Cap on All Prices/Rates

Cap on All Prices/Rates

A system of regulated health care prices involves a state governmental agency with the legal authority to establish explicit prices (the exact price) that providers must be paid, and payers must pay for a defined set of services, such as all acute care hospital facility prices. An alternative approach would be for a state to authorize a regulatory agency to a set a maximum limit on all prices paid (i.e., price caps), but allow providers and payers to negotiate payment levels below the established cap. In addition to legal authority to set prices (or price caps) the regulating governmental agency in these systems would also have the authority to update (or “inflate”) the established prices (or price caps) each successive year.

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In the 1960s and 1970s, approximately 30 states established governmentally controlled programs to either review or regulate health care prices. Most of these rate-setting or rate review systems set the prices paid by commercial insurers to acute care hospitals. Of these states,  seven legislated mandatory rate setting systems applicable to all acute care hospitals in the state.  Five of these states (New York, Maryland, New Jersey, Massachusetts and Washington), also were authorized to set hospital prices for all payers, including Medicare and Medicaid. The 1960s, 1970s and early 1980s were characterized by very rapid growth in hospital spending by both commercial and governmental payers. Thus, the primary purpose of these systems was to slow the growth in spending on hospital care. In addition to setting rates and rate updates to slow the rapid growth in hospital prices and spending, these systems set rates sufficient to cover “efficient” hospital operating costs and pay for hospital uncompensated care (these systems included add-ons to regulated hospital rates to finance hospital uncompensated care and share that cost across participating payers).

In recent years, several prominent pro-market health economists wary of excessive government intervention in health care, but also concerned about rapid growth in hospital and other health care prices in the commercial sector, recommended that state governments implement a system of price caps on all in-network and out-of-network health care services paid by commercial insurers. Under this proposal, a governmental regulatory agency (such as a cost commission or a state department of health) would establish price caps for all health care services (possibly including both hospital and non-hospital services). These economists recommended setting price caps at relatively high levels (e.g., capping the maximum price of a specific service at five times the 20th percentile of median negotiated prices in each geographic area). They believed that setting very high price caps would help reduce health care spending in a given year by truncating the very highest prices in a geography (often referred to as “supra-competitive” or “monopoly prices) but also allow market-based negotiations between commercial insurers and providers for prices below the price cap, to proceed unimpeded.

Because very high price caps would likely affect only a small number of providers a complementary proposal was to also cap the rate at which base historical prices could grow year over year. They reasoned that price growth caps could also guard against the concern that the caps will serve as a “sentinel” price, leading providers with significant market power to increase prices to reach the level of the price cap per service. An additional recommendation was to tier the allowed price growth rates based on the level of these base prices by provider (i.e., apply more stringent growth restrictions for providers with the highest prices and more generous price updates for the lowest priced providers).  Thus, in addition to slowing the rate of price growth and spending growth over time, this feature of their proposal could potentially reduce the existing, and sometimes extreme price variation across providers.

Although this proposed system would likely not be as successful at reducing health spending growth as a system of explicit price setting (such as the existing Traditional Medicare payment system or past historical all-payer state-based hospital price setting systems), regulatory restrictions on the growth of health care prices would likely slow price growth and spending growth in the commercial sector in future years. This type of system would still be vulnerable to the tendency of providers to increase the volume of services they provide. Finally, although this proposal was intended to minimize the level of government intervention in the existing commercial health care market, such a system would require a complex system of data collection, and regulatory price compliance not much different from the methods employed by the highly regulatory rate systems of used by Medicare and previous all-payer state-based hospital rate setting systems.

Governmental regulatory pricing systems can control health care costs because the regulating agency has the legal authority to both set the initial (or base) price levels for each health care services delivered by a provider and to determine the rate at which these prices increased year over year (i.e., regulate annual “updates” to the base regulated prices). In the past, such annual regulated price updates were traditionally set to be lower than historical growth rates in prices thus creating savings relative to past experience. The legal ability to first set base price levels and then control the growth in these prices over time allowed these governmental systems to be more effective at controlling health care cost growth than unregulated or “market-based” systems, which relied on multi-lateral negotiations between many different insurers and providers to determine both the level of prices and the rate of growth of prices. Beginning in the early 1990s, the rapid consolidation of provider groups (through two rounds of hospital mergers and acquisitions) into large multi-hospital health systems gradually tipped the balance of the negotiating power over prices in favor of hospitals. Since that time, hospitals have continued to merge (“horizontal” mergers) and engage in so-called “vertical” mergers with area physicians, adding to the negotiating power of these providers. This circumstance is a primarily reason why commercial health care prices have grown so rapidly since the mid- to late-1990s.

The cost control capabilities of regulated pricing systems were also enhanced by modifications in the “structure” of regulated payments (also referred to as the “bases of payment”). Early price regulatory systems, at both the state and federal levels, set regulated prices on the basis of reported provider costs in a previous year (referred to as “cost-based” or “retrospective” payment systems).  These early payment systems led to rapid and unsustainable increases in governmental spending on health care, because knowing that any retrospective increase in operating costs would be reflected in higher governmental prices in a future year, providers had little incentive to control their operating costs.

To correct this weakness, government regulators developed what is referred to as a “prospective” payment system. Under prospective payment, the government established a rate for each service in advance of a particular year and kept that rate in effect for the entire year. Providers were paid these prospectively established rates regardless of the operating costs they incurred during a year. Prospective payment systems represented a substantial departure from previous retrospective cost-based payment systems of the past because prospective payment gave providers strong incentives to improve their operating efficiency. This was because under prospectively established prices, increases in provider operating costs during a year would result in operating losses, while decreases in operating costs (i.e., improved provider operating efficiency) would result in higher profits. Prospectively established prices were then updated annually by regulatory agencies at rates that were lower than the historical growth in provider prices and consistent with prevailing governmental budgetary constraints. Regulated prospective pricing and price update systems were first developed on an experimental basis in four of the five all payer state-based hospital rate setting systems and have since been commonly used by governmental payers around the world in and in the U.S. by the Medicare and Medicaid programs.

Although these governmental payment systems were more effective at controlling provider spending than the unregulated and multilateral negotiated commercial payment systems, providers realized they could generate increased payments and higher profit margins by increasing the number of services they provided per patient. In response, both the state-based all payer hospital rate regulatory systems and Medicare and Medicaid developed what were referred to as “bundled payment structures,” payment for bundles of services provided to the patient when admitted or when treated on an outpatient basis. Bundled payment structures offset the tendency of providers to increase the volume of services per patient episode they delivered because providers were paid a fixed amount per type of case (based on a patient’s clinical diagnosis) for inpatient care and a fixed amount per outpatient visit for outpatient care, regardless of the services provided during the patient care episode.

In what is continuously a game of “cat and mouse” between regulators and regulated providers, price regulated hospitals responded to the government’s innovative bundled payment approach and restrictions on annual price updates by increasing the number of admissions, visits, and procedures they performed during a year. To counter this behavioral response of providers several state-based all-payer regulatory systems developed rate mechanisms (“volume adjustment systems”) within their payment approach that adjusted provider price updates based on providers’ annual volume changes (lowering rate updates when volumes grew and increasing price updates when volumes declined). This volume adjustment system was highly effective at reducing provider incentives to unnecessarily increase the provision of health care services.

A state interested in implementing this payment approach would need to pass a law empowering a state regulatory agency, such as a cost commission or the department of health, with the legal power to determine and enforce the regulated prices, or price caps, payers must pay for both in- and out-of-network services. Under this payment approach, the designated state regulatory agency would also be enabled by the legislation with the authority to annual update (or “inflate”) the regulated prices (or base provider prices) each year. A state would need the authority to enforce compliance with established regulated service prices, price caps and price updates. Compliance can be enforced by applying financial penalties on provider for significant deviations from the regulated prices or price caps. A state must also have the authority to collect data from plans and providers on all health care service prices and the ability to audit providers and plans in order to support enforcement of regulated prices, price caps and price updates. 

State rate setting programs generally took two or more years to implement (i.e., establish the regulatory agency, collect data, establish rate methods and begin setting rates) and two or more years to have an impact on slowing the rate of growth of hospital prices and overall spending.

Seven states operated mandatory regulated hospital pricing systems in the 1970s and 1980s. Of these states, New York, Maryland, New Jersey, Massachusetts, and Washington, were authorized to set and update hospital prices paid by all payers, including Medicare and Medicaid, with the approval of federal Waivers from national Medicare reimbursement methodologies.  The Connecticut and West Virginia hospital regulatory system applied to just commercial prices.  The West Virginia system was unique in that it set both a price cap and a price floor for each hospital, allowing hospitals and payers to negotiate final hospital prices within the price floor and price cap corridor.  Both Connecticut and West Virginia had the authority to update the regulated (or negotiated prices) on an annual basis, with West Virginia also tiering the updates based on the relative priciness of each hospital (i.e., lower priced hospitals received higher price updates and higher priced hospitals received lower price updates). Maryland is the only remaining state-based hospital regulatory system still in operation, however, this system transitioned away from regulating explicit hospital service prices to a system of regulating and annually updating hospital global budgets as of 2014. The national Traditional Medicare payment system and state Medicaid payment systems are also examples of regulatory pricing and price update models.

Montana implemented price caps for that ranged from 220 to 225 percent of Medicare for inpatient services and 230 to 250 percent of Medicare for outpatient services. The Oregon State Employee and Public Employee programs implemented price caps of 200% of Medicare for in-network rates and 185% of Medicare for out-of-network rates. 

These price limits have saved these states millions of dollars by truncating high in- and out-of-network price paid by these state plans. See analysis on the savings generated by Montana and information on the savings generated by Oregon.

The all-payer rate setting systems implemented in the 1970s and early 80s eventually came under intense criticism by hospital leaders and legislators, in large part because these systems did indeed effectively limit hospital revenue growth up through the mid-1980s. This level of constraint was unpopular with non-profit hospitals who inherently pursue strategies to expand their services, revenue growth and spheres of influence in their health care markets (so-called “empire building”) or for-profit hospital managers who are incentivized to increase prices and revenues to maximize hospital profits.

In response to this criticism, all-payer rate setting agencies repeatedly modified their rate setting methods and changed their policy emphasis from one focusing on cost control to one emphasizing improved hospital financial performance. The frequent changes to rate methods made these already complex systems even more complex and understood by only a small group of rate setters and hospital personnel. This circumstance contributed to the perception that hospital rate-setting was increasingly subject to insider manipulation. This along with these systems’ reduced cost control effectiveness, the emergence of managed care as a new and more effective cost-containment strategy and changes in the political leadership of New York, New Jersey and Massachusetts (to parties favoring market-based solutions over regulatory solutions) led directly to the repeal of rate-setting authority in these states in the early-mid 1990s.

While the Maryland system experienced some of these same circumstances in the early 1990s, its key stakeholders were extremely reluctant to terminate the all-payer rate system largely because of Maryland’s highly favorable Medicare waiver arrangement with the federal government. This arrangement basically equalized Medicare, Medicaid and Commercial hospital rate levels resulting in very high payments (relative to the rest of the US) from Medicare and Medicaid. In 2014, it was estimated that termination of Maryland’s Medicare waiver, which would cause the state to revert to the much lower hospital payment levels of the national Inpatient and Outpatient Prospective Payment Systems (IPPS and OPPS) would have reduced hospital payments by over $2.0 billion per year (or about 14% of total system revenue). The state’s highly favorable waiver arrangement has galvanized support for the all-payer system from all parties, including the hospital industry. Maryland also was able to adapt its system to allow managed care companies to operate effectively within the state and thus avoided the so-called “collision” between rate setting and managed care experienced in Massachusetts, New Jersey and New York.

Rate-setting models where the state sets rates for all services and then also controls annual updates to these rates require significant regulatory authority, complex rate setting methods, regulatory oversight and resources. Past experience has demonstrated that while these systems did effectively control hospital cost growth and meet other key policy goals from the late 1970s to mid-1980s (and through the early 1990s in the case of Maryland), over time they were difficult to operate and manage and they were more prone to the dangers of regulatory capture and failure. Consequently, states will likely want to consider the lower intensity methods described here before pursuing a highly regulated and more complex rate setting model.

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