10
Hospitals New Payment Schemes and Hospital Behavior

Sean Ennis

The cost of hospital care in the United States rose 734 percent between 1960 and 1994. Hospital costs grew much faster than the economy as a whole, with the percent of GDP accounted for by hospital care increasing from 1.7 percent to 4.9 percent. Because of this dramatic increase in real costs, both employers and the government have sought ways to reduce their spending on hospital care, or at least slow its rate of growth.

In the 1970s, the government tried to slow capital investment in health care by introducing certificate-of-need (CON) laws. These laws required state government approval to build new hospitals, to increase the size of existing medical facilities, and to purchase new medical equipment. The passage of these laws was motivated largely by the belief that health care costs were increasing because of the proliferation of duplicative facilities and equipment. Despite the widespread adoption of CON laws across the country, health care costs continued to grow rapidly.

In the 1980s and 1990s, the focus of cost control shifted away from the regulation of facilities toward increasing price competition. Historically, price competition had been limited for several reasons: the payment system lacked an incentive to provide fewer services or more efficient services; the insurance companies reimbursed care at any hospital, not just the lower-priced ones; and the physician and patient had almost complete control over the course of treatment. In recent years, employers, insurers, and the government have tried to increase price competition and reduce waste by reforming the basis for hospital payment, developing selective hospital networks, and restricting the ability of physicians to control the course of a patient's treatment.

Payment reform has involved changes in the unit of accounting that is reimbursed. An example of payment reform is the change from charging the insurer of an appendicitis patient separately for everything (e.g., bandages, blood tests, and bed-days), to charging one all-inclusive price based simply on the diagnosis. With this change, the payment more closely relates to the illness than to the precise bundle of services provided, creating an incentive for the hospital to seek ways of reducing the cost of treatment.

Increased price competition has resulted when insurers negotiate prices with hospitals, perhaps threatening to move patients away (by, for instance, dropping the hospital from the network of

____________________
The views expressed herein are not purported to represent those of the U.S. Department of Justice.

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