Practice Management News

Does Higher Hospital Profitability Drive Up Healthcare Costs?

Hospital profitability strategies, such as patient cherry-picking and tax exemption status, may be contributing to higher healthcare costs.

By Jacqueline LaPointe

- The push to maximize hospital profitability across for- and non-profit organizations is driving up healthcare costs, contends a new commentary in The American Journal of Medicine.

Higher hospital profitability may be increasing healthcare costs across for- and non-profit hospitals, a new commentary argues

Hospitals are focusing on boosting profitability rather than reducing healthcare costs and improving quality of care because of non-profit tax exemption status changes and patient cherry-picking at for-profit hospitals, argued Robert M. Doroghazi, MD, a retired cardiologist.

“I believe the quest for profits between all hospitals, nonprofit and for-profit, has been one of the main drivers causing our healthcare costs to be the highest in the world, far outstripping inflation,” Doroghazi wrote.

He added that “current hospital competition has done nothing but drive up costs: new hospitals are often described by locals as a Taj Mahal, with spacious, well-appointed rooms, art work on the walls, and lobbies larger than in-door football fields. Hospitals add high-end, expensive technology that benefits few, and then unleash their Madison Avenue-size advertising budget to tell everyone they are the fourth in the area to have a helicopter.”

Non-profit hospitals contributed to increased healthcare costs because of higher profitability rates and declining charity care spending, Doroghazi explained. Seven of the ten most profitable hospitals in 2013 were non-profit organizations, including the top four most profitable hospitals, stated a cited Health Affairs from May.

Since the IRS modified tax exemption status requirements in 1969, non-profit hospital profitability has increased, the commentary added. Prior to 1969, the Internal Revenue Service (IRS) identified tax-exempt hospitals based on the level of charity care. But after Medicare and Medicaid appeared in 1965, charity care significantly decreased as more individuals gained healthcare coverage.

In response, the IRS changed tax exemption status in 1969 to account for community benefit, rather than charity care. However, the broader definition of community benefit “allowed hospitals to substitute programs in community health improvement and determinants of health for direct charity care,” Doroghazi stated.

As a result, the Congressional Joint Commission on Taxation estimated that the value of the non-profit tax exemption was $12.6 billion in 2002.

With non-profit hospital profitability rising, the IRS modified the tax exemption status policy in 2009 to include stricter community benefit definitions. With this change, the IRS intended for non-profit hospitals to spend at least five percent of healthcare revenue on charity care.

However, charity spending did not reach the five percent threshold even though non-profit hospital profitability accelerated after the status modifications, the commentary stated. The value of the tax exemption nearly doubled to $24.6 billion in 2011, according to a cited 2015 study in Health Affairs.

But charity care accounted for only 1.9 percent of operating expenses at non-profit hospitals, reported researchers in a cited New England Journal of Medicine study from 2013.

Doroghazi contended that non-profit hospital executives redirected some of the tax exemption revenue to “personal enrichment,” including executive compensation. He added that chief executive officer compensation increased by 24.2 percent from 2011 to 2012.

“I do not believe the average chief executive officer on that list is more valuable to society than 100 registered nurses,” wrote Doroghazi.

After charity care spending thresholds were not successful, the IRS recently implemented tax exemption status changes that will require hospitals to develop a written financial assistance policy that applies to all emergency and medically necessary care. Hospitals will also have to assess community healthcare needs every three years.

However, Doroghazi noted that these “cosmetic changes” would not motivate non-profit hospitals to shift their focus away from increasing hospital profitability.

Additionally, for-profit hospitals have added to rising healthcare costs, the commentary stated. For-profit hospitals must generate enough excess healthcare revenue to pay investors. But Doroghazi pointed out that hospitals either have to provide more affordable and efficient care, charge more for their services, or cherry pick patients to produce enough revenue to remain profitable.

While some hospitals are working on transforming care delivery, most hospitals have already increased prices. Out of the 50 highest-charging hospitals according to a 2015 Health Affairs study, 49 are for-profit hospitals.

As a result, for-profit hospitals cherry pick patients by taking on less patients who cannot pay and maximizing the profitable patients, including those that require more expense procedures, the commentary stated.

Doroghazi suggested that hospitals refocus their profitability strategies using the Henry Ford model to drive down healthcare costs. Like Henry Ford who built higher quality and less expensive cars, hospitals should center competition around providing more affordable and higher quality care.

To resolve non-profit hospital issues, Doroghazi also recommended that Congress redefine a non-profit institution as an organization that “makes no profit, aside from that required to maintain quality operations, prudent reserves, and fund future capital needs.”

Administrator compensation at non-profit hospitals should also match those of other non-profit organizations, such as the Boy Scouts of American and the Salvation Army, Doroghazi added.

While the recent commentary in The American Journal of Medicine questioned hospital profitability benefits, the Congressional Budget Office announced in September that hospitals would need to significantly boost productivity to remain profitable under the Affordable Care Act.

If hospitals want to stabilize profitability at a six-percent average profit margin by 2025, then providers must increase hospital productivity by 0.8 percent, the report claimed. Hospitals would also have to couple increased productivity rates with total revenue boosts or healthcare costs reductions of an additional 0.2 percent a year.

“Those hospitals may face significant pressure in the future, but the extent of that pressure and their profit margins will depend crucially on their productivity growth,” the report stated. “If they achieve the same productivity growth as the economy as a whole—and if they use those gains in productivity to limit the growth of their costs and do not respond to financial pressures in other ways—then the share of those hospitals with negative margins would rise to 41 percent in 2025.”

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