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In the previous segment, we discussed cost shifting,
where hospitals face with a temporal decline in prices paid by public insurers,
raise their prices to commercial insurers.
In this segment, we will discuss a related phenomenon known as cross subsidization.
Cross subsidization is the practice of channeling revenue
from profitable services to subsidize unprofitable services.
Know that such practice does not depend on temporal shocks to prices,
and can be a perfectly predicted part of running a hospital.
So how does this work?
Think of a general community hospital as providing
multiple services which are typically organized in service lines.
Some of these services are for the most part profitable,
like cardiology, neurosurgery, oncology, or orthopedics.
While some services are often unprofitable,
like inpatient psychiatry, substance abuse, or trauma care.
Cross subsidization is the practice where support for
unprofitable services comes from the profits generated by profitable ones.
The extent of reliance on
cross subsidization and its magnitude are difficult to establish,
mainly since these practices are tied to an accounting system with hospitals specific,
idiosyncratic, overhead, and cost allocations.
While not well documented,
cross subsidies are often considered the principal
mechanism through which hospitals provide unprofitable care.
Other mechanisms exist, such as
Federal Disproportionate Share Hospital programs or Bisch payments,
and regulated uncompensated care pools which operate in nine states.
Both mechanisms are designed to redistribute
funds to hospitals who provide disproportionately more uncompensated care.
But cross subsidies are not unique to hospitals.
There is clear evidence of regulation driven
cross subsidization in privately owned regulated firms.
Regulation of the transportation and telecommunication
industries has broadly consisted of requirements
for providing some unprofitable services in return
for entry restrictions to block competition on other services.
Airlines cross subsidize lower-density traffic with profits from high- density traffic.
Railroads, prior to the creation of Amtrak in 1971,
cross subsidized unprofitable passenger services with profits from freight.
In telecommunications, profits from
long distance services were used to subsidize local services.
But unlike hospital, cross subsidies in
transportation and telecommunication were quite visible.
All could observe every airline or
train fare and the same is true for the price of local and long distance calls.
Studies of these industry suggested that this regulation was highly inefficient,
and all these industries were deregulated.
Cross subsidization and was found to be
a distortive and unproductive way of achieving social goals.
In 2014, I led a team of researchers to uncover evidence of cross subsidies.
To do so, we focused on markets that experienced entry by cardiac specialty hospitals.
These hospitals focus on a single profitable service line, cardiology.
This led to revenue pressure in cardiology among general community hospitals.
This should not be surprising as these hospitals are now competing for
both cardiologists and cardiac patients with a new specialty entrance.
But the question we were out there was,
did general community hospitals most exposed to entry by
cardiac specialty hospitals reduced their provision of uncontested services,
that are considered to be unprofitable?
Services like psychiatry, substance abuse, and trauma care.
In other words, did hospitals that lost revenue due to
specialty entry responded by reducing the funding to unprofitable services?
We also wanted to study the effect of entry on
uncontested services that are considered to be profitable, like neurosurgery.
We might expect more resources devoted to
neurosurgery as a source of both profit and cross subsidization.
Entry of specialty hospitals into a profitable service line will reduce
incumbent's profit and thereby may compromise the ability
of incumbent general hospitals to cross subsidize unprofitable services.
We studied the effect of entry by three specialty cardiac hospitals in Arizona,
on the provision of psychiatric, trauma,
and substance abuse care by incumbent general community hospitals.
We also tested the effect of entry on incumbents provision of neurosurgery,
and uncontested but profitable service.
We studied Arizona because entry occurred in two markets,
Phoenix and Tucson, which are geographically well delineated.
In addition, entry was limited to
cardiac specialty hospitals over a relatively short period of time,
allowing us to use longer time series for the pre and post entry periods.
Our study covered 1997 to 2007.
We used different geographic, contracting,
and patient volume measures to assess the exposure of
each hospital to entry by single-specialty cardiac hospitals.
For example, hospitals who hire their own cardiologists have strong relationships
with insurance companies and are geographically
far from the location chosen by the entrant,
will be less exposed to entry.
Let's look at the effect of specialty entry on the net revenue per cardiac discharge.
While there is not much change over time in
net revenue for hospitals least exposed to entry by specialty hospitals,
the net revenue dropped sharply once entry of
specialty hospitals began for those hospitals most exposed to entry.
Know that hospitals exposed to entry had higher net payment revenue.
This is not an accident.
It serves to remind us that single- specialty entrant
carefully considered their potential competitors and location,
and entered areas with high earning potential.
But all of these findings are to be expected.
We want to know what happened to the uncontested and potentially unprofitable services?
We found that hospitals most exposed to entry reduced their provision of
services considered to be unprofitable and expanded their admissions for neurosurgery,
a highly profitable service.
Admissions fell 16 percent in inpatient psychiatry,
17 percent in substance abuse,
and five percent in trauma care.
To understand why the weakest effect is for trauma care,
recall what makes a service unprofitable.
The first element is inadequate reimbursement rates,
and the second is, a relatively high proportion of uninsured non-paying patients.
In psychiatry and substance abuse,
we have both elements of play.
In trauma, reimbursement rates are typically adequate.
So, profitability hinges on the patient population and the type of trauma.
Suburban hospital's trauma center,
we'll see many motor vehicle crash victims.
And these patients will typically carry health insurance or at least car insurance.
On the other hand, hospital's trauma center in the inner city we'll
see many gunshot and stabbing victims and these patients are more likely to be uninsured.
So we have evidence of cross subsidization by hospitals,
but this evidence does not mean
that cross subsidization is an efficient way to provide community benefits.
If we have learned anything from the experience of other industries,
it is that it may be wise to preserve activities deemed socially vital,
as opposed to preserving the regulatory mechanisms set forward to facilitate them.
In the next segment, we will shift our attention to the economics of post acute care,
a rapidly growing part of the U.S. healthcare sector.
Ezekiel J. Emanuel, MD, PhDDiane v.S. Levy and Robert M. Levy University Professor
Guy David, PhDGilbert and Shelley Harrison Associate Professor of Health Care Management
