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OCR for page 74
~, investor Ownership and He
7 Cow of Medical Care
What is the effect of investor ownership
on health care costs? Some observers be-
lieve that the rise in investor-owned health
care organizations exacerbates the cost
problem that investor-owned organiza-
tions will exploit inadequacies in whatever
system is used to pay for care; that cost in-
creases will result from the need to attain
consistent earnings growth to maintain the
price of their stock; and that it is costly to
pay dividends, taxes, and the salaries that
business executives expect from the reve-
nues they generate.
Others, however, expect investor own-
ership to help alleviate the cost problem,
particularly if payment systems reward re-
straints on expenses. Several factors are cited:
the motivation and clarity of purpose that
come with the for-profit form; economies of
scale that result from multi-institutional ar-
rangements; flexibility ofthe corporate form
that permits rapid response to changing con-
ditions; advantages in developing a reposi-
tory of managerial skills because greater
financial incentives and more extensive ca-
reer paths can be offered; and cost advan-
tages that can flow from cared! decisions
regarding markets to be targeted Cocation?
services offered, types of patients sought).
(See the Appendix to Chapter 1 for ~ sum-
mary of economic theories about the be-
havior of for-profit and not-for-profit
organizations. ~
The contradictory speculations indicate a
74
need to define different types of cost, to
identify the nature of various parties' con-
cerns about cost, and to examine the avail-
able evidence.
This chapter defines different types of cost
and reviews evidence on ownership-related
differences in hospital costs. Ibe impact on
the cost of acquisition of hospitals by for-
profit chains is discussed next, followed by
a review of what is known about cost dif-
ferences Mat relate to the ownership of other
types of health care facilities, such as nurs-
ing homes and freestanding ambulatory care
centers. The chapter closes with the com-
mittee's conclusions.
DEFINITION AND MEASUREMENT OF
COSTS- AND WHO IS CONCERNED
Costs can be categorized according to who
incurs them. First, providers of health care
incur operating costs including capital
costs in producing goods or services. They
purchase resources, including plant and
equipment. They also incur costs for the
supplies and personnel required to provide
patient care. For purposes of clarity we will
call these costs "expenses."
Second, the purchasers of health care pay
a price for the care they buy. For some pay-
ers this price is based on We hospital's charges
(or a discount therefrom); for some, the price
is based on reimbursement for allowable ex-
penses incurred. In either case the price
OCR for page 75
INVESTOR OWNERSHIP AND THE COSTS OF CARE
paid becomes cost to purchasers and reve-
nue to providers. We will call costs to the
purchasers of health care "price."
Accordingly, two types of questions arise
regarding cost and type of ownership. The
first is concerned with ownership-related
differences in expenses per unit of output.
The second is concerned with ownership-
related differences in the price that pur-
chasers pay for similar services.
The two questions are of interest to dif-
ferent groups. Economists, who are con-
cerned with efficiency, are interested in the
relationship of ownership type to expense
per unit of output. Some theorize that the
not-for-profit organization's prohibition on
distribution of profits leads to an emphasis
on other goals, which are not conducive to
efficient operations. For example, it is ar-
gued that administrators of not-for-profit
hospitals seek'added prestige for their hos-
pitals by increasing the range of services,
equipment, and personnel, which results in
an expansion of services without adequate
regard for their need or likely use (Lee, 1971~.
It is commonly believed that the economic
discipline that is assumed' to accompany the
more singular purpose of for-profit organi-
zations helps them to avoid such pitfalls and,
hence, to operate more efficiently.
Purchasers of care are more interested in
price than in productive efficiency, espe-
cially since the' move away from cost-based
reimbursement by Medicare and most Blue
Cross plans. Questions of relative efficiency
are of little interest unless they translate into
lower prices. Until recently, charge-paying
purchasers have been generally inattentive
to price differences among hospitals, in part
because higher hospital prices could be
passed along in higher premiums and be-
cause patients and the physicians who or-
dered services were substantially insulated
from price differences because of thi'rd-par~
payments. Thus, keeping strict control of
expenses was often not a necessity for hos-
pitals. This picture is of course changing rap-
i~y. Medicare's prospective payment system
75
and the emergence of much more price
competition are putting pressure on both
expenses and price. Providers who can over
services for lower prices now stand to gain
market share. Questions of quality wit likely
become more salient.
Measurement and comparisons of hospi-
tal expenses end ' revenues are complicated
by hospitals' being "multiproduct firms." A
firm with one standard product devotes all
expenses to the production of that product,
making it' relatively simple to calculate the
cost per item. But hospitals have numerous
"products," including many types of inpa-
tient services, outpatient services, ancillary
services, and, at some'hospitals, educational
and nonpatient care services. Even if the
discussion is limited to inpatient services,
these can be measured as admissions, days
of care, and canny for patients with specific
diagnoses. Comparisons remain Occult even
after a unit of comparison has been selected.
For instance,' a day of care in one hospital
may differ from' a day of care in another
hospital in terms of services provided and
their frequency and quality. Severity of ill-
ness of patients with the same diagnosis can
vary widely. Another problem is that cal-
culations of expense per unit of ''output are
influenced by the method used to allocate
indirect costs (such as administration, laun-
dry, capital costs, etc.) to revenue depart-
ments.~ Although payers who paid on the
basis of incurred costs all specified indirect
cost-allocation methods, there nevertheless
was considerable leeway for hospital man-
agers to manipulate allocation to maximize
revenues. In addition, if a hospital was part
of a multi-institutional system, some indi-
rect expenses could be allocated either to a
hospital or to over entities (such as the home
office), depending on the incentives in reim-
bursement rules. Thus, several variations in
cost-allocation processes can make expense
comparisons among institutions imprecise,
even for a welI-defined service such as a
Drain scan.
Price comparisons are further compli
\
OCR for page 76
76
cased by differences in the extent to which
hospitals provide uncompensated care. A1-
though cost-based purchasers pay on the ba-
sis of expenses incurred in the care of their
covered patients. others Dav what the hns
FOR-PROFIT ENTERPRISE IN HEALTH CAM
published studies. Only such data would al-
low differences due to ownership type to be
distinguished clearly from differences as-
sociated with membership in a multi-insti
, ~tutional system.
pital charges. Such charges must be set at ~.7 11 . 1.
a level that covers the institutions' expenses
in caring for patients who either pay less
than their share of expenses or pay nothing.
Thus the price for charge payers and certain
cost payers includes a subsidy to patients
who cannot or do not pay for the full costs
of their care.2 Differences among institu
tions in the amounts of uncompensated care
that they provide are thus likely to affect
their charges, unless the institution has ac
cess to nonpatient care revenues with which
to subsidize uncompensated care. For those
concerned with the price of care for partic
ular groups for instance, a privately in
sured employee group- such price and cost
shifting and resultant price differences are
important.
Finally, it is important to recognize that
all available studies are of hospitals oper-
ating under economic incentives and con-
straints that existed prior to the introduction
of Medicare prospective payment.3 Al-
though these studies describe expenses,
prices, and margins under one set of incen-
tives, comparative data are not yet available
to indicate how different types of hospitals
have responded to the new incentives.
However, early data show that growth in
hospital expenses has slowed significantly.
rew avallaole studies compare me two
twes of systems. However the authors of
one national study that did make this com-
parison note, '~e clear pattern that emerges
from the study is that in 1980 there were
much greater similarities among hospitals of
the same ownership type (for-profit or not-
for-profit) than among hospitals of the same
organizational type (multi-hospital system
tar ~'o~ct~nr~incr)
~^ ^~ ,/ .... Clearly in 1980 the
strategies and performance of for-profit and
not-for-crofit multi-hospital system hospi-
tals had not converged as some observers
believe they have today" (Watt et al., 1986a).
Expenses
According to popular belief and economic
theory (see the Appendix to Chapter 1), for-
profit organizations produce services less ex-
pensively. Indeed, the assumed expense
disadvantage of not-for-profit hospitals has
prompted serious doubt about public poli-
cies that are believed to encourage the not-
for-profit mode (Clark, 1980~. Studies ex-
amined by the committee show the postu-
lated for-profit advantage in expenses to be
a myth.
Table 4.1 summarizes eight studies that
analyzed hospital expenses as they relate to
ownership. one methods, data sources and
dates, and geographic scope of the studies
varied considerably. As might be expected,
therefore, results were not entirely consis-
tent; however, the weight of the evidence
and the overall direction is clear: not-for-
profit hospitals controlled their expenses
more effectively than did for-profit hospitals
of the same general size. (All studies ex-
cluded large teaching hospitals from their
analyses.)
Five of the studies compared the ex-
penses per day in for-profit and not-for-profit
STUDIES OF HOSPITAL EXPENSE
AND PRICING
Many studies examine the relationship
between type of hospital ownership and ex-
penses, prices, and profitability. The com-
mittee focused on recent studies that examine
investor-owned chain hospitals, rather than
for-profit hospitals in general. The ideal
comparisons of independent and chain hos-
pitals, both for-profit and not-for-profit, are
not always possible from available data and
OCR for page 77
INVESTOR OWNERSHIP AND TlIE COSTS OF CARE
hospitals, making more or less rigorous at-
tempts to control for institutional size and
geographic location. On this measure, for-
profit chain hospitals had higher expenses
than not-for-profit hospitals in four of the
five studies. The range was from 3 percent
Tower in a Florida study to 10 percent higher
in a national study. In another national study
the difference was not statistically signifi-
cant.
Seven of the studies compared expenses
per case (sometimes measured as "per ad-
mission" or "per discharge." For-profit hos-
pitals' expenses were again found to be higher
than not-for-profit hospitals in six of the seven
studies. The range was from 4 percent lower
(again in the Florida study) to 8 percent higher
in one of the two national studies. On this
measure, the differences were not statisti-
cally significant in two of Me seven studies;
however the two studies with the largest
number of observations found for-profits to
have statistically significant higher costs.
Studies that examined both perfidy and per-
case expenses generally found the not-for-
profit advantage to be larger on the former
measure, largely because of shorter average
lengths of stay in for-profit hospitals.4
The pattern of differences in expenses
notwithstanding, two studies one national
(1974-1980) and one in California (1977-
1981)-showed no major difference in the
average annual rate of increase in expenses
per discharge between for-profit chain hos-
pitals and not-for-profit hospitals (Coelen,
1986; Pattison, 19861. During this period of
rising hospital expenses, for-profit chain
hospitals constrained expenses no better and
no worse than not-for-profit hospitals.5 '~ '
One reason for the for-profits' expense
disadvantage can be found in rates of oc-
cupancy. Unit expenses (expenses per case
or per day) are affected by the hospital's
occupancy rates, owing to the number of
cases to which fixed expenses must be al-
located. In 1983, when overall hospital oc-
cupancy was 73 percent, for-profit chain and
for-profit independent hospitals had occu
77
pancy rates of 62 and 64 percent, respec-
tively, lower than the 74 and 75 percent
occupancy rates of not-for-profit chain and
independent hospitals (Peter Kralovec,
Hospital Data Center, American Hospital
Association, 1985, unpublished data).6
One study estimated that each additional
percentage point of occupancy reduces op-
erating expenses by $2.00 per case, total
patient care expenses by about $2.50 per
case, and general and administrative ex-
penses by about $3.00 per case (Watt et al.,
1986b). Thus, according to this study the
1983 12-percent difference in average oc-
cupancy rate between for-profit and not-for-
profit chain hospitals accounts for $2S.56 in
operating expenses per case. This repre-
sents only 1.5 percent of the $1,712.88 av-
erage operating expenses per case in for-
profit chain hospitals. However, it accounts
for almost one-third of the $78. 72 difference
in average operating expenses per case be-
tween for-profit chain and not-for-profit chain
hospitals.
Because of the large size offor-profit chain
hospital organizations, economies of scale
might be expected to occur in some areas.
Investor-owned hospitals might be expected
to have Tower administrative expenses be-
cause of their profit orientation and their
economies of scale. But both national and
California data show that investor-owned
hospitals operate with higher administrative
expenses than their not-for-profit counter-
parts (Pattison and Katz, 1983; Pattison, 1986;
Watt et al., 1986a). Earlier caveats con-
cerning different ways of allocating over-
head costs in hospitals are particularly
applicable to chain organizations. Such or-
ganizations have some flexibility in spread-
ing corporate overhead expenses across
hospitals. Under cost-based reimbursement
it was advantageous to allocate as many ex-
penses as were allowable to the central office
so that they could be reallocated to the hos-
pitals with the greatest Medicare loads. These
costs became the prices to government pay
ers.
OCR for page 78
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80
Economies of scale resulting from bulk
purchasing might also be expected to lower
expenses of investor-owned chains for drugs
and supplies. However, Wad et al. (1986a)
fount] higher aggregate expenses for drugs
and supplies sold to patients in for-profit
chain hospitals than in not-for-profit hospi-
tals on a per-day basis. If savings in the pur-
chase price had been realized there, they
were absorbed by the use of more charge-
able items per day in for-profit than not-for-
profit hospitals (Pattison and Katz, 19831.
Personnel constitute a major hospital ex-
pense. Data from studies of 1978 and 1980
showed that for-profit chain hospitals em-
ployed fewer full-time equivalent staff per
adjusted average daily census than did not-
for-profit hospit~s.7 However, the for-profit
hospitals paid higher salaries and benefits
per employee, which largely eroded any dif-
ference that might have shown up in lower
total personnel expenses (Watt et al., 1986a).8
Capital costs are incurred in the pur-
chase, construction, and improvement of
plant and the purchase of major equipment.
For-profit chain hospitals operated with sig-
nificantly higher capital costs relative to op-
erating costs than did not-for-profit hospitals
(Anderson and Ginsberg, 1983; Watt et al.,
1986a,b). This is due in part to the younger
accounting age of for-profit chain facilities
than not-for-profit facilities, but it is not
known how much accounting age reflects
the newer facilities or the timing of acqui-
sitions. Nor is it known how much capital
costs reflect the cost of acquisitions rather
than expenditures to improve plant or
equipment. Also not known is the extent to
which acquisitions represent the rescue of
hospitals in danger of closure or needing
renovation and the extent to which con-
struction represents the addition of unnec-
essary capacity.
Prices
How do the prices paid by purchasers of
care compare at for-profit and not-for-prof~t
FOR-PROFIT ENTERPRISE IN HEALTH CARE
hospitals? Studies have examined two as-
pects of price-overall price to payers and
strategies used by hospitals, such as markup
and patient selection.
Table 4.2 arrays six studies of price dif-
ferentials between for-profit chain hospitals
and not-for-profit hospitals. The studies con-
sistently found that prices of for-profit chain
hospitals were substantially higher than the
prices of not-for-profit hospitals chain or
independent. The price-per-day differential
for charge payers ranged from 23 to 29 per-
cent higher in for-profit chain than not-for-
profit hospitals; for cost payers, from 11 to
13 percent. Although smaller, the per-case
differential was still substantial, ranging Tom
17 to 24 percent for charge payers and from
8 to 15 percent for cost payers such as Med-
icare. Across both types of payers the dif-
ferences in the average price realized by the
hospitals (net patient revenues) ranged from
12 to 14 percent; when measured per ad-
mission, to about 17 percent on a per-day
basis. Because investor-owned companies
own less than 10 percent of the nation's hos-
pital beds, these differences in price are the
equivalent of less than half of one percent
of the nation's hospital cost.9
It can be argued that the price paid by a
community for hospital care should include
nonoperating revenues provided to not-for-
profit (anc! public) hospitals from philan-
thropy and grants, and that adjustments
should be made for the net difference be-
tween tax subsidies to not-for-profit hospi-
tals and taxes paid by the for-profits.
Philanthropy and grants can be viewed as a
price paid by the community for care and,
thus, as an economic cost to the community.
It can also be argued that tax payments are
returned to public coffers and therefore rep-
resent a reduction in net price to the com-
munity. Several studies attempted to make
these complex adjustments (Table 4.3~.
All of the studies began with net patient
service revenue the average price mea-
sure described above and made additional
adjustments. Lewin et al. (1981), using 1978
OCR for page 81
INVESTOR OWNERSHIP AND THE COSTS OF CARE
data, removed an estimated income tax fig-
ure from the for-profit hospitals' average.
Sloan and Vraciu (1983) performed the same
adjustment using different data that in-
cluded a more explicit measure of taxes (but
not a higher income tax rate). Finally, Watt
et al. (1986a) widened the adjustment to
standardize for differences in public subsi-
dies and contributions received by not-for-
profit hospitals in 1980. Sloan and Vraciu's
results from Florida, which show little re-
maining price difference after removing taxes,
stand in contrast to the other two studies,
which cover more states and show a residual
difference of about 10 percent. While the
latter difference is large, the authors were
unable to estimate its statistical significance.
Watt et al. (1986a) point out that taxes paid
by the for-profit group accounted for less
than half the difference in price per day be-
tween the for-profit and not-for-profit hos-
pitals.
These calculations of"community" cost
have been criticized on the grounds that
taxes accrued to the nation, not to the local
community, and that only a small portion of
tax money is spent on health. Furthermore,
the studies measured accrued, not paid, taxes.
For growing organizations, taxes paid are
lower than taxes accrued (see Chapter 3; see
also Lewin et al., 1983; Conger, 1983~. Fi-
nally, the studies make no adjustments for
differences between types of hospitals in the
costs of capital, especially the subsidy rep-
resented by greater access to tax-exempt
bonds by not-for-profit hospitals.
The studies reviewed to this point have
used average hospital revenues per case as
a measure of price. A small study by Blue
Cross/Blue Shield of North Carolina (1983)
took a different approach. This study com-
pared payment claims of six for-profit chain
hospitals with similar-sized not-for-~rofit
hospitals for three frequently performed
procedures (hysterectomy, cholecystec-
tomy, and normal deliveries) in 1981 and
1982. Charges at for-profit chain hospitals
were higher (ranging from 6 to 58 percent)
81
than those at not-for-profit hospitals, with
the exception of one for-profit chain hospi-
taT's charges for normal deliveries which
were 10 percent lower than the comparison
hospital's. Comparison of the for-profit chain
hospitals with other hospitals in the same
communities showed a near-perfect pattern
of higher charges by the former.
MARKUP
Given the findings of equal or higher ex-
penses and considerably higher prices in for-
profit chain hospitals, there is likely to be a
difference in the markup by hospitals of dif-
ferent ownership types. The most visible
component of hospital price is routine daily
service-the basic room rate. Because this
component is likely to be the most price
sensitive, many hospitals try to keep routine
service prices close to expenses, or even
accept a Toss, recouping profits on ancillary
services for which demand is generated
once the patient is in the hospital (e.g., di-
agnostic tests). This strategy appears to have
been pursued more vigorously by for-profit
than not-for-profit hospitals, although it is
followed by both.
Four studies using data from different
sources and years all show that routine daily
room services were priced at or below ex-
penses by all types of hospitals (Lewin et
al., 1981; Watt et al., 1986a; Pattison and
Katz, 1983; State of Florida Hospital Cost
Containment Board, 19841.~° However, an-
cillary services appeared to be marked up
to be highly profitable. In Florida in 1982,
the markup for ancillary services at for-profit
hospitals was 121 percent; at state hospitals,
88 percent; and at not-for-profit hospitals,
74 percent (State of Florida Hospital Cost
Containment Board, 1984~. California data
indicate that all ownership types earned in-
come on clinical laboratories, central service
and supplies, pharmacy, and inhalation
therapy, but in each case for-profit chain
hospitals made a greater profit than not-for-
profit or public hospitals (Pattison and Katz,
OCR for page 82
82
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OCR for page 84
Study Controls
Data Sources Measure Findings
84
FOR-PROFIT ENTERPRISE IN HEALTH CARE
TABLE 4.3 Summary of Study Findings Concerning Net Community Cost
Lewin et al. 53 matched pairs of 1978 Medicare Cost Net patient ser- For-profit chain hos
(1981) hospitals Reports, California, vice revenue pitals 18 percent
Florida, Texas less taxes per higher than not-for
adjusted day profit hospitals be
fore tax adjustment;
12 percent higher
after tax adjust
menta
Sloan and Nonteaching hospitals Data reported to Net operating For-profit chain hos
Vraciu (1983) under 400 beds Florida State Cost fiends per ad- pitals 2 percent
Containment Board lusted patient higher than not-for
dayb profit hospitals
Net operating Difference not statisti
fi~nds per ad- cally significant
justed admis
sionb
Watt et al. 80 matched pairs of Medicare Cost Be- Net patient ser- For-profit hospitals 17
(1986a) hospitals, adjusted ports, 1980; AHA vice revenue percent higher than
for case-mix differ- Annual Survey of standardized not-for-profit hospi
ences Hospitals, 1980; Of- for differences tats before adjust
fice for Civil Rights in accrued meet; 10 percent
Survey of lIospi- taxes, public higher afteradjust
tals, 1980 subsidies, and menta
contributions
income, per
adjusted day
Methodological difficulties in calculating Me measures precluded estimation of statistical significance. The 18
percent difference in net patient revenues in the 1981 study and the 17 percent difference in the 1986 study were
statistically significant (p < .01~.
bNet operating funds are defined as net operating revenues (net of contractual allowances and unpaid accounts)
minus income taxes.
19831. Furthermore, ancillary services that
were profitable were used with greater fre-
quency per patient day and per admission
in for-profit chain hospitals than in not-for-
profit hospitals. However, ancillary services
that broke even or lost money were used at
similar rates in for-profit chain and not-for-
profit hospitals. In California, ancillary ser-
vices contributed a higher proportion of to-
tal revenues in for-profit chain than in not-
for-profit hospitals in 1982 (69 percent com-
pared with 63 percent), and this differential
occurred after a period of years in which
hospitals of all types of ownership shifted
more inpatient charges to ancillary services
(Pattison, 19861. In another study that used
national data, differences in pricing or use
of ancillary services, or both, resulted in
significant differences in ancillary service
charges per case: in for-profit chains, charges
were almost 34 percent higher and in not-
for-profit chains, a htHe over 5 percent higher
than independent not-for-profit hospitals
(Coelen, 1986~.
The studies reviewed so far measure
markup on individual components of patient
care. Watt et al. (1986b) took a broader mea-
sure gross patient care markup, defined as
total patient charges divided by total oper-
ating costs ant! found that for-profit chain
hospitals averaged 14.2 percentage points
higher than not-for-profit chain hospitals.
OCR for page 86
86
factors, the authors found no statistically sig-
nificant difference in after-tax margins on
total revenues between Florida's for-profit
chain and not-for-profit hospitals. The raw
data showed not-for-profit hospitals to be
slightly more profitable than for-profit hos-
pitals.
As studies show, nonpatient care reve-
nues and taxes paid have a substantial im-
pact on the bottom line of both not-for-profit
and for-profit hospitals. Comparing the prof-
itability of hospitals by measures other than
margin on total net (aDcer-tax) revenues omits
an important source of revenue for not-for-
profit hospitals, and an important deduction
from revenues of for-profit hospitals. Al-
though for some purposes it is important to
compare levels of profitability achieved
through patient services, such a measure
does not indicate the financial health or fu-
ture viability of hospitals. Indeed national
figures indicate that the average u A. hos-
pital had a negative margin on patient care
service until the 1980s, although this is to
some degree an artifact of the tendency of
many not-for-profit and public hospitals to
expend any surpluses as fast as they were
achieved. Positive total net margins were
achieved only through the contribution of
Inpatient care revenues (see Table 5.1,
Chapter 51.
The studies reviewed have all used con-
trols to try to ensure that the hospitals being
compared are similar in characteristics such
as so location, and teaching status that
are expected to affect profitability. Thus, the
studies' finding that for-profit hospitals are
more profitable than not-for-profit hospitals
(even when margin on after-tax total net in-
come is the measure) is based on similar not-
for-profit and for-profit hospitals. But for-
profit and not-for-profit hospitals are not
similar in all ways. For-profit hospitals, for
example, are more often located in sun-belt
states, are smaller than not-for-profit hos-
pitals, and are virtually never teaching hos-
pitals. National, uncontrolled data that
compare for-profit (chain and independent)
FOR-PROFI T ENTERPRI SE IN HEALTH CARE
TABLE 4.4 Total Net Margin of U. S.
Community arid For-profit Acute Care
General Hospitals, 1980-1984
Year
United States For-profit
1980
1981
1982
1983
1984
4.6
4.7
5.1
5.1
6.2
3.9
4.4
5.1
4.2
4.8
SOURCES: Office of Public Policy Analysis,
American Hospital Association, Chicago, Ill.;
Federation of American Hospitals, Statistical Pro-
file of the Investor-Oumed Hospital Industry, 1979
and 1980, 1981, 1983, and personal communica-
tion, SamuelMitchell, Director ofResearch, Fed-
eration of American Hospitals, 1985. For-profit
figures are after taxes.
with all U. S. community hospitals (includ-
ing for-profit and not-for-profit hospitals and
nonfederal public hospitals), show that the
for-profit group as a whole has not been more
profitable than the average U. S. hospital in
terms of total net margin. Indeed, in four
of the past five years, the for-profit hospitals
have been less profitable; in one year, prof-
itability was equal (see Table 4.4~. Further-
more, during the period covered by the
studies reviewed, for-profit hospitals and the
companies that own them did not on average
generate high profit margins when com-
pared to other industries. Average profit
margins for two-thirds of American indus-
tries exceeded margins for the hospital sec-
tor (The Value IAne Investment Survey, 1981
and 1982, cited in Sloan and Vraciu, 1983~.
In sum, the studies reviewed show that
for-profit chain hospitals have been more
profitable than similar not-for-profit hospi-
tals, but not-for-profit hospitals as a group
have been less profitable than the average
hospital. Thus, a for-orofit chain hospital of
the same size, in the same location, and
similar in other aspects to a not-for-profit
hospital is likely to achieve higher margins.
The reverse is true for the average for-profit
hospital, compared with the average com-
munity hospital.
. . ~
OCR for page 87
INVESTOR OWNERSHIP AND THE COSTS OF CARE
COSTS AND ACQUISITION OF
HOSPITALS
The grown of for-profit chains through
acquisition (and, to a lesser extent, through
construction) has led to two concerns about
impact on cost. The first, particularly among
third-party payers who pay charges, per-
tains to the for-profit sector's willingness to
price "aggressively" (i. e., to charge more).
The second concern stems from the capital
costs associated with an acquisition, which
can be passed on to charge payers, as well
as to cost payers, who have included capital
costs (interest, depreciation, and, for for-
profits, return on equity) as a reimbursable
expense under cost-based reimbursement
(and currently as a "pass through" under
prospective payment). Until recently, ac-
quisitions also put in place a new and higher
depreciation schedule (based on the price
paid for a facility), which was reimbursed as
an expense and thereby contributed impor-
tant cash flow.
A General Accounting Office (GAO) re-
port on the costs associated with Hospital
Corporation of America's 1981 acquisition of
Hospital Affiliates International found a first-
year net capital cost increase of$55.2 million
from the acquisition of the 54 Hospital Af-
filiates hospitals $62.5 million from inter-
est, $8.4 minion from depreciation, minus
$15.7 million in savings from a reduction in
home office costs. GAO calculated Medicare
cost increases at only two of the acquired
hospitals, and estimated them to be nearly
$600,000 in the year following acquisition
(U.S. General Accounting Office, 1983~.~2
The GAO report did not conclusively an-
swer the question of the magnitude of the
increase in hospital prices that results from
hospital mergers and acquisitions. How-
ever, the fact that very substantial increases
in reimbursable expenses could result from
an acquisition, even with no change in the
services being provided, led Congress to
change the law that permitted an acquiring
company to revalue the assets it acquired
87
for purposes of being reimbursed for de-
preciation expenses under Medicare.
Three studies shed light on the changes
made by new owners after an acquisition.
One study grouped hospitals by length of
ownership by a chain, noting that average
expenses were Tower in hospitals that had
longer affiliations with a for-profit multihos-
pital system than in those with a shorter
affiliation. They found support for a hypoth-
esis that companies acquire poorly managed
hospitals and improve their efficiency (Becker
and Sloan, 1985~. Two studies conducted for
the committee described some character-
istics of acquired hospitals and analyzed
changes in the years immediately following
acquisition. Pattison (1986) studied nine
California hospitals acquired by for-profit
systems between fiscal years 1977-1978 and
1981-1982. The study showed evidence that
the hospitals were initially in financial trou-
ble and that the change in ownership gen-
erated some dramatic operating changes. At
the beginning of the period the hospitals
showed an after-tax Toss of $1.38 per patient
day, which was changed to a $23.70 after-
tax profit per patient day about two-and-a-
half years after acquisition a profit level
below that of other for-profit chain hospitals,
but substantially higher than that of com-
parison for-profit hospitals that remained in-
dependent.
Apparently, some of the increase in prof-
itability was achieved by initiating operat-
ing-cost efficiencies. In 1978, expenses per
day were $12 higher in for-profit hospitals
that were later acquired than in those hos-
pitals that remained independent. By 1982,
expenses per day were $15 lower in the ac-
quired than in the still independent for-profit
hospitals. However, occupancy showed only
a slight improvement, rising from 48 to 50
percent, while inpatient charges per day rose
89 percent" only slightly more than the 86
percent increase in the unacquired for-profit
hospitals. Thus, profitability improvements
in the acquired hospitals evolved partly
through tight control of expenses relative to
OCR for page 88
88
charges. Capital costs per day increased from
$11 to $55, partly because of additional debt,
which increased from $7,800 to $57,700 per
bed. This striking increase of over 600 per-
cent should be put in context. For-profit
hospitals that remained independent more
than doubled their debt per bed to $24,000,
while hospitals that were already part of
investor-owned chains increased their debt
per bed only 60 percent, to $39,000 (Pat-
tison, 1986~.
A detailed description of 15 hospitals
bought by for-profit chains in Florida be-
tween 1979 and 1981 (Brown and Kloster-
man, 1986) confirms the California finding
of low profit levels before acquisition: their
pre-acquisition after-tax margin was below
that of unacquired hospitals, although their
pretax operating margin was higher than that
of unacquirec} hospitals. The data also sug-
gest that potential for improvement in the
control of expense existed, because pre-ac-
quisition operating expenses per adjusted
admission were roughly 10 percent higher
than in unacquired hospitals.
Profitability after acquisition varied. Three
years after acquisition by for-profit chains,
2 of the 15 Florida hospitals were operating
in the red. One-third of the acquired hos-
pitals achieved margins comparable to other
for-profit hospitals in the state, and almost
half had margins higher than unacquired
hospitals. During the three years after ac-
quisition, the previously independent hos-
pitals acquired by for-profit chains improved
their margins to become more profitable than
the average unacquired hospital. This was
not true of acquired hospitals formerly in
for-profit chains. Despite high operating ex-
penses before takeover, such expenses per
adjusted admission increased at a faster rate
after acquisition by for-profit chains than did
operating expenses in unacquired hospitals.
Gross and net revenues per adjusted ad-
mission and ancillary revenues per adjusted
admission generally increased at a higher
rate in hospitals acquired by for-profit chains
than in unacquired hospitals again despite
FOR-PROFIT ENTERPRISE IN HEALTH CARE
high pre-acquisition levels. These data sug-
gest that any improvements in profitability
were achieved not through tight control of
expenses but rather through higher prices.
Another strategy to enhance profitability af-
ter acquisition reductions in uncompen-
sated care is discussed in Chapter 5.
The data from Florida and California sug-
gest that acquisitions by for-profit chains had
the effect of increasing the cost of care. In-
creases in charges in acquired California
hospitals were only slightly above those of
unacquired for-profit hospitals. In contrast,
in Florida some hospitals acquired by for-
profit chains showed substantially larger in-
creases in revenue per adjusted admission
than hospitals whose ownership did not
change. For hospitals that belonged to for-
profit chains before acquisition, the rate of
increase in net revenues per adjusted ad-
mission was significantly higher than the rate
of increase in other hospitals. Since finan-
cially troubled hospitals seem to be common
acquisition candidates, it is possible that in
the absence of a change in ownership, the
former owners might have had to either raise
prices to improve the financial standing of
the hospitals or close the hospitals.
NURSING HOME COSTS
Nursing homes provide a striking contrast
to hospitals and their cost-based/charge-based
system of reimbursement. Nursing homes
operate with a payment system that has not
changed fimdamentally in recent years. Also,
the nursing home business unlike the hos-
pit~ business is marked by constraints on
growth, imposed by regulation and by lim-
ited competition caused by high occupancy
rates and lack of alternatives for long-term
care.
Nursing home care is generally charged
on a per diem basis. Medicaid accounts for
roughly half of all nursing home revenues.
States vary in the way the Medicaid pay-
ment is determined, but typically, the per
diem rate is cost-based within the limits of
OCR for page 89
INVESTOR OWNERSHIP AND THE COSTS OF CARE
the state-imposed cap. The cap can apply to
operating or capital expenses, or both. There
are no limits on charges to private-pay pa-
tients, except in Minnesota, where nursing
homes cannot charge private-pay patients
more than the Medicaid rate.22 Estimates of
the price differential between Medicaid and
private pay hover around the 18-20 percent
mark (Lawrence Lane, unpublished data
prepared for the Institute of Medicine Com-
mittee on Nursing Home Regulation, 19841.
An extensive review of the literature on
nursing homes was conducted for the com-
mittee (Hawes and Phillips, 19861. Most
available studies of nursing home expenses
anc! prices fait to distinguish investor-owned
chain from independent proprietary nursing
homes. The usual comparison is between
not-for-profit and for-profit ownership. Very
few studies use national data, or control for
severity of illness or quality of care.
Empirical studies generally show signifi-
cantly higher reported per-patient-day ex-
penses in not-for-profit than in for-profit
nursing homes (Hawes and Phillips, 19861.
Studies that control for factors that affect
expenses, such as location, patient case mix,
intensity, and some proxies for quality, show
that an expense differential exists, but the
magnitude is smaller than found in studies
lacking controls. A study of Illinois nursing
homes in 1976, notable for its controls for
patient mix, facility size, occupancy rate,
and other variables, found that for-profit fa-
cilities were more efficient, providing a given
level of care at lower cost to the facility, but
there was no difference in cost to payers
(Koetting, 1980~. There are tentative indi-
cations that for-profit nursing homes achieve
expense savings through Tower patient care
expenditures, but spend more on property-
associated costs (CasweD and Cleverly, 1978,
cited in Hawes and Phillips, 1986~. How-
ever, lower for-profit expenses do not trans-
late into Tower charges. The few studies that
focus on charges show no or small differ-
ences between the two types of ownership
(Hawes and Phillips, 1986~.
89
Findings of lower expenses in for-profit
nursing homes was confirmed by a study
that used a four-way classification to inves-
tigate the effects of ownership and affiliation
of selected efficiency measures (Hiller and
Sugarman, 1984~. A sample of approxi-
mately 1,100 nursing homes was drawn from
the 1977 National Nursing Home Survey.
Chain for-profit homes had the lowest av-
erage cost, operating cost, and nursing cost
per resident day, followed by for-profit in-
dependent nursing homes (see Table 4.4~.
However, regression analysis suggested that
lower for-profit average and nursing costs
were due to such factors as occupancy rates
and location, not ownership or chain affili-
ation. Finally, the data in Table 4.5 show
chain for-profit nursing homes to have the
highest before-tax profit per resident day
after inclusion of nonpatient care revenues.
Independent not-for-profit nursing homes
had a negative bottom line. For both for-
profit and not-for-profit homes, chain-affil-
iated facilities were substantially more prof-
itable than independent facilities. Regression
analysis suggested that ownership accounts
for only a small (3 percent) part of the dif-
ferences among ownership groups in this
measure of profit.
In an effort to differentiate more finely
among ownership groups than did earlier
studies, Hawes and Phillips (1986) analyzed
data from private not-for-profit nursing homes
that participated in the Ohio Medicaid pro-
gram in 1977 and three types of for-profit
nursing homes: those owned by individuals
operating 3 or fewer homes; intrastate chains,
usually of 4 to 10 homes; and interstate,
publicly held chains. Not-for-profit homes
were found to operate with expenses higher
by $6 to $8 per patient day than the average
for-profit homes, and interstate chains had
expenses of $1.50 higher per patient day
than the other two for-profit forms. A similar
pattern (Table 4.6) was found in expendi-
tures for direct patient care (nursing, social
services, supplies, etch. Administrative and
general service expenses are items for which
OCR for page 90
go
FOR-PROFIT ENTERPRISE IN HEALTH CARE
TABLE 4.5 Selected Nursing Home Cost and Profit Measures
by Ownership and Affiliation, National Nursing Home
Survey, 1977
For-profit
Not-for-profit
Measure Chain Independent Chain Independent
Net profit (before tax) per
resident day $ 1.00 $ 0.19 $ 0.32$-0.66
Average cost per resident
daya 22.38 31.43 40.5037.38
Operating cost per
resident dayb 4.67 7.52 9.878.18
Nursing cost per resident
day 7.25 10.14 13.7112.06
aIncludes all costs (including operating, labor, and fixed).
b Operating cost includes the cost of food, drugs, and services such as laundry
or nursing services purchased from outside sources. Excluded are labor costs
(payroll) and fixed costs of capital expenses and rent.
SOURCE: Hiller and Sugannan (1984~.
chain operators might be expected to show
economies of scale, and Table 4. 6 shows that
interstate chains in Ohio had the lowest ex-
penses per patient day for these two cate-
gories. However, the costs of ownership
(interest, depreciation, and rent payments)
are lower for not-for-profit than for all types
of for-profit nursing homes. Controlling for
such factors as location, certification, and
quality (by proxy measures), the differences
among ownership types are reduced, but
remain significant.
Ibe higher for-profit ownership expenses
could be due in part to acquisitions and sell-
ing of nursing homes to take advantage of
tax and reimbursement benefits. Capital
payments for depreciation, interest, and a
return on equity are generally reimbursed
by public programs, particularly Medicaid.
The 1981 tax provisions on accelerated cost
recovery also spur acquisition activity. How-
ever, some states have moved to slow ac-
quisition activity by limiting reimbursement
for capital and interest costs. As in the tos-
pi~l industry, chain grown in nursing homes
has been achieved mainly through acquisi
TA;BLE 4.6 Comparison of Average Nursing Home Expendi-
tures per Patient Day in Major Cost Centers, State of
Ohio, 1977
Type of Ownership
~-
For-profit For-profit For-profit
Individual Intrastate Interstate Not-for
Ownership Chain Chain profit
Cost Center (N = 382) (N = 78) (N = 32) (N = 87)
General services costs 2.47 2.44 2.04 3.27
Ownership or rent 3.12 3.12 3.10 2.69
Patient care costs 9.05 8.90 9.52 13.16
Administrative costs 2.73 2.90 2.53 3.17
SOURCE: Hawes and Phillips (1986).
OCR for page 91
INVESTOR OWNERSHIP AND THE COSTS OF CARE
tion partly because construction has been
limited by states, constraining the expansion
of the supply of nursing homes through cer-
tificate-of-need restrictions, and partly be-
cause inflation of building costs has made
acquisition cheaper than construction. Al-
though payment by Medicaid is frequently
inadequate, the nursing home market con-
tinues to attract for-profit enterprises that
generate sufficient total revenue to provide
an adequate return on investment.
In sum, for-profit nursing homes, oper-
ating with reimbursement that has similar-
ities to the Medicare prospective payment
system being implemented for hospitals but
lacking the competition that hospitals are
now confronting, operate with lower ex-
penses but with similar charges than not-
for-profit nursing homes. Lower for-profit
expenses are in some cases the result of lower
patient care expenditures, and there is some
evidence that chain operations are more ef-
ficient in the provision of general and ad-
ministrative services. Limited evidence from
Ohio suggests that interstate chain homes
operate with expenses that are substantially
lower than not-for-profit homes, but some-
what higher than other for-profit homes.
Despite Tow Medicaid reimbursement lev-
els, profitability is sufficiently high to attract
for-profit providers to the nursing home
business in many states.
OTHER FOR-PROFIT PROVERS
Although there is no literature available
on the comparative cost of freestanding for-
profit and not-for-profit urgent care centers,
surgery centers, imaging centers, and the
like indeed, there are little data available
on the extent of not-for-profit ownership of
such centers the growth of freestanding
centers represents a dynamic entrepreneu-
rial trend in American health care. It un-
doubtedly has important cost implications,
although these may shed little light on the
comparative behavior of for-profit and not
91
for-profit institutions. Both for-profit and not-
for-profit hospitals and investor-owned com-
panies have established new ambulatory care
centers, but it is not known whether the
practice is more common among not-for-profit
than among for-profit organizations. Many
of the centers established by not-for-profit
organizations are set up as for-profit subsidi-
aries.
Some of the new types of ambulatory care
centers are based on innovations. The in-
novations can be in marketing, such as pri-
mary care centers' convenient hours and
location or lack of an appointment require-
ment. Other innovations, particularly in am-
bulatory surgery centers, involve new
technologies and new ways of providing ser-
vices. Trough such innovations and through
various means of reducing overhead, in-
cluding specialization, selection of particu-
lar types of patients, and limiting hours of
service, many new types of ambulatory care
centers are able to charge less for services
than do the hospitals with which they com-
pete, a finding documented in several stud-
ies reviewed by Ermann and Babel (1986~.
There are also many anecdotes of hospitals
Towering their charges to compete with free-
standing centers.
Many innovations in various types of am-
bulatory care centers have undoubtedly led
to significant unit-cost savings to many pay-
ers and greater convenience for many pa-
tients. The competitive responses they have
stimulated on the part of hospitals may also
help control certain health care costs.
Whether the thousands offreestanding cen-
ters that now exist represent a net reduction
in health care costs is much less certain,
however, because they constitute additional
capital investment and because existing in-
stitutions that lose patients to the centers
must spread their overhead over fewer cases.
Also, if existing institutions lose revenues
from services on which they can make money,
they may be less able to provide unprofit-
able services and uncompensated care. These
OCR for page 92
92
are matters that deserve scrutiny as the cost
implications of freestanding centers are as-
sessed.
MONITORING COST TRENDS
Almost all the analyses of expenses and
prices reported here were based on data
collected in an environment that differs sig-
nificantly from that in which hospitals and
physicians find themselves today. Much of
the data in this report provides an important
baseline, but continued and expanded data
collection and monitoring of expenses and
prices are essential. The move away from
cost-based reimbursement; the rapid growth
of preferred provider organizations, health
maintenance organizations, and many new
forms of ambulatory care; and the expansion
of home care all indicate that major changes
are taking place in the way medical care is
organized and paid for in the United States.
These changes, which alter many of the eco-
nomic incentives to providers and create a
competitive environment, are likely to affect
provider behavior with respect to prices,
control of expenses, and in many other ways.
Dramatic changes are occurring and seem
likely to continue.
Data systems to monitor operating and
capital expenses and prices wit} need to be
sensitive to subtle changes in the hospital
product as well as to changes in national
health care expenditures, in providers' uses
of resources, and in expenses and prices for
different payers and different population
groups. Moreover, to determine savings and/
or cost shifting in the health care system as
a whole, the various new types of nonhos-
pital providers should be monitored. In light
of the findings from the studies reviewed in
this chapter that suggest a greater respon-
siveness of for-profit providers to economic
incentives, it is important to Pack differ-
ences between not-for-profit and for-profit
providers as the new incentives take hold.
Multi-institutionaI systems, also separated
into for-profit and not-for-profit, shouted be
FOR-PROFIT ENTERPRISE lN HEALTH CARE
monitored to determine the relationships
between ownership and system member-
ship.
The major sources of data today include
Medicare costs reports, which are the only
existing source of national hospital expense
information; some very valuable state re-
porting systems; and regular surveys by or-
ganizations such as the American Hospital
Association. No sources were identified for
data on national nursing home expenses.
The committee believes that Medicare cost
reports provide valuable information and
should be maintained even as cost-based
reimbursement is phased out. The commit-
tee would also like to see other states adopt
hospital reporting systems uniform with those
already in place in some states. States should
develop similar kinds of uniform reporting
systems to monitor operating and capital ex-
penses and prices in nursing homes and other
out-of-hospital facilities.
Until quite recently, most analyses of hos-
pital expenses were conducted without ref-
erence to case mix or case severity, which
affect the costs of care. Medicare's case-mix
index, a measure of costliness of cases treated
by a hospital relative to the average of all
Medicare patients, is for hospitals only and
is based on Medicare program data. It is the
only national source of case-mix informa-
tion. The Prospective Payment Assessment
Commission (ProPAC) is working to refine
and improve the index. The commission has
not yet decided on how it will respond to
the needs of non-Medicare private and pub-
lic payers who are beginning to use the sys-
tem for their own purposes (Prospective
Payment Assessment Commission, 19851.
The committee emphasizes the need for
continued improvement of case-mix and case-
severity measures, and the use of such mea-
sures in studies of expenses and prices.
The committee is aware that much useful
data is being collected by insurers, employ-
ers, providers, and other organizations con-
cerned with the price of health care.
However, for reasons of confidentiality and
OCR for page 93
INVESTOR OWNERSHIP AND THE COSTS OF CAM
competitive position, such organizations have
been reluctant to make their data publicly
available. The committee believes that with
the proper assurance of confidentiality and
the removal of individual identifiers, valu-
able inflation could be released. The
committee urges those in control of relevant
data to work with agencies, such as the Na-
tional Center for Health Statistics, to ar-
range for increased release of information.
CONCLUSIONS
The evidence reviewed in this chapter re-
veals several patterns in the cost-related be-
havior of for-profit and not-for-profit
institutions. First, studies of hospital costs
that control for size (and in some cases for
case mix and other factors) show for-profit
hospitals to have slightly higher expenses
than not-for-profit institutions ranging from
a statistically insignificant level to 8-10 per-
cent higher when payment is based on costs
incurred.
Second, studies (again, controlling for size
and sometimes other variables) show that
for-profit institutions charge more per stay
than not-for-profit institutions ranging from
8 percent for cost payers to 24 percent for
charge payers. Using the difference in for-
profit chain and not-for-profit chain prices
found in a national study, for-profit chains'
high prices added approximately $470 mil-
lion, or less than 1 percent to the nation's
bill for hospital care. If for-profit chain hos-
pitals increase their share of the hospital
market and maintain the price differential,
the price impact will increase.
Bird, controlled studies comparing the
profitability of for-profit chains and not-for-
profit hospitals show that for-profit chains
have achieved higher levels of profitability
before and after taxes. They are also less
likely than not-for-profit hospitals to have
losses on patient revenues and more likely
to have high margins on patient revenues.
Nonoperating revenues such as charitable
contributions and investment income are
93
important sources of revenues for not-for-
profit hospitals, contributing substantially to
their overall margins. But national, uncon-
trolled data show that for-profit hospitals have
lower (after-tax) margins on total net reve-
nues than the average U. S. hospital.
Fours, data from nursing homes suggest
that when payment levels are fixed on a per
diem basis, for-profit institutions restrict ex-
penses more than not-for-profit institutions,
which have lower margins, obtain revenues
from philanthropy, and have more charge-
paying patients. The cost savings are ob-
tained on patient care expenses, not on cap-
it~ or administrative expenses.
These findings support the broad conclu-
sion that for-profit institutions responc! more
precisely to economic incentives than do not-
for-profit institutions. (The for-profit hos-
pitals' shorter lengths of stay and their lower
occupancy rates are inconsistent with this
broad interpretation.) Under circumstances
in which it is economically rewarding to
charge more (e.g., when payers pay charges
and when there is little price competition),
for-profit institutions have charged more.
Under circumstances that reward invest-
meet, they have invested more. Under cir-
cumstances in which it has been economically
rewarding to have higher expenses, even if
allowable expenses are sharply defined, ex-
penses of the for-profits have been slightly
higher. Under circumstances where prices
are fixed, such as nursing homes, Weir ex-
penses have been lower. Economic rewards
that derive from revaluation of assets and
increased reimbursement may also explain
why changes of ownership have occurred
rather frequently among for-profit hospitals
and nursing homes.
In addition to comparisons of costs asso-
ciated with different types of ownership, the
question ofthe effect offor-profit health ser-
vices on the nation's health care costs also
deserves comment. Two areas of heavy for-
profit influence nursing homes and di-
alysis treatment are characterized by fixed-
payment methods that provide strong in
OCR for page 94
94
centives to limit expenses per unit of service
(per day or per dialysis treatment). In other
areas of for-profit growth, including both
ambulatory care centers of various sorts and
health maintenance organizations, new en-
trepreneurial organizations have been com-
peting on the basis of price, services, and
convenience. As noted earlier, the emer-
gence of ambulatory care centers may have
resulted in many reductions in unit price
and cost to payers, although the increased
capacity these centers represent may well
have increased national health care costs.
A comparison of expenses and charges on
a per-day or per-case basis, however, does
not adequately answer the question of im-
pact on total community costs of hospital
services. It can be argued that the true costs
of care to communities must take account of
government grants and charitable contri-
butions received by not-for-profit facilities
and taxes paid for for-profit facilities. The
few studies that make these complex and
·~cult-to~uanti* adjustments suggest that
for-profit hospital care is more expensive,
but less so than indicated by simpler mea-
sures of prices and cost.
Comparisons of hospital charges and ex-
penses also overlook the fact that the for-
profit sector has made substantial capital in-
vestments in the modernization and con-
struction of health care institutions and the
acquisition of financially weak institutions
that in some cases might otherwise have
perished. In this regard, an important his-
torical question about the impact of the for-
profit sector on the nation's health care costs
is not whether their investments in health
care have increased costs but whether the
capacity that has resulted from their in-
vestment is a net gain. This is partly an issue
of values about the operation of markets and
the objectivity of community health care
needs. However, occupancy rates in hos-
pitals in early 1985, at 66 percent nationally,
suggest overbedding, and the investor-owned
chains, with occupancy rates of 10-12 per-
cent less than the national average, have
FOR-PROFIT ENTERPRISE IN HEALTH CARE
more unused capacity than the average hos-
pital. Only the future will reveal whether
the costs of unused capacity will be absorbed
by communities or by the hospitals them-
selves.
Although some predict that for-profit health
care organizations will lead the way toward
lower-cost care now that economic incen-
tives reward such behavior, this should not
be regarded as a forgone conclusion. Their
expenses and prices have been higher in the
past; they have high ongoing capital ex-
penses because of past acquisition activities;
their average lengths of stay are already
shorter; they have Tower occupancy rates
across which to spread fixed costs; they have
less access to nonpatient care revenues; and
they must not only earn a profit to stay vi-
able but they must also pay taxes on these
profits (as well as on their property.) The
strategies they (and not-for-profit hospitals)
adopt will undoubtedly affect Me shape and
configuration of our health care system, the
provision of at least some services to those
patients who are unable to pay, and perhaps
the quality of care.
NOTES
Cost allocation is an accounting technique that is
used to spread the common overhead expenses of an
institution (e.g., the administrator's salary, insurance)
among its revenue-producing departments. This re-
quires identifying outputs, defining expenses to be al-
located, and establishing rules for allocating expenses
to outputs (Yoder, 19801.
2 Some cost payers allowed some costs of bad debts
and charity care in their calculation of reimbursable
costs. Medicare so treated the bad debts of only its
beneficiaries (incurred when deductibles and co-pay-
ments were not paid), not of other patients. Some cost-
based Blue Cross plans treat charity care as an allow-
able expense, and in some areas in which Blue Cross
pays charges less a discount, payment includes a factor
for bad debt and charity care incurred by all patients
in the hospital.
3Under retroactive cost-based reimbursement, hos-
pitals were paid on the basis of the cost of providing a
service; thus, the greater the expenditure, the greater
the reimbursement. Cost-based reimbursement con-
tained few restraints on the provision of costly services
OCR for page 95
INVESTOR OWNERSHIP AND THE COSTS OF CARE
and virtually no restraints on capital spending. On the
contrary, expenditures on plant and equipment could
be recaptured more swiftly by higher utilization, as
well as through depreciation and other capital pay-
ments. However, some restraints were imposed by dis-
allowance of certain costs, by limits on costs per day,
by utilization controls by professional services review
organizations, and by capital controls under certificate
of need. By paying a flat rate per diagnosis, the DRG
approach severs the direct link between expenses and
reimbursement and reverses the incentive for greater
intensity of services in particular cases. A hospital with
expenses that exceed the payment rate will lose money,
and a hospital with expenses below the payment rate
will earn income. Thus, new incentives exist to provide
cost-effective care.
4In 1983 the average length of stay in for-profit chain
hospitals was 6.4 days, compared with 6.7 days in for-
profit independent and public state and local hospitals,
7.2 days in not-for-profit chain hospitals, 7.4 days in
not-for-profit independent hospitals. One reason for
the relatively shorter length of stay in for-profit chain
hospitals might be that they treat less sick patients,
which would presumably be shown by a lower Medi-
care case-mix index; regional factors may also play a
role, since hospitals on the West Coast have a sub-
stantially shorter length of stay than East Coast hos-
pitals. Indeed, two studies have found that after adjusting
for differences in case mix, location, and other factors,
differences in length of stay among ownership types
virtually disappear (Coelen, 1986; Freund et al., 1985~.
Watt et al. (1986b), however, in their multiple regres-
sion analysis of national data, found that for-profit chain
hospitals had only slightly lower Medicare case-mix
indices than did not-for-profit chain hospitals (0.999
compared with 1.0171.
5One study (Ashby, 1982) showed more rapid growth
of expenses in for-profit than not-for-profit hospitals
between 1973 and 1978, but this study does not dis-
tinguish investor-owned from proprietary for-profit
hospitals.
6This differential was sustained as overall occupancy
rates dropped to 66 percent in early 1985. The major
for-profit chains had occupancy rates ranging from 55
percent at Hospital Corporation of American to 43 per-
cent at Republic Health Corporation (Tatge, 1985a).
Some not-for-profit multIhospital systems were run-
ning closer to the national average-three of five listed
in one recent report had occupancy rates between 60
and 64 percent, although one was 45 percent (Tatge,
1985b).
'Adjusted daily census, adjusted patient day, and
adjusted admissions reflect inpatient care adjusted to
reflect the volume of outpatient care provided.
8Data provided to the committee by the American
Hospital Association show investor-owned chain hos-
pitals had lower labor expenses per adjusted patient
95
day than did not-for-profit hospitals in three out of four
regions of the United States and for the United States
as a whole ($183.49 versus $212.31 in 1983~. However,
because of the absence of controls for hospital size or
range of services, it cannot be determined if these fac-
tors, rather than type of ownership, are responsible for
the difference.
9Data supplied to the committee by the American
Hospital Association show 2,544,000 admissions in for-
prof~t hospitals in 1983. Watt et al. (1986b) found net
patient care revenues adjusted per admission at inves-
tor-owned hospitals to average $184.55 more than the
similar figure for not-for-profit chain hospitals and
$137.94 more than independent not-for-profit hospi-
tals. Thus, the difference is equivalent to $351-$469
million of the nation's total hospital expenditures of
more than $100 billion.
20A problem of cost allocation should be noted with
respect to routine daily service. Under Medicare cost-
based reimbursement, it was advantageous to allocate
expenses to routine daily service up to a set limit,
beyond which payment was not made. The advantage
occurred because Medicare paid hospitals the average
cost for all patients for the routine daily service com-
ponent of care, and, until 1982 paid hospitals an ad-
ditional "nursing differential" payment on the assumption
that Medicare patients required more nursing care than
the average patient. However, the average cost for
Medicare patients, who tend to have long stays, may
actually have been lower than the average cost for other
patients.
22 Hospital Corporation of America challenged sev-
eral of GAO's findings and noted some omissions in
the analysis-particularly that GAO omitted that Med-
icare's share of the $55 million cost increase was only
about $8 million. Furthermore, over $135 million in
one-time federal capital gains tax liabilities were in-
curred, which more than offset Medicare's total future
cost increase James P. Smith, Hospital Corporation of
America, Washington, D.C., personal communication,
1984~.
22 For a discussion of differences in Medicaid nursing
home reimbursement policies and incentives among
states, see Holahan (1983~. Some changes in reim-
bursement methods are being considered, and some
are being implemented. Medicare, which pays only 2
percent of nursing home costs, is considering moving
to resource utilization groups similar in concept to
Medicare's hospital prospective payment system. Some
state Medicaid programs are using or considering reim-
bursement systems that recognize differences in case
max.
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Representative terms from entire chapter:
nursing homes
