Unbiased Analysis of Today's Healthcare Issues

How does payment reform affect providers in competitive vs. non-competitive markets?

Written By: Jason Shafrin - Apr• 23•17

How does payment reform affect access to care?  And what does payment reform mean?

Payment reform can mean manythings but in this context we will mean substituting fee-for-service or cost-plus reimbursement schemes for fixed reimbursement for a fixed episodes of care or fixed bundles of services during a specific time frame.

One example of how payment reform worked, is Medicare’s Inpatient Prospective Payment System (IPPS).  One study using data from California in the early 1980s (Meltzer et al., 2002) found that costs fell more for providers in the most competitive markets after theIPPS was implemented.  More generally, there is evidence that the less sensitive the reimbursement system is to differences in marginal costs across patients, the more providers tend to reduce costs (see Grabowski et al., 2011; Huckfeldt et al., 2014; Newhouse and Byrne, 1988; Sood et al.,2013)

To further examine the interaction of payment reform and changes in provider cost, a recent paper by Sood et al. 2017 examines the effect of changes to home health payments in the late 1990s.  The specific reform evaluted was the 1997 Interim Payment System (IPS).

The authors use Medicare claims data between 1996 and 2000 to examine how the implementation of IPS changed provider cost.  The study focuses patients discharged from a hospital for a stroke admission who used home health services.  Cost data come from Medicare cost reports.  Using these data, the authors run an OLS regression measuring the relationship between home health agencies competition (measured using the Herfindahl-Hirschman Index) and various outcomes including home health days, cost or the probability of any home health use.  The key variable is the interaction between the HHI and whether the IPS was instituted in the given year.

Using this specification, the authors find that:

…there was significant variation in costs by level of competition in the pre-IPS period, with more competitive markets having higher costs. After the IPS, costs declined in all markets but there were larger declines in costs in more competitive markets. The decline in costs was driven by both changes in the probability of any home health use (extensive margin) and a decline in the number of home health days among existing users (intensive margin). As a result of the heterogeneous response to the payment reform, costs and the number of home health days converged in more and less competitive markets and the significant variation in costs or intensity of care by level of com-petition in the pre-IPS period nearly disappeared in the post-IPS period.

Why would competitive markets have larger decreases in cost?  Shouldn’t these markets already have a lot of discipline?  We would expect payment reform to have less of an effect on competitive markets, right?

The authors claim that average treatment intensity (and thus cost) is higher in more competitive markets.  Second, they propose that payment reforms that reduce reimbursement lead to a larger reduction in profit margins in more competitive markets as equilibrium intensity is higher in more competitive markets.  The authors do find evidence that in more competitive markets, there was more firm exit and home health agencies that did exit were the ones that were high-cost.

One issue with this analysis is that it is very short-term.  They authors correctly make the point that “payment reform serves to eliminate some of the most inefficient providers”.  This sounds like a good thing.  However, payment reductions generally are positive in the short run.  The highest cost providers exit.  In the long-run, however, less entry will occur with lower reimbursement, there will be less competition, and access to care could be reduced.  Ideally, one would hope high-quality, low-cost firms would enter, but payment reform may incentivize only low-quality, low cost firms to enter.


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