High Spending on Hospitals Makes Healthcare Less Affordable

Anyone who has survived a serious injury or life-threatening illness is likely grateful for the care they received in a hospital. Advances in hospital care mean that people today can recover from injuries and diseases that would have meant certain death in the not-too-distant past.

However, in addition to saving many lives, hospitals have also become the biggest drivers of increasingly unaffordable healthcare costs. Spending on hospital care has grown faster in the past five years than any other type of healthcare spending, and payments to hospitals are the largest single category of total healthcare spending.

The good news is we don’t have to cut back on life-saving hospital care in order to reduce total spending on hospital services. The reason is that a lot of what we spend on hospital care today is either unnecessary, avoidable, or even harmful for patients. For example, national data show that 5% of hospital admissions for commercially insured patients and 17% of admissions for Medicare patients could have been avoided through better primary care or use of alternative, lower-cost treatments. For many common conditions, 20% or more of the patients who are admitted to hospitals have to be admitted again within 30 days after discharge. Worst of all, there are over 1.5 million preventable infections, errors, and complications every year, which not only harm patients but cost billions of dollars to treat.

In other words, all too often, higher spending on hospital care means a community is getting worse healthcare, not better, and that it’s paying a lot more than necessary for the care it does receive.

 Nowhere is this more true than in Pittsburgh. Although Pittsburgh’s hospitals have been national leaders in developing and delivering life-saving treatments in areas such as cancer, heart disease, and organ transplants, Pittsburgh is also a national leader in the overuse of hospitals. American Hospital Association data show that in 2010, there were 170 hospital admissions per 1,000 residents in the Pittsburgh region, the highest rate among the major regions in the country and 49% higher than the national average. Pittsburgh also had the 2nd highest rate of surgeries and the 7th highest rate of emergency room visits.

These high rates aren’t because we have an older population or because patients are coming here from other parts of the world. For example, Medicare data show that Pittsburgh seniors are hospitalized at the second highest rate among major regions, 18% more than the national average.

There are many initiatives around the country that have successfully reduced rates of hospitalizations, infections, and readmissions to hospitals by improving care to patients. The Pittsburgh Regional Health Initiative has been a national leader in developing such initiatives.

Hospitals, however, have had little incentive to participate in or support these initiatives because they cause the hospitals to lose revenue. What should really matter to hospitals is their margins (their profits), not their revenues, but two factors – the cost structure of hospitals and the way we pay for hospital services – mean that lower revenues generally cause financial losses for hospitals.

Hospitals have a lot of fixed costs they have to pay for regardless of how many patients they admit. Everyone wants the emergency room, surgery suite, and burn unit to be equipped, staffed, and ready to go even if there are no patients who need them on any given day. But hospitals don’t get paid for services that aren’t used. The emergency room runs a deficit if there aren’t enough true emergencies, so is it any wonder that hospitals advertise how quickly you can be seen in their emergency rooms even for minor problems? 

The more fixed costs a hospital has, the more lucrative every additional admission is, and the more problematic it is to have fewer admissions. Here’s a simple example. Assume that a hospital has $200 million in annual costs and that 2/3 of those costs ($133 million) are fixed (they don’t change with fewer patients), while 1/3 ($67 million) are variable (i.e., the costs decrease with fewer patients). The hospital admits 15,000 patients per year, and is paid an average of $13,500 per patient, for a total of $202.5 million in revenue. Since total revenue exceeds total cost, the hospital has a slim but positive 1.25% operating margin.

Now let’s suppose that improved primary care in the community results in 10% fewer people needing hospital care. What would happen to our hypothetical hospital? Its variable costs would decrease by 10% to $60 million, but its fixed costs would remain at $133 million. Total costs would now be $193 million, 3% less than before. Revenues, however, would decrease by 10% (to $182 million) because there are 10% fewer patients. The net result is an $11 million loss (a negative 6% margin).

Conversely, if primary care in the community deteriorates and 5% more people are hospitalized, the hospital’s revenues will increase by 5%, but its costs will increase by less than 2%, giving the hospital a margin of 5%, better than before. The hospital only “wins” when people in the community are sicker.

This problem is bigger in Pittsburgh than in most communities because we have so many hospitals. Pittsburgh has the 3rd largest number of hospitals per capita and the 2nd largest number of hospital beds per capita among the largest 40 metropolitan regions. That’s a lot of fixed costs that have to be paid for. If physicians do a better job of helping patients with asthma, diabetes, emphysema, heart failure, and other chronic diseases stay well and stay out of the hospital, many hospitals in Pittsburgh, particularly community hospitals, could experience significant financial losses.

Fortunately, a hospital doesn’t have to go bankrupt in order for the community to be healthier and for payers to spend less. Paying the hospital slightly more per admission in conjunction with programs to reduce avoidable admissions could enable the hospital to maintain its margins even though it’s getting less total revenue. This would be a true win-win-win: patients would be healthier, healthcare spending would be lower, and the hospital would remain financially viable.

Moreover, reducing hospital costs doesn’t necessarily mean losses in jobs, particularly direct patient care jobs. In fact, only 44% of hospital spending in our region goes to payroll costs, the third lowest percentage of any major region in the country, so many of our hospitals should be able to significantly reduce costs without cutting jobs.

Unfortunately, instead of pursuing win-win-win solutions, most communities around the country are locked in win-lose battles between hospitals and health plans. Hospitals are doing everything possible to fill beds and raise prices, while Medicare and health plans are trying to cut hospital payments to offset the higher cost of more admissions. Health systems are building more hospitals to generate more admissions rather than helping patients stay healthy, and hospitals are merging, not to reduce duplicative fixed costs, but to increase their leverage in demanding higher prices from health plans and patients.

Is there a better way? Fortunately, yes.

First, health plans need to commit to adjust their payments to hospitals so hospitals can continue to cover their costs when admissions decline due to better outpatient care. Second, hospital CEOs and Boards of Directors need to support programs to reduce unnecessary hospitalizations and to eliminate unnecessary and duplicative hospital costs so their hospitals can deliver high-quality care with less revenue.

Maryland has implemented this kind of approach for rural hospitals through a state-mandated program, and as a result, they’ve seen dramatic reductions in hospital admissions and readmissions without negative financial impacts on hospitals. Similar or better results could be achieved in southwestern Pennsylvania without state intervention if hospitals, health plans, physicians, and employers could work together in a more collaborative way.

(A version of this post appeared as the Regional Insights column in the Sunday, October 6, 2013 edition of the Pittsburgh Post-Gazette.)