Hospital costs and excess bed capacity

BRIEFING 

Hospital Costs and Excess Capacity

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Main Theme

 

This paper develops and applies a novel approach for empirical estimation of how the presence of excess hospital beds affects the determination of marginal costs and, consequently, optimal reimbursement levels.

 

Method

 

Development and application of appropriate measures of excess capacity to a multi-product hospital cost function. The article introduces a methodology for incorporating excess capacity into the estimation of hospital cost functions, thereby obtaining more accurate measures of marginal costs.

 

Distinction between short-run and long-run marginal costs in the presence of excess capacity. The analysis highlights the crucial differences between these two types of costs and their relevance to reimbursement policy.

 

An examination of the bed-staffing problem and its impact on cost estimation. The article discusses how hospitals' practice of maintaining slightly excess staff in anticipation of uncertain demand can bias short-run marginal cost estimates.

 

Why does this matter?

 

Assessment of the Adequacy of Hospital Payments is crucial for ensuring government does not overpay nor underpay for services.

 

Calculating appropriate payment is difficult because of:

 

Theoretical ambiguity regarding optimal reimbursement for excess capacity. Reimbursement based on short-run marginal cost, although socially optimal, would result in losses for the hospital. Full reimbursement, including the short-run fixed costs associated with excess capacity, would subsidize wasted capacity.

 

Existence of significant excess capacity in American hospitals. Several previous studies (Gaynor and Anderson, 1995; Keeler and Ying, 1996; Mobley and Magnussen, 1998) that have highlighted this phenomenon.

 

The problem of "oversupply of beds" can lead to an underestimation of short-term marginal costs. Indeed, the estimate of fixed costs (related to bed capacity) can be overestimated, which mechanically leads to an underestimation of variable costs and therefore of short-term marginal costs.

 

Three alternative measures of marginal costs are developed

 

Short-run marginal cost (SRMC): The incremental cost of accommodating a patient assuming a fixed capacity (beds).

 

Long-run marginal cost without capacity adjustment (LRMC without bed adjustment): Estimated assuming that hospitals adjust their capacity optimally, ignoring the potential existence of excess capacity.

 

Long-run marginal cost "envelope" (LRMC envelope): What the long-run marginal costs would be if excess capacity were eliminated and bed levels were optimally adjusted (using a target occupancy rate of 80% as an example).

 

Empirical strategy

 

The study compares estimated marginal costs for Medicare and Medicaid patients with actual reimbursements in California (data used to illustrate method are from 1994)

 

Two specifications of translog cost functions are used for estimation: a short-run cost function including bed-days as a fixed factor, and a long-run cost function estimated without the bed-day variable.

 

The revenue equations for Medicare and Medicaid are simplified and estimated using ordinary least squares. They aim to determine the additional revenue generated by an additional "typical" patient of each type.

 

The study uses hospital-level data for California. The sample includes more than 350 short-stay general and pediatric hospitals.

 

Empirical findings

 

With a standard specification of the cost function ignoring excess capacity, the estimated marginal costs for Medicare and Medicaid patients are greater than reimbursement.

 

By properly incorporating excess capacity, the estimated short-run marginal costs are considerably lower, suggesting that Medicare reimbursement is more than adequate in the short run.

 

Medicare reimbursement also covers the long-term marginal cost "envelope."

 

The adequacy of Medicare and Medicaid reimbursement depends crucially on the assumption made about the fixed or variable nature of capacity. 

 

Comparing marginal costs and revenues reveals that:

 

Short-run marginal costs (with beds considered fixed) are much lower than revenues for Medicare and Medicaid patients.

 

The estimated long-run marginal costs without capacity adjustment are higher than revenues for both patient types, although the difference may be within reasonable statistical error.

 

Long-run marginal "envelope" costs are lower than actual revenues for Medicare and Medicaid, suggesting that if excess capacity were eliminated, current reimbursements would be sufficient to cover marginal costs.

 

For "other" patients (private, self-pay and indigent), revenues appear to be slightly lower than the "envelope" marginal costs.

 

Conclusions and Implications for Future Research

 

The article highlights the crucial importance of economic theory and appropriate estimation techniques for analyzing hospital costs and determining optimal reimbursement levels.

 

The assumption that hospital charges equal costs, or that hospital accountants' cost allocation techniques automatically generate meaningful cost estimates by patient type, does not appear to be correct.

 

Less aggregated estimates are desirable for more detailed analysis.

 

Future research could focus on more detailed analysis of "other" patients and why their revenues appear lower than their "envelope" marginal costs.

 

Determining which type of marginal cost (or combination thereof) should guide reimbursement remains a crucial policy question.

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Citation

Ennis, S., Shoenbaum, M. and Keeler, T. (2000) "Optimal Prices and Costs for Hospitals with Excess Bed Capacity", Applied Economics, 32: 1201-1212. https://doi.org/10.1080/000368400404344  

 

Paper Summary Initial Draft By NotebookLM

Research Paper​

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Key Quotes

 

"The primary innovation of this paper lies in incorporating appropriate theoretical measures of hospital excess capacity to a multiproduct empirical hospital cost function, and in showing how proper measures of marginal cost can be applied to the examples of Medicare and Medicaid reimbursement in California."

 

"Correctly incorporating excess capacity into our model leads to considerably lower estimates of short-run marginal costs, suggesting that Medicare hospital reimbursement is more than adequate in the short run."

 

"The extent to which Medicare reimbursement covers costs thus depends crucially on whether capacity is assumed fixed or variable."

 

"We wish to show how crucial it is which definition of costs one selects and how one estimates those costs in determining what reimbursements will be."

 

"If the long-run envelope approach is selected as a standard, then the government should be able to reduce hospital spending by roughly 30%. In contrast, if the standard is based on the idea that current occupancy rates are optimal, then payment levels should be 7% higher.”