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Hospital profit margins from treating Medicare patients have fallen from a positive 2.2% in 2002 to a negative 7.1% in 2015, and they are expected to fall to a negative 10% this year. Medicare has never fully covered the cost of care but the gulf has widened, hospital executives say, for a number of reasons:

– Expensive deployment of Electronic Medical Records, information technology.

– Budget Control Act of 2011 cut provider Medicare benefits by 2%.

– Disproportionate share hospital payments to hospitals with high charitable loads were reduced under the Affordable Healthcare Act.

– Alternative payment models were begun, an approach intended to reward high-quality and cost-efficient care; alternative payment models also intend to reward taking risk on patient outcomes.

– Plans to move Medicare to a value-based model from a fee-for-service model bring the greatest challenge to hospitals struggling with negative Medicare margins. About a fourth of hospitals are meeting goals to lower healthcare costs and meeting care-coordination goals. The AHA reports that the average community hospital spends $7.6 million per year to meet federal mandates.

The 450-page MedPAC (Medicare Payment Advisory Commission) report to Congress from March 2017 (…/default-…/reports/mar17_entirereport.pdf), however, reveals that many factors influence financial outcomes. In fact, MedPAC figures from 2015 show total hospital all-payer margins of 6.8%. What, then, are some differences between hospitals?

– Payer mix. The more commercially insured patients, the better the margins. NewYork-Presbyterian Healthcare System CEO, Dr. Steven Corwin, is quoted as saying “The 150 million or 160 million people with employer insurance support the entire healthcare system.”

– Administrative efficiency and effective use of Information technology. Good coding and use of artificial intelligence to manage coding and billing are a requirement for optimal reimbursement, and many hospitals lag behind.

– Shortages of health care personnel at some hospitals, especially key specialties that provide highly technical and reimbursed procedures.

In general, the payment differences between Medicare-Medicaid and commercial insurance make the most difference to a healthcare system. But the effect on Medicare margins may be counterintuitive; higher payments from commercial insurance may alter spending and costs. In 2015 testimony before the House Ways and Means Committee, MedPAC Director Mark Miller said that: “Part of the reason Medicare margins are low is that hospitals have high costs per case driven in part by lack of fiscal pressure from private payers. The Health Care Cost Institute reports that payment rates from private insurers have grown at an average of over 5 percent annually from 2011 through 2013. Commercial rates, on average, are about 50 percent higher than hospital costs and over 50 percent higher than Medicare rates. This allows hospitals to have higher costs which, in turn, makes Medicare margins more likely to appear inadequate. There is evidence that higher private insurer payments result from hospital consolidation—that is, hospitals have gained greater market power relative to private insurers. When financial resources are abundant hospitals spend more—increasing their number of inputs and cost per input. All else equal, higher costs per case result in lower Medicare margins.”

Bottom Line: For now, commercial insurance can close the Medicare low-margin gap. Worse Medicare margins, higher costs and more regulatory mandates, however, will put hundreds of hospitals at a tipping point.