The frightening future that's haunting hospitals

October 31, 2013
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On this Halloween, hospitals around Indiana are spooked. The state’s three largest hospital systems have all announced plans to cut about 900 positions from their work forces. Most smaller hospital systems have also had cuts—just not large enough to make the news.

So what’s haunting these hospitals’ C suites?

The simple answer is, cuts in payments to hospitals by Medicare, the federal insurance program for seniors.

Here’s a rundown of Medicare cuts of the recent past and present:

Since about 2008, Medicare has been reducing payments for some specialist physicians—many of which are now employed by hospitals. The fiscal-cliff deal on Jan. 1 this year chopped out $15 billion in payments to hospitals. And the budget sequester, which hit March 1, sapped another $10 billion.

But the scariest picture comes from future cuts—and the very real possibility that hospitals will not be able to make up for Medicare’s reductions by hiking prices on private insurers. If anything, it looks like private insurers will mimic Medicare’s by whittling down their own payments to hospitals.

For the most sobering picture of the Medicare cuts that could come, check out the graph on page 7 of this May report by the Office of the Actuary at the Centers for Medicare and Medicaid Services.

It shows that Medicare paid 67 percent as much as private health insurers for the same inpatient services. And more importantly, it shows that percentage will decline steadily for the next 75 years, until Medicare payments equal just 40 percent of private insurers’ payments. The report warns that such cuts are not realistic if allowed to go on indefinitely, because they will put hopsitals out of business. But for now, they are the law.

Why will Medicare payments decline? Because a provision of the Affordable Care Act, aka Obamacare, calls for a new way to calculate the annual increases in Medicare’s payments to hospitals that assumes hospitals are going to get better at being cost efficient.

Before, Medicare essentially compared hospitals’ cost of operations against their peers, but now the Medicare program will assume that hospitals can generate the same level of productivity gains as the rest of the economy.

Judging by hospitals’ track record, they have no hope of keeping up with the rest of the productivity gains of the rest of the economy.

One reason for this is that labor-intensive businesses, like health care, have a much harder time reducing costs than, say, manufacturers, who can more readily replace people with robots.

But another key reason is that hospitals, especially those that are not-for-profit organizations, are inherently revenue maximizers, not cost minimizers. (I borrow these notions from this article by economist Joe Newhouse, now at Harvard Medical School.)

That is to say, whatever money the hospitals bring in they seek to spend—on new services, new facilities, new people. They do not try to keep costs low in order to maximize profits or to entice more consumers with lower prices. That's a good situation for holding up quality standards, but it also generates higher and higher levels of spending that must be maintained.

Hospital spending appears to go up so long as Medicare allows it, and it only goes down when Medicare forces it to go down.

That’s what Chapin White, a senior research fellow at the D.C.-based Center for Studying Health System Change, found when he studied hospitals’ behavior after the sudden Medicare cuts that were passed as part of the Balanced Budget Act of 1997.

Those cuts didn’t affect all hospitals equally: some saw cuts, and some kept seeing increases in Medicare payments. The hospitals that saw cuts, reduced their expenses—mainly through staff and fewer staffed beds—to exactly match the new revenue level, maintaining profit margins at roughly the same size as before.

Hospitals, like those in the Indianapolis market, that enjoyed continued increases, also kept their margins about the same—which means they raised their spending to match the extra revenue.

This time, the Medicare cuts are hitting the Indianapolis hospitals—and they are cutting staff and expenses right in line with White’s latest research findings.

White’s research has been groundbreaking because he was able to analyze data from private insurers, in addition to more widely available Medicare data. What he found was that insurers generally followed Medicare payments—whether they were going up or down. So if hospitals now hope to make up falling Medicare payments by “cost shifting” to private insurers, White thinks that’s a pipe dream.

Instead, as I have written before, hospitals are in the frighteningly unfamiliar position of being forced to do more with less.

  • Finally getting to the heart of the matter
    Thanks for putting up this article JK. People have assumed that hospitals are making cuts purely to maintain massive profits and line the pockets of the elite with even more money. While profitability might be part of it, this broader issue of reimbursement from Medicare affects all hospitals - for-profit and non-profit alike. If the reimbursement is down by a large percentage, then hospitals don't have the same level of money to work with and therefore have to make drastic cuts. Consider a hospital that exists in a very low income area that consists largely of Medicare payments. Does that hospital just close up shop and leave that area without a hospital? What makes it more alarming is when private insurers start to push for the same level of reimbursement reduction, and that REALLY puts hospitals in a bind. My spouse is a mgr at one of these hospitals (not executive level, but in the general know), and this is the sobering reality of why we're seeing massive cuts across all hospitals.
    • The linked PDF graph
      JK, the link to the PDF graph has an extra character causing the link to break.
    • To Dan
      Thanks for your comments, and thanks for pointing out the broken link. It's fixed now.
    • good article
      Much better article than your last one about over-staffing, JK. Thanks for backing up your assertions with facts. My wife just lost her job at IU Health..I appreciate you helping me to understand why.
    • For Profit
      This is exactly why I disliked Medicare not being accepted by for profit hospitals. If hospitals are for profit, they will attempt to minimize costs while examining their exposure to potential lawsuits. I hate non-for-profit hospitals. Every non-for-profit I have been remotely involved with has not been very concerned with keeping costs down. The health care system is screwed up. Congress has passed the affordable health care act, thus we should give it time to shake out to see if it actually improves anything. I hope it does, but I am skeptical.
      • For-profit hospitals
        Some for-profit hospitals (such as Cancer Treatment Centers of America) have been accused of cherry-picking their patients. They pay for limos etc for patients with good insurance. Accept very few with Medicare. Not sure how much cost-control goes on at that type of hospital.
      • All the same
        Rates for all procedures should be relatively similar whether it is Medicare, direct pay or private insurance footing the bill. Private insurance or direct pay should not be expected to pay more than is reasonable and customary for medical care. What other industry operates this way??? The insurance companies should put way more pressure on hospitals and Dr groups to pay reasonable and customary charges that would probably be closer to Medicare rates. Are the insurance companies being "persuaded" to not rock the boat so the government can pay out as little as possible through Medicare while shifting the burden of higher health care costs to corporations and people with more means?
      • Do more with less?
        Do more with less? Comon, the graph clearly shows the objective is to run the non-profit hospitals out of business. Doesnt take a genius to figure that out. Sheesh.
      • Nice
        Excellent article JK. I have a slide that I use at Grand Rounds and at medical meetings showing the healthcare segment as the only industry that has has a negative productivity growth in the us market. A lot of that, even acknowledging the labor intensive nature of medicine, is lack of adoption of technology that does in fact improve efficiency and outcomes. The resistance to any methods that necessarily being a change to the current volume growth gravy train is so deep and systematic that the largest payer has no choice but to signal drastic actions. Until the system is broken for providers, it will never be fixed for patients.
        • Patient-centric care
          As I read about the impact of disclosure, fair pricing, comparisons of treatment processes in the medical world, it seems that there's a huge reform coming to medicine in the United States. One article aimed at hospital managers, talks about how radically the hospital business model will have to change to go from one where medical facilities could grow no matter what the cost (using insurance payment dollars) to a model that is patient centric. Briefly, it means that the patient's needs are to be addressed in the most cost-effective way with less hospitalization, fewer tests, and more effective care. Indianapolis Hospitals, like many in the U.S., are going to be adapting to this new model and that will shift jobs. Isn't that how it is in other industries when big changes take place? The headlines about Medicare/Medicaid cuts don't tell much of the story. In fact, the ACA restored funding to Medicaid payment rates which had been reduced. Little by little, the information is getting out on what wise steps were included in the ACA-- even in Indiana.
        • Next round this spring
          Expect a whole other round of cuts this spring by the big three. ACA will reduce the patient census more than anticipated. I'll be interested to see how many administrators are on the chopping block. Clinical staff can administer. Administrative staff can't provide care.
        • It will all hit us where it hurts ACCESS
          You can't throw 900 healthcare providers out of the system and not have long waiting lines for services (perhaps even critical services). You can't continue to get quality care if suddenly there is no money there to pay for it. Rationing is inevitable. The result will be more deaths of the poor and elderly. It always comes down to this. The poorly named Affordable Healthcare Act is about control and not about healthcare. The CEO of Blue Cross recently stated that the "average" premium cost will go up 47%. uhhh how is that affordable???? He did say that was an average and that some would double. He did not talk about deductibles . I have heard they will be nearly impossible for those with type 1 diabetes. Now imagine all this in a nation where corporations are forced to put all workers on part time to prevent the horrendous loss of income through massive increases in premiums. You thought the recession was bad.... just wait. Republican Senator Long refused to even allow a vote on the Nullification of Obamacare in Indiana. Both of the political parties want this control over us. The system that now turns no one away will now ration us all. Thanks a lot Obama and the traitors in the Democratic and Republican parties.
        • To NiceOldSport
          Sorry to take so long to respond, but I would love to see that slide. I didn't know health care was the only industry with negative productivity growth. That's stunning.

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