• Economies of scope? What?• E of Scale – situations in which the LRAC of a

provider decline as output increases. Some studies suggest E-of-S and D-of-S, with efficient scale ~250 beds).

• E of Scope – situations in which an organization can jointly produce two or more goods (or services) more cheaply than under separate production of the goods.

Field of Dreams

“…when values, theory, incentives and strategies were aligned. Hospitals were going to vertically integrate to keep utilization and costs down and also be accountable for health, not just health care; and finally, once under the integrated umbrella, we could shift resources to their highest and best use across the continuum of care: from inpatient to outpatient, from step-down to home care, from inpatient surgery to the outpatient surgery center. It was a beautiful moment…we rejoice and moved on.” (Health Care in the New

Millennium, p. 185)