Do Private Insurers Subsidize Public Programs?

Does cost shifting exist?  Do hospitals actually use private insurance to subsidize inadequate reimbursement from Medicare and Medicaid?  Insurers claim it does, but they would, wouldn't they? 

The first thing that you learn when you ask this question is that health care accounting is really, really screwed up.  Either hospital administrators are all unusually skilled dissemblers, or they really do preside over some alternate accounting universe, innocent of marginal costs or indeed clear unit pricing.  Presumably, this is a response to very, very heavy regulation--they design their accounting more to look good for the regulators than to, say, illuminate the actual cost of things.

Keith Hennessy offers the standard economic argument as to why cost shifting is not a problem:

While doctors and hospital administrators swear by it, I have always been skeptical of the cost-shifting argument.  If you believe that a hospital will raise the prices it charges privately insured patients in reaction to cuts in reimbursement rates from government programs, you must believe (1) the hospital has pricing power and (2) it has until now charged less than it could.  (1) is quite plausible in some circumstances.  I find (2) incredible.  If someone has pricing power, I generally believe they will exert it.  Are we to believe that providers of medical care were charging privately insured patients less than they could have before the cuts in government payment rates?  I am happy to hear arguments on the other side.

The PWC study assumes that medical care providers will pass through every dollar of reduced Medicare provider reimbursement rates as a dollar of higher costs to privately insured patients.  That's absurd.

I agree that one-to-one pass through is absurd, but I'm a little more open to the possibility of cost shifting.  Shadowfax outlines one way it might work:

From a theoretical economic point of view, this is accurate.  If health care providers were perfectly rational actors operating in a vacuum where their only goal was to maximize revenue, it would make sense.  You take what you can get.

But I would argue that the cost of providing health care -- especially for a hospital -- is relatively inelastic on a year-to-year basis.  The number of nurses, the payroll costs, the capital expenditures.  All of these are not quite fixed costs, but there is very limited ability to make drastic changes in them.  Yes, you can decide not to build the $300 million cancer center, or to build a less-opulent version of the cancer center for only $200 million -- there is long-range elasticity in the cost of providing care.  But once the buildings are in place, the scanners and equipment are purchased, and the staff is hired, the need to meet this year's operating budget becomes imperative. 

Government-funded revenue is completely fixed.  It's inelastic. There's no negotiation possible -- the rates are set and providers can take them or leave them.  But prices with private payers are negotiable.  When you are looking at a budget shortfall, or in the case of physicians, declining physician compensation, and you need more money, there's only one place to go -- to the insurers.  It's the only variable source of funding.

It's true that the "rational" thing to do would be to maximize the revenue from the private insurers every single year.  But in the real world it turns out that it's not so easy.  Providers have limited leverage, and it is a bilateral negotiation with a very powerful opponent.  You can't fight a scorched-earth battle every year, and with every insurer.  The only real threat we have is to drop out of an insurer's network -- which is the "nuclear option" in the health care contracting world.  You make that threat every year, and soon enough the insurers stop believing it.  You follow through on the threat, and it is a massive war, with media attention and angry patients and the risk of losing money if patients leave and don't come back.  Worse, you could go to war and lose -- you bear the cost of the war in PR and lost revenue and wind up with lower reimbursement anyway.  There are real risks and costs of taking the hardest possible line in negotiating reimbursement rates with the private insurers. The analogy I use is that most insurers and providers live in a state of perpetual détente.  We edge to the brink and back, over and over again.

. . .

So when do we go to the mat?  When do we pull the trigger?  When the budget crisis hits.  That can be caused by a drop in government funding, or the inciting factor could be anything else -- a change in the number of the uninsured, wage escalation, etc.   And I agree with the assertion that the pass-though is not 100%.   If nothing else, the insurers are not willing to give you 100% of your goal in every negotiation.  But the idea that there is no causal relationship is absurd.

Partly the disagreement is just over the time frame.  Over the short term, there probably is cost shifting, for the reasons Shadowfax outlines.  Over the long run, it might well even out.

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But there is a reason to suspect that cost-shifting exists, and it has to do with the costs rising basically evenly across regional competitive groups.  If one hospital has a budget problem, say because their staff went on strike, they can't make up the hole by going to the insurer and saying, "We need more money."  On the other hand, when the government sets rates, they do it for everyone.  So if they lower Medicare reimbursements across the board, hospital administrators know that everyone else is in the same hole.  They can demand more money, because everyone else is going to be demanding more money too.  This is why unionized industries, or cartels, really can often pass higher costs onto consumers.