Hospital Market

Outline

Why are nonprofits in hospital market? How do hospitals compete? What is hospitals’ objective function?

Background High share of total health spending led to

hospitals as target for cost containment Hospitals very labor-intensive (54%) Multiple payment sources

Characteristics of Hospitals Vast majority are private not-for-profit (NFP) Who are the residual claimants? Tripartite structure of hospital management

For-profit Organization supervised by the board elected by shareholders the ability to raise capital through equity and

bond markets the ability to separate ownership from control limited liability to shareholders

Nonprofit Organization Nonprofits not owned by shareholders Nonprofits do not have a governing broad

elected by shareholders Nonprofits cannot participate in equity funding

arrangements Nonprofits can accept charitable gifts Nonprofits may enjoy the tax exemptions

Stylized Facts on Nonprofit Organization operate in service sector, but no in

manufacturing one operate locally, not nationally have a higher quality of product than for-profit

firms, when they compete Have a self-perpetuating board of trustees are supported by, but not rely on tax exemptions rely on gifts or bonds for financing have a church related history rely on gifts of money or time or both for their

operations

Impact of Ownership Status on Health Care

Non-for-profit (NFP) organizations concentrate in the area of education, health care, and the arts. Hospital facilities: U. S. (60% ), France (16%),

Germany (33%) NFPs do not distribute profits to individual equity

holders (Non-Distribution Constraint) . NFPs enjoy some advantages including tax

exemption (corporate income and property taxes), better access to tax-exempt bond financing, and eligibility for private donations.

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Ownership Types in Taiwan

Public: managed by the government or public enterprises or universities

Private NFP: private universities or donations for purposes of charity or medical research

Private FP: physicians

Table 1 : Distinctions between FP and NFP Hospitals in Taiwan

Nonprofit HospitalsFor-profit Hospitals

Juridical persons making a certain amount of donation

Physicians under relevant medical regulations

Owners of Hospitals

Cannot distribute surplusCan distribute some proportion of profits

Right of Surplus Distribution

Before 1995, nonprofits were exempted from corporate tax. Since 1995, corporate income tax is not exempted if less than 80% of earning are not well spent. Land and property tax are exempted.

Owners of hospitals have to pay personal income tax from earningsNot exempted from land and property tax.

Tax Treatment

1. Charitable contributions2. Debt3. Retained earnings

1. Equity capital from establishers2. Debt3. Retained earnings

Sources of Capital

Sale of labor and services Charitable contributions

Sale of labor and servicesComposition of Revenue

Table 2: Number of Hospitals and Beds by Ownership Between 1996 and 2002

Number of Acute-Care Hospitals

Year Government Non-profits For-profits Total

1996 94 73 454 621

1998 97 74 423 594

2000 98 79 407 584

2002 95 82 370 547

Number of Beds in Acute-Care Hospitals

Year Government Non-profits For-profits Total

1996 32,273 30,641 29,106 94,016

1998 36,807 32,995 30,116 101,916

2000 38,592 36,892 32,171 109,655

2002 41,646 40,058 33,512 117,218

Concerns of Critics of Hospital Concerns of Critics of Hospital Ownership Conversions Ownership Conversions

Are the charitable assets properly valued or are they being sold too cheaply?

Will the transaction be subject to independent review?

Is the community at risk of losing valuable health care services?

Will the new entity continue to provide uncompensated care?

Will the proceeds of the sale be used to promote the original NFP mission (which federal tax laws requires)?

Theoretical Models of NFP Ownership Quality is uncertain or not contractible

Arrow (1963): NFP exists because of the uncertainty of identifying quality of care.

Hart et al. (1997) and Glaeser and Shleifer (2001): “incomplete contract theory.

Different objectives: Newhouse (1970): maximize

quality/quantity/prestige instead of profits or revenues

Bypass the monopoly profits Non-for-profit firms arise and supported by potential

customers through gifts of time and efforts in order to bypass natural monopolies arising from the scale of economy that the community would otherwise confront.

Theoretical Predictions of NFP

Quality is uncertain or not contractible NFP provides better quality of care NFP incurs higher expenditures

Different objective NFP provides better quality of care NFP incurs higher expenditure

Local public good NFP provides more uncompensated care

Findings from Previous Empirical Studies (I)

Most empirical studies are based on U. S. data Expenditure

No difference: Institute of Medicine (1986), Becker and Sloan (1985)

FPs are higher: Sloan et al. (2001), Granneman et al. (1986), Silverman et al. (1999)

Quality No difference: Keeler et al. (1992), Sloan et al. (2001),

Ettner (2001) NFPs are better: McClellan and Staiger (2000), Shen

(2002), Picone et al. (2002) Results from U. S. data are mixed and often

complicated by the complex setting of health system in U. S.

Study by Sloan et al. “Is there a Study by Sloan et al. “Is there a Dime’s Worth of Difference? Dime’s Worth of Difference?

Study Goals ◦ Re-ask old question: How do for-profit

hospitals compare on cost and quality? ◦ Use much longer cost and outcome

streams which allow us to examine patient “steering” post discharge

◦ Have several alternative indicators of outcomes—survival, changes in functional and cognitive status, and in living arrangements (admission to a nursing home)

◦ Not a hospital ownership conversion study

Why Payments Might be Why Payments Might be Higher For Patients Admitted Higher For Patients Admitted

to FP Hospitals to FP Hospitals

Upcoding of DRGPhysician fees may be higher More referrals to SNFs, home health

agencies owned by firm Not due to more lab tests, etc.

Study by Sloan et al. “Is Study by Sloan et al. “Is there a Dime’s Worth of there a Dime’s Worth of Difference? Conclusion Difference? Conclusion

Adjusting for endogeneity, FPs more expensive to U.S. Medicare, especially for downstream payments

Did not find differences in outcomes suggesting that quality comparable between FPs and the other ownership types

Should we be bothered by the added expense to Medicare from the FPs?

Results•Medicare Payments

◦ Both total payments for 6 months and payments less payments for index admission (“downstream payments”) were lower if patient admitted to NFP or G hospital than if admitted to a FP hospital.

◦ Differentials ranged from 8-11% for G and 5-6% for NFP (see Table 5)

◦ Differentials larger for downstream payments than for total payments

Mortality◦None of the ownership variables

were statistically significant at even the 10% level

◦Effect sizes very small

Regulation and Regulation and Competition Among Competition Among

Hospitals Hospitals

Trends of # of Hospitals and Beds

Trends of # of Hospitals (by accreditation)

Trends of # of Hospitals (by accreditation)

From 1995 to 2013 ， the number of beds increases from 90000 to 145000 ， but the number of hospital decreases from 787 to 474. Obviously, there is a trend of bigger hospitals.

Among hospitals, the number of community hospitals drops from 568 to 370, approximately 35% closed within 20 years.

On the contrary, major hospitals rises from 13 to 22, and minor teaching hospitals rises from 48 to 82.

# of beds (by accreditation)

Bed occupancy rate (by accreditation)

Structure: Putting it all TogetherStructure: Putting it all Together

Is the hospital market competitive, or not?

Case Study:

UNITED STATES OF AMERICA, Plaintiff, vs. MERCY HEALTH SERVICES and FINLEY TRI-STATES HEALTH GROUP, INC. Defendants.

Filed October 17, 1995

Mercy and Finley: only 2 acute care hospitals in Dubuque, Iowa propose to merge.

Justice Department sues for preliminary injunction.

Facts

Dubuque population = 86,403

Mercy: 320 staffed beds, average daily census = 127.

Finley: 124 staffed beds, average daily census = 63.

competition - outside 70m radius, but within 100 m.

Waterloo

DubuqueCedar Rapids

Iowa City, Iowa

Madison, Wisconsin

Freeport, Illinois

Insurance coverage for Mercy/Finley patients

50% Medicare/Medicaid

25% Fee-for-service (traditional indemnity)

25% Managed care (HMOs, PPOs) Negotiated 15-30% hospital price discounts.

Justice Department case

1) Where do Dubuque patients go for hospital care?

88% inside (Mercy or Finley)

12% outside

2) Where are Mercy/Finley patients from?

76% inside (Dubuque)

24% outsideDubuque the relevant geographic market, and merger

constitutes a monopoly.

Ruling

District court judge rejects Justice Department’s definition of geographic market as too narrow.“The government continues to fail to look at the

merger within the context of current market trends. All evidence is that there is a great deal of competition for health care dollars…”

“…if DRHS [merged entity] reacted in a noncompetitive manner, an HMO that could successfully induce Dubuque area residents to use alternative hospitals would be at a significant cost advantage.”

“There is also evidence that managed care entities can successfully induce Dubuque residents to use other regional hospitals for their inpatient needs.”

Merger of Mercy and Finley would not/could not result in higher prices.

Case Study ConclusionCase Study Conclusion

Even if only one hospital exists in a given geographic region, it may not be able to act as a monopolist

Ability of large, managed care buyers to shift patients can keep the market competitive.

Hospital ConductHospital Conduct

Large #s of sellers and low barriers to entry promote competition.

We expect increased competition to lead to:Higher output and quality.Lower price.

However, the hospital market has important differences.Hospitals don’t necessarily maximize

profits.Government is a major payer

Prices not set competitively.

Consumer less likely to shop around. Insurance and asymmetric info.

• Is hospital market competition good or bad for consumers?

Markets with fewer hospitals may face higher prices.But hospitals in more concentrated

markets may be larger, and econ of scale may reduce costs.

Look at price and quality effects of hospital mergers.

MAR Worse When There are MAR Worse When There are More Hospitals More Hospitals

More hospitals in market more competition among hospitals for doctors (and their patients) more Medical Arm Race

Cost and quality much higher than is socially optimal

Regulatory (Government) Regulatory (Government) Responses Responses

Entry regulation: certificate of need (CON)

Revenue or price regulation: Nixon price controls, state rate setting programs

Utilization review: Professional Standards Review Organizations Peer Review Organizations for Medicare

• Keeler and coauthors measured competition within a local market in this study and many others measured by the Herfindahl-Hirschman Index (HHI)

(6.5)

• Si = fraction of total hospital discharges in the market that hospital i has

• In other studies, output has been defined as patient days rather than discharges

• If the hospital is a monopolist (has all discharges in the market) HHI is 1

• If there are four hospitals with unequal number of discharges, the HHI is 0.152 + 0.352 + 0.272 + 0.232 = 0.27

• As the number of hospitals in a market rises, the HHI approaches 0 in value

• The key assumption underlying the use of the HHI as a measure of competition is that sellers find it easier to collude in price-setting when the HHI is higher.

Herfindahl- Hirschman Index (HHI)

Data from Los Angeles in 1990-1993 suggests that hospital mergers would ↑ prices >5%. 

(Town & Vistnes 2001)

Hospitals that merged between 1989 and 1996 lowered their costs two years after consolidation relative to comparable hospitals that didn’t merge

(Dranove & Lindrooth 2003)

Even if hospitals lower costs, they may not pass price savings on to consumers. Hospitals that merged in 1997-2001 raised their

negotiated PPO prices relative to the median market price.

Other studies suggest that hospital consolidation does not improve the quality of care.

These results suggest that more competitive hospital markets favor consumers.

How do hospitals compete?

The Profit-Maximizing The Profit-Maximizing HospitalHospitalThe Base Case

Profit Maximization When Only Profit Maximization When Only Quantity of Service is Only Quantity of Service is Only Decision Variable Decision Variable

Assume hospital faces a downward sloping demand curve◦P=p(x) inverse demand curve◦Let profit be π Then π = p(x)x - C(x)

Where C(x)= total cost of production output at quantity x◦dC/dx is the first derivative of total cost with respect to x

Profit Maximization When Only Profit Maximization When Only Quantity of Service is Only Quantity of Service is Only Decision Variable ContinuedDecision Variable Continued

dC/dx is the firm’s marginal costP(x)x = Total revenue R(x)dR/dx = dp/dxx+p(x) = Marginal

revenueProfit is maximized at

dπ/dx = dp/dxx+p(x)-dC/dx = 0

p

x

D

MR

AC

MC

x*

p*

p

x

D

MR

MC

x*

p*

AC

Profit (or “Cash Flow”)Maximization:Positive and Zero Profit Cases

Quantity is set at the quantity at which marginal revenue equals marginal cost. Once optimal quantity x* has been determined, optimal price p* is read from the demand curve. The optimal values are shown graphically in Chapter 5, Fig. 5.5, Panel A.

Profit Maximization When Only Quantity of Service is Only Decision Variable Continued

p

x

D

MR

AC

MC

x*

p*

p

x

D

MR

MC

x*

p*

AC

Profit (or “Cash Flow”)Maximization:Positive and Zero Profit Cases

Newhouse Model Newhouse Model

Explains how hospitals behave when they have an objective other than profit maximization

See introduction of paper for characteristics of hospital author trying to explain, at least as of 1960s

Hospital maximizes utility subject to a constraint

Derive constraint and then introduce hospital utility function

Fig. 6.1. Hospital Demand and Cost Curves for

Hospitals with High (H) and Low (L) Quality

Fig. 6.2. Hospital Demand and Cost Curves for Hospitals with

High (H), Low (L), and Very High (HH) Quality

Fig. 6.3. Hospital Quantity-Quality Frontier

Introduce Hospital Utility Function Introduce Hospital Utility Function

Fig. 6.4. The Hospital’s Optimum Quantity and Quality

How quality is measuredHow quality is measuredMore $=More quality???Perhaps higher ratio of staff to

patients (average daily census) Perhaps more and more

technologically sophisticated equipment

Sophisticated services, such as open heart surgery program, high level trauma unit, treatment unit for rare cancers, neonatal intensive care unit

Other Metrics for Hospital Other Metrics for Hospital Quality Quality Nurse staffing (to average daily census) Facilities and services offeredHospitals’ credentials (certifications,

affiliations) Patient outcomes: mortality rates (at

discharge, at 30 days following admission, at 1 year following admission, etc.)

Patient outcomes: rehospitalization rates Patient outcomes: change in functional

status, in cognitive status Process of care (chart reviews)