Hospitals Need to Boost Productivity Yearly Under Affordable Care Act

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Changes in laws and regulations stemming mostly from the Affordable Care Act (ACA) could have significant effects on hospitals’ finances, according to a blog post from the Congressional Budget Office.

Authors Tmara Hayford and Lyle Nelson note the ACA reduces Medicare’s payment updates for hospitals but also expands insurance coverage, which should reduce the amount of uncompensated care hospitals provide.

Hayford and Nelson reference the working paper the CBO released that calculated hospitals’ profit margins and the share of hospitals that might lose money in 2025 under several scenarios.

The following is an excerpt from the blog post on the key findings and limitations of their analysis.

Our analysis of hospitals’ profit margins incorporates the effects of the cuts in Medicare’s hospital payment updates specified in the ACA, other reductions in federal payments to hospitals specified in the ACA and in other recent laws, and demographic changes (which will put downward pressure on hospitals’ margins as more patients shift from higher-paying commercial insurance to lower-paying Medicare coverage). The analysis also incorporates the effects of the expansion of insurance coverage under the ACA, which will improve hospitals’ finances by reducing the number of patients who are uninsured. The analysis focuses on about 3,000 hospitals that provide acute care to the general population and are subject to the reductions in Medicare’s payment updates; it thus excludes most rural hospitals and all of Medicare’s “critical access” hospitals.

As a starting point, we estimated that the average profit margin of the hospitals included in the analysis was 6.0 percent in 2011 and that 27 percent of them had negative profit margins (in other words, they lost money) in that year. That share may be surprisingly high but is similar to the shares of hospitals with a negative annual profit margin over the past two decades. Although some hospitals have closed over that period, others have opened, overall access to care remains good (as measured by indicators such as service use and hospital capacity), and the quality of care may have improved.

Findings About Profit Margins

Our results indicate that the magnitude of the financial challenges hospitals will face in the future depends crucially on whether and to what extent they can improve their productivity over time—that is, whether they can produce the same output (treatments and procedures) at the same level of quality with fewer inputs. In general, hospitals could use improvements in their productivity to increase the quality of care they provide (and some evidence suggests that they have done so in the past). For this analysis, however, we assumed that increases in hospitals’ productivity would be used instead to limit the growth of their costs.

Using that approach, we projected hospitals’ profit margins under different assumptions about their productivity growth that reflect a range of plausible outcomes, and we obtained the following results:

If the hospitals we examined were able to improve their productivity in line with productivity growth in the economy as a whole—by about 0.8 percent per year, on average, through 2025, according to CBO’s estimate—then the share of them with negative profit margins would increase to 41 percent in 2025, and their average profit margin would fall to 3.3 percent.

If, instead, those hospitals were able to improve their productivity by 0.4 percent per year, the share of them with negative profit margins would increase to 51 percent in 2025, and their average profit margin would fall to 1.6 percent.

If those hospitals were unable to increase their productivity (or to reduce cost growth in some other way), then the share of them with negative profit margins would increase to 60 percent in 2025, and their average profit margin would fall to negative 0.2 percent.

Those findings reflect the fact that Medicare’s payment updates for those hospitals now depend on the overall rate of productivity growth in the economy. The ACA generally specified that their payment update each year equal the estimated percentage change in the average price of hospitals’ inputs minus the estimated growth in productivity in the economy overall. (The ACA imposed additional reductions through 2019 that vary by year but are, on average, smaller than the productivity-related reductions; subsequent legislation has further reduced those payments.) Consequently, if those hospitals were not able to increase their productivity by enough to fully offset those reductions in payment updates—or did not use those productivity gains to reduce the growth of their costs—then Medicare’s payments would not keep pace with their costs of treating those patients, and profit margins for those hospitals would decline (holding all other factors equal).

To hold their aggregate profit margins in 2025 at about the 2011 level of 6.0 percent, the hospitals that we examined would have to increase total revenues (without increasing costs), reduce total costs (without reducing revenues), or achieve a combination of revenue increases and cost reductions. If they can increase productivity at the economywide rate, then the additional growth in revenues or reduction in costs would have to average 0.2 percent per year. If, instead, they are unable to reduce costs through higher productivity, then the additional growth in revenues or reduction in costs would have to average 0.5 percent per year (see figure below). (In our analysis, those changes in revenues and costs applied to all patients, whereas productivity growth had differential effects on Medicare, Medicaid, and private patients—as discussed in the paper.)

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