The Hospital Market, Part 2The Hospital Market, Part 2

Professor Vivian Ho

Health Economics

Fall 2007

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 AdvertisingHospital Advertising

% of hospitals that advertise rose from 36% in 1995 to 50% in 1998.

We often see ads for local hospitals in newspapers and magazines.

Why?

Dorfman-Steiner model of advertisingDorfman-Steiner model of advertising

The profit-maximizing amount of advertising occurs where:

If Ea equals .2, then 1% ↑ in advertising → .2% ↑ in demand.

And if EP equals 4, then Ea / EP 0.05 To max profits, hospital should spend 5% of total

revenues on advertising.

Demand of Elasticity Price Revenues Total

Demand of Elasticity gAdvertisinesExpenditur gAdvertisin

Hospital will spend more on advertising when:

Ea is higher.

EP is lower.↑ advertising costs $.  But when demand is

less elastic with respect to price, these costs can be passed onto the consumer.

Hospitals with greater market power will advertise more aggressively.

What type of advertising will What type of advertising will hospitals use?hospitals use?

Advertising the availability of services that all hospitals have may ↑market size, but not your own patient base.

Hospitals will use advertising to differentiate their product.Hospital rankings.Luxury services.

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 ¯ costs.

Look at price and quality effects of hospital mergers.

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.

Does Ownership Type Affect Does Ownership Type Affect Conduct?Conduct?

Empirical Evidence

Prices higher for for-profit hospitals, but NFP & public hospitals enjoy tax advantages, municipal bond discounts.

Only small differences in costs by ownership type.

But public hospitals provide more uncompensated care Data from CA calls into question tax-exempt status of

NFPs.

Has managed care changed Has managed care changed conduct?conduct?

Empirical Evidence

HMO hospitalization rates 15-20% lower than those of fee-for-service insurance plans.

However, HMO growth has not led to decrease in total hospital costs per capita at market level.

Maybe further HMO penetration required.Government still a dominant payer, and

reimburses generously.Maybe managed care doesn’t work.

Outcomes for patients covered by HMOs similar & sometimes better than those for fee-for-service patients.

Hospital Market PerformanceHospital Market Performance

How have price and quantity changed?

Year

Total Hospital Expenditures

(billions of dollars)

Average Annual Change from

Previous Period

Spending as a Percentage of

Gross Domestic Product

1960 $ 9.3 ___ 1.8%1970 27.6 11.6% 2.71980 101.0 13.9 3.61990 251.6 9.6 4.32000 417.0 5.2 4.22007 696.5 7.6 5.0

Hospital Expenditures in the United States, 1960-2007

Source: U.S. Department of Labor, Bureau of Labor Statistics, CPI Detailed Report (various issues).

Table 14-8 Hospital Price Inflation Trend in the United States 1975-2006

YearGeneral Inflation Rate

(urban consumers)Hospital Room InflationRate (urban consumers)

1975 9.1% 17.1%1980 13.5 13.11984 4.3 8.31988 4.1 9.31990 5.4 10.91992 3.0 8.81996 2.7 4.5

Inpatient Hospital Services

1998 1.6 2.71999 2.2 3.82000 3.4 5.52001 2.8 6.32002 1.6 8.42003 2.3 6.82004 2.7 5.72005 3.4 5.72006 3.2 7.0

Hospital inflation rate exceeds general rate for all but 1 year.

Despite move to prospective reimbursement by Medicare in 1983, hospital inflation continued.Possible explanations

1) generous insurance

2) fee-for-service medicine

3) lack of profit motive

4) quality competition

What about Quantity?What about Quantity?

Source: American Hospital Association, Hospital Statistics

1. Average length of stay declined, and admissions and occupancy rates declined through the 1990’s.

2. But staffing, outpatient visits rose.

Community Hospital Inputs and Utilization Trends in the United States, 1975-2005

Year Hospital Staffing

Ratio

Occupancy Rate (%)

Admission Rate (per 100 population)

Average Length of

Stay (days)

Outpatient Visits (per 100

population)

1975 3.00 74.9 15.5 7.7 88.3

1980 3.35 75.6 15.9 7.6 89.0

1985 3.86 64.8 14.0 7.1 91.7

1990 4.21 66.8 12.5 7.2 120.6

1995 4.59 62.8 11.8 6.5 157.7

2000 4.61 63.8 11.7 5.8 185.2

2006 xxx 68.9 11.7 5.5 200.2

Was growth in staffing, outpatient Was growth in staffing, outpatient visits inappropriate?visits inappropriate?

Ratings of inappropriate use of 3 medical treatments among 1981 Medicare population, as defined by expert panel of MDs.

Procedure Inappropriate use(%)

coronary angiography 17%

carotid endarterectomy 32%

upper GI tract endoscopy 17%

Similar findings in 1979-1982 for coronary artery bypass graft patients.

More recent studies find less inappropriate use in New York.However, practice variation studies show

many surgical procedures performed less often relative to other areas in U.S.

Source: Marc L. Berk and Alan C. Monheit, “The Concentration of Health Expenditures: An Update,” Health Affairs 20 (Spring 2001), Exhibit 1.

Table 14-10 Concentration of Health Expenditures by

the U.S. Population, Selected Years Percent of U.S. Population Ranked by Expenditures

1970 1977 1980 1987 1996

Top 1% 26% 27% 29% 28% 27% Top 2% 35 38 39 39 38 Top 5% 50 55 55 56 55 Top 10% 66 70 70 70 69 Top 30% 88 90 90 90 90 Top 50% 96 97 96 97 97 Bottom 50% 4 3 4 3 3

Distribution of health expenditures has become more concentrated.

Most severely ill patients receiving high-cost critical care in hospitals.

1/7 of all health expenditures spent on those in last 6 months of life.Do we need to ration health care costs for

the very ill?