The Hospital Market, Part 2 Professor Vivian Ho Health Economics Fall 2007

Structure: 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 l Mercy and Finley: only 2 acute care hospitals in Dubuque, Iowa propose to merge. l 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  Dubuque  Cedar Rapids  Iowa City, Iowa  Madison, Wisconsin  Freeport, Illinois

l Insurance coverage for Mercy/Finley patients  50% Medicare/Medicaid  25% Fee-for-service (traditional indemnity)  25% Managed care (HMOs, PPOs) l 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% outside  Dubuque the relevant geographic market, and merger constitutes a monopoly.

Ruling l 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 Conclusion l Even if only one hospital exists in a given geographic region, it may not be able to act as a monopolist l Ability of large, managed care buyers to shift patients can keep the market competitive.

Hospital Advertising l % of hospitals that advertise rose from 36% in 1995 to 50% in l We often see ads for local hospitals in newspapers and magazines. l Why?

Dorfman-Steiner model of advertising l The profit-maximizing amount of advertising occurs where: l If E a equals.2, then 1% ↑ in advertising →.2% ↑ in demand. l And if E P equals 4, then E a / E P 0.05  To max profits, hospital should spend 5% of total revenues on advertising.

Hospital will spend more on advertising when: l E a is higher. l E P 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 hospitals use? l Advertising the availability of services that all hospitals have may ↑market size, but not your own patient base. l Hospitals will use advertising to differentiate their product.  Hospital rankings.  Luxury services.

Hospital Conduct l Large #s of sellers and low barriers to entry promote competition. l We expect increased competition to lead to:  Higher output and quality.  Lower price.

l However, the hospital market has important differences.  Hospitals don’t necessarily maximize profits.  Government is a major payer l Prices not set competitively.  Consumer less likely to shop around. l Insurance and asymmetric info. Is hospital market competition good or bad for consumers?

l Markets with fewer hospitals may face higher prices.  But hospitals in more concentrated markets may be larger, and econ of scale may ¯ costs. l Look at price and quality effects of hospital mergers.

l Data from Los Angeles in suggests that hospital mergers would ↑ prices >5%. l (Town & Vistnes 2001) l Hospitals that merged between 1989 and 1996 lowered their costs two years after consolidation relative to comparable hospitals that didn’t merge l (Dranove & Lindrooth 2003) l Even if hospitals lower costs, they may not pass price savings on to consumers.  Hospitals that merged in raised their negotiated PPO prices relative to the median market price.

l Other studies suggest that hospital consolidation does not improve the quality of care. l These results suggest that more competitive hospital markets favor consumers.

Does Ownership Type Affect Conduct? l 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.

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

Has managed care changed conduct? l 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. l Outcomes for patients covered by HMOs similar & sometimes better than those for fee-for-service patients.

Hospital Market Performance How have price and quantity changed?

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

l Hospital inflation rate exceeds general rate for all but 1 year. l 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? 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, YearHospital Staffing Ratio Occupancy Rate (%) Admission Rate (per 100 population) Average Length of Stay (days) Outpatient Visits (per 100 population) xxx

Was growth in staffing, outpatient visits inappropriate? l Ratings of inappropriate use of 3 medical treatments among 1981 Medicare population, as defined by expert panel of MDs. ProcedureInappropriate use(%) coronary angiography17% carotid endarterectomy32% upper GI tract endoscopy17%

l Similar findings in for coronary artery bypass graft patients. l 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.

l Distribution of health expenditures has become more concentrated. l Most severely ill patients receiving high- cost critical care in hospitals. l 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?