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Causal Chains and Cost Shifting: How Medicare's Rescue Inadvertently Triggered the Managed-Care Revolution

Published online by Cambridge University Press:  27 April 2009

Rick Mayes
University of Richmond


The conventional wisdom on how managed care came to replace traditional fee-for-service reimbursement as the nation's dominant mode of health insurance is that enlightened businesses and their employers led the way in responding to the emergence of market forces in health care in the 1990s. A common textbook treatment of managed care's ascendancy puts it this way: “Transformation of the health care delivery system through managed care has been driven principally by market forces, and reinforced by government.” The irony is that the opposite sequence of events is a more accurate portrayal of what actually happened. As this article shows, the transformation of America's health-care system through managed care was initially triggered—albeit indirectly—by government actions and then driven by market forces. In other words, before business behavior was a cause of managed care's extraordinary growth, it was largely a response to and an unintended consequence of government policymaking: in this instance, Congress's reform of Medicare in 1983.

Copyright © The Pennsylvania State University, University Park, PA. 2004

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117. Thanks to Mark Peterson for showing me this line of argument.

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122. Reinhardt, “The Predictable Managed Care Kvetch,” 908.

123. Oberlander, The Political Life of Medicare, 199.

124. Personal communication with Jack Ashby, MedPAC Hospital Research Director (7 August 2003): “The 14% PPS margins [in Fig. 1] come from ProPAC publications and are based on Medicare cost report data. The 0.98 to 1.01 payment-to-cost ratios [in Table 4] are, of course, from the AHA annual survey. The first and perhaps primary difference between the two measurements is that the cost report figure is an inpatient margin, while the AHA numbers cover all services hospitals provide for Medicare beneficiaries. Medicare inpatient margins have always been, and still are, much higher than Medicare outpatient margins. Besides that, though, the two data sources are fundamentally different in two ways. First, the cost report measure is based on Medicare-allowable costs while the AHA measure captures all costs per the hospitals' books. This difference also leads to a higher margin value for the cost report data. Second, the cost report measure reflects a complex method for allocating costs among payers, while the AHA data reflect a simple application of an RCC to charges by payer to produce costs by payer. While the proof has been illusive to date, we have anecdotal evidence that hospitals over the years have set their charges so as to maximize the allocation of costs to Medicare, which then biases the AHA payment to cost ratio downward. Charges are used in the cost report allocation also, but to a lesser degree than in the AHA data. This factor also leads to a higher value for the cost report data, and this manipulation of charges was at its zenith in the first few years of the PPS. The net result of all this in our minds [at MedPAC] is that the AHA data are quite useful for monitoring trends (which includes providing evidence that there has been cost shifting), but are much less useful in establishing the level of margins or payment/cost ratios.”