How Medicare Reimbursement Structures Drive Up Hospital Costs

Medical costs top multiple recent polls as the greatest financial worry for Americans, and as the chief healthcare budget decision-makers in families, as well as higher individual healthcare spenders, women feel the burden keenly. 

Hospital costs make up the largest portion—approximately 31%—of these expenditures. A recent study from the Paragon Health Institute specifies Medicare mismanagement as a major contributing factor to increasing prices. Touted at its 1965 inception as a means to keep care affordable and accessible, Medicare has instead turned into a bewildering black hole of funding.

Inefficient reimbursement strategies contribute substantially by limiting competition, raising prices, reducing benefits, and preventing transparency. As the National Taxpayers’ Union explains of Medicare, “[P]erverse incentives created by the government reward hospitals for their size instead of the value they provide patients.”

Among several others, Paragon’s study notes the following weaknesses and potential improvements in Medicare’s hospital payments:

Fee-For-Service Drawbacks

Medicare Part A, the primary coverage for hospital expenses, operates on a fee-for-service (FFS) basis. Because providers receive a separate payment for each item on the extensive list of covered services, they are incentivized to overtreat; because Part A covers the first 60 days of services after their $1,736 deductible, patients are incentivized to accept overtreatment. 

This tendency is not merely hypothetical but proven in case after case. From the $11.5 billion of unnecessary and duplicate imaging listed in a Third Way report, to the intentionally oversized eye droppers that dispense more liquid than can fit in an eye, as reported in ProPublica’s Wasted Medicine series, the excess often becomes tax-funded healthcare waste. It comes in big and small ways.

But volume-driven overtreatment is only part of the problem; how Medicare structures its payments to hospitals compounds it further.

Incentivized Inefficiency

Medicare reimburses hospitals with flat fees for overhead costs, which are relatively steady expenditures used to maintain facilities and fund administration. They are not directly related to patient care. Roughly two-thirds of hospital costs across the nation now fall into the overhead category, but many hospitals manage to operate at only one-third.

Paragon reports that hospitals with high overhead and low productivity sometimes receive more funding than more efficient hospitals with greater productivity. Such a practice provides no motivation to restrict overhead spending and focus on providing care. 

Moreover, Medicare overhead reimbursements can be allocated for outpatient services as well as true hospital stays. This muddies the waters and incentivizes overhead spread.

Restrictions On Eligible Facilities 

Physician-owned hospitals (POHs) and ambulatory surgical centers (ASCs) often provide more tailored and efficient care for lower prices than their hospital counterparts, but unfortunately, their mere existence is restricted by many government regulations. Adding insult to injury, the ones allowed to operate are unable to secure the same Medicare payments as regular hospitals. A patient at a hospital-owned outpatient department garners up to 217% more payment from Medicare than does a patient in an ASC or a physician’s facility.

Proposed Solutions

To increase care options and decrease confusion and expenditures, Paragon lists potential reforms to Medicare reimbursement rules:

Site neutrality: By paying the same amount for comparable procedures and products across different facility types, Medicare would eliminate much of the motivation of larger hospitals to collect other existing practices. Consequently, competition could thrive, driving down costs. Paragon offers several tips for achieving a smooth transition to site neutrality in a separate paper. 

Transparency: More provider options only help if patients are aware of their existence and advantages/disadvantages. Although the past five years brought welcome advances in mandated price transparency, more remains to be done. A PatientRightsAdvocate.org study found that six months after major transparency rules went into effect, fewer than 6% of hospitals were compliant. Notably, it added, “Hospitals with higher revenues and in highly consolidated markets were found to be more likely to flout the law.” More oversight and enforcement must take place.

Tough Love: Perhaps most important in the fight against skyrocketing costs is the need for Medicare overseers to stop accepting the excuses from hospitals. Despite claims of revenue loss for Medicare patients, Paragon found that, overall, Medicare pays enough to profit hospitals. The government need not carve out exceptions to benefit them. The hospitals are all right. It’s the patients who need their rights respected.