Skip to main content
SpringerLink
Log in

Cost inefficiency under financial strain: a stochastic frontier analysis of hospitals in Washington State through the Great Recession

  • Published:
Health Care Management Science Aims and scope Submit manuscript

Abstract

The importance of increasing cost efficiency for community hospitals in the United States has been underscored by the Great Recession and the ever-changing health care reimbursement environment. Previous studies have shown mixed evidence with regards to the relationship between linking hospitals’ reimbursement to quality of care and cost efficiency. Moreover, current evidence suggests that not only inherently financially disadvantaged hospitals (e.g., safety-net providers), but also more financially stable providers, experienced declines to their financial viability throughout the recession. However, little is known about how hospital cost efficiency fared throughout the Great Recession. This study contributes to the literature by using stochastic frontier analysis to analyze cost inefficiency of Washington State hospitals between 2005 and 2012, with controls for patient burden of illness, hospital process of care quality, and hospital outcome quality. The quality measures included in this study function as central measures for the determination of recently implemented pay-for-performance programs. The average estimated level of hospital cost inefficiency before the Great Recession (10.4 %) was lower than it was during the Great Recession (13.5 %) and in its aftermath (14.1 %). Further, the estimated coefficients for summary process of care quality indexes for three health conditions (acute myocardial infarction, pneumonia, and heart failure) suggest that higher quality scores are associated with increased cost inefficiency.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2

Similar content being viewed by others

Notes

  1. Under HVBP, CMS reduces all participating hospitals’ base operating Diagnosis Related Groups (DRG) payment amounts by a fixed percentage at the beginning of each fiscal year to set aside for later redistribution based on hospital performance. The hospitals’ final adjustment factors determine how much of the initial reduction they each earn back. The HRRP program is designed to diminish hospitals’ monetary gain from inappropriate readmissions pertaining to specific medical conditions. In FY 2013, hospitals received adjustment factors based on their excess thirty-day risk-adjusted readmission rates related to heart attack, heart failure, and pneumonia cases. CMS uses the adjustment factors to determine the proportion of the hospitals’ base operating DRG payments they will be returning each hospital for that year.

  2. See section 6.1 for further discussion of the BPF.

  3. See section 6.2 for discussion of the probability distribution function of this error term.

  4. See section 6.3 for more details about assumptions of the structure of the cost function.

  5. The results of the estimation do not depend on the input price chosen for normalization.

  6. The estimated coefficients assuming a Cobb-Douglas cost function for the output and input variables are positive and significant (p < 0.05).

  7. Scale efficiency refers to the level of output that minimizes the average cost of producing one unit of output [58].

  8. Coelli et al. [58] and Rosko and Mutter’s [44] review of hospital inefficiency studies have shown that changing the distribution of the deterministic error has a small effect on estimated inefficiencies.

References

  1. Reiter K, Jiang H, Wang J (2014) Facing the Recession: How did Safety-net Hospitals Fare Financially Compared with Their Peers? Health Serv Res 49:1747–1766

    Google Scholar 

  2. Lusardi A, Schneider DJ, Tufano P (2010) The economic crisis and medical care usage. National Bureau of Economic Research. http://www.nber.org/papers/w15843. Accessed 6 June 2015

  3. Mortensen K, Chen J (2013) The Great Recession and Racial and Ethnic Disparities in Health Services use. J Am Med Assoc Intern Med 173(4):315–317

    Google Scholar 

  4. Dranove D, Garthwaite C, Ody C (2014) Health Spending Slowdown is Mostly due to Economic Factors, not Structural Change in the Health Care Sector. Health Aff 33(8):1399–1406

    Article  Google Scholar 

  5. Teff N, Kageleiry A (2014) State-Level Unemployment and the Utilization of Preventive Medical Services. Health Serv Res 49(1):186–205

    Article  Google Scholar 

  6. Gordon T (2012) State and Local Budgets and the Great Recession. http://www.brookings.edu/research/articles/2012/12/state-local-budgets-gordon

  7. Cawley J, Moriya AS, Simon KI (2011) The impact of the macroeconomy on health insurance coverage: Evidence from the Great Recession (Working Paper No. 17600). National Bureau of Economic Research. http://www.nber.org/papers/w17600. Accessed 6 June 2015

  8. American Academy of Family Physicians (2009) Patient Care During the 2008–2009 Recession–Online Survey. http://www.aafp.org/dam/AAFP/documents/media_center/recession/Executive-Summ-Patient-Care-Recession-Survey-20090520.pdf. Accessed 6 June 2015

  9. Maeda JL, Henke RM, Marder WD, Karaca Z, Friedman BS, Wong HS (2014) Association Between the Unemployment Rate and Inpatient Cost per Discharge by Payer in the United States, 2005–2010. BMC Health Serv Res 14:378

    Article  Google Scholar 

  10. Rosko MD, Mutter RL (2014) The Association of Hospital Cost-Inefficiency with Certificate-of-Need Regulation. Med Care Res Rev 71(3):280–298

    Article  Google Scholar 

  11. Rosko MD (1999) Impact of Internal and External Environmental Pressures on Hospital Inefficiency. Health Care Manag Sci 2:64–78

    Article  Google Scholar 

  12. Rosko MD (2001a) Cost Efficiency of U.S. hospitals: A Stochastic Frontier Approach. Health Econ 10:539–551

    Article  Google Scholar 

  13. Rosko MD, Proenca J (2005) Impact of Network and System use on Hospital X-Inefficiency. Health Care Manag Rev 30:69–79

    Article  Google Scholar 

  14. Hsieh H, Clement D, Bazzoli G (2010) Impacts of Market and Organizational Characteristics on Hospital Efficiency and Uncompensated Care. Health Care Manag Rev 35(1):77–87

    Article  Google Scholar 

  15. Newhouse J, Garber A, Graham R, McCoy M, Mancher M, Kibria A (2013) Variation in health care spending: Target decision making, not geography. Committee on geographic variation in health care spending and promotion of high-value care; Board on Health Care Services; Institute of Medicine (IOM)

  16. Carey K, Burgess Jr JF (1999) On Measuring the Hospital Cost/Quality Trade-off. Health Econ 8(6):509–520

    Article  Google Scholar 

  17. Mukamel DB, Zwanziger J, Tomaszewski KJ (2001) HMO Penetration, Competition, and Risk-Adjusted Hospital Mortality. Health Serv Res 36(6):1019–1035

    Google Scholar 

  18. Deilya ME, McKay NL (2006) Cost Inefficiency and Mortality Rates in Florida Hospitals. Health Econ 15:419–431

    Article  Google Scholar 

  19. Jha AK, Orav EJ, Dobson A, Book RA, Epstein AM (2009) Measuring Efficiency: The Association of Hospital Costs and Quality of Care. Health Affairs (Millwood) 28(3):897–906

    Article  Google Scholar 

  20. Deficit Reduction Act of 2005. Pub L No. 109–171, [S] 5001(c), 120 Stat 4, 30

  21. CMS 2008 Changes to the hospital inpatient prospective payment systems and fiscal year rates: final rule. 42 CFR [S] 411–413, 489

  22. WSHCA 2010 Hospitals–Safety Net Assessment. https://legiscan.com/WA/text/HB2956/2009. Accessed 6 June 2015

  23. CMS (2012) Hospital Value-Based Purchasing Program frequently asked questions. Medicare.gov. http://www.cms.gov/Medicare/Quality-Initiatives-Patient-Assessment-Instruments/hospital-value-based-purchasing/Downloads/FY-2013-Program-Frequently-Asked-Questions-about-Hospital-VBP-3-9-12.pdf. Accessed 26 June 2015

  24. Kaiser Health News (2012) By State: hospital Quality Bonuses and Penalties http://khn.org/news/value-based-purchasing-by-state-chart. Accessed June 1, 2015

  25. Gilman M, Adams E, Hockenberry J, Milstein A, Wilson I, Becker E (2015) Safety-net Hospitals More Likely than Other Hospitals to Fare Poorly Under Medicare’s Value-Based Purchasing. Health Aff 34(3):398–405

    Article  Google Scholar 

  26. Kumbhakar S, Lovell CK (2000) Stochastic frontier analysis. Cambridge University Press, Cambridge, England

    Book  Google Scholar 

  27. Lovell C (1993) Production frontiers and productive efficiency. In: Fried H, Lovell C, Schmidt S (eds) The measurement of productive efficiency. Oxford University Press, New York, pp. 82–111

    Google Scholar 

  28. Battese G, Coelli T (1995) A Model for Technical Inefficiency Effects in a Stochastic Frontier Production Function for Panel Data. Empir Econ 20:325–332

    Article  Google Scholar 

  29. Mutter R, Rosko M, Wong H (2008) Measuring Hospital Inefficiency: The Effects of Controlling for Quality and Patient Burden of Illness. Health Serv Res 43:1992–2013

    Article  Google Scholar 

  30. Baumol WJ, Panzar JC, Willig RD (1982) Contestable markets and the theory of industry structure. Harcourt Brace Jovanovich Inc, New York

    Google Scholar 

  31. Battese G, Heshmati A, Hjalmarsson L (2000) Efficiency of Labour use in the Swedish Banking Industry: A Stochastic Frontier Approach. Empir Econ 25:623–640

    Article  Google Scholar 

  32. Herr A (2008) Cost and Technical Efficiency of German Hospitals: Does Ownership Matter? Health Econ 17(9):1057–1071

    Article  Google Scholar 

  33. Besstremyannaya G (2011) Managerial Performance and Cost Efficiency of Japanese Local Public Hospitals: A Latent Class Stochastic Frontier Model. Health Econ 20(S1):19–34

    Article  Google Scholar 

  34. Herr A, Schmitz H, Augurzky B (2011) Profit Efficiency and Ownership of German Hospitals. Health Econ 20(6):660–674

    Article  Google Scholar 

  35. Li T, Rosenman R (2001) Estimating Hospital Costs with a Generalized Leontief Function. Health Econ 10:523–538

    Article  Google Scholar 

  36. Rosko MD, Mutter RL (2010) Inefficiency Differences Between Critical Access Hospitals and Prospectively Paid Rural Hospitals. J Health Polit Policy Law 35(1):95–126

    Article  Google Scholar 

  37. Santerre RE, Neun SP (2013) Health economics: Theory, insights and industry studies, 6th edition, 6th edn. South-Western

  38. Kahn III CN, Ault T, Isenstein H, Potetz L, Van Gelder S (2006) Snapshot of Hospital Quality Reporting and pay-for-Performance Under Medicare. Health Aff 25(1):148–162

    Article  Google Scholar 

  39. Folland S, Hofler R (2001) How Reliable are Hospital Efficiency Estimates? Exploiting the Dual to Homothetic Production. Health Econ 10:683–698

    Article  Google Scholar 

  40. Joskow P (1980) The Effects of Competition and Regulation on Hospital bed Supply and the Reservation Quality of the Hospital. Bell J Econ 11:421–447

    Article  Google Scholar 

  41. Rosko MD (1996) Understanding Variations in Hospital Costs: An Economic Perspective. Ann Oper Res 67:1–21

    Article  Google Scholar 

  42. Banks D, Paterson M, Wendel J (1997) Uncompensated Hospital Care: Charitable Mission or Profitable Business Decision? Health Econ 6:133–143

    Article  Google Scholar 

  43. Rosko M, Mutter R (2008) Stochastic Frontier Analysis of Hospital Inefficiency: A Review of Empirical Issues and an Assessment of Robustness. Med Care Res Rev 65:131–166

    Article  Google Scholar 

  44. Gaskin DJ (1997) Altruism or Moral Hazard: The Impact of Hospital Uncompensated Care Pools. J Health Econ 16(4):397–416

    Article  Google Scholar 

  45. Davidoff AJ, LoSasso AT, Bazzoli GJ, Zuckerman S (2000) The Effect of Changing State Health Policy on Hospital Uncompensated Care. Inquiry 37(3):253–267

    Google Scholar 

  46. Rosko MD (2004) The Supply of Uncompensated Care in Pennsylvania Hospitals: Motives and Financial Consequences. Health Care Manag Rev 29(3):229–239

    Article  Google Scholar 

  47. Berenson R, Bodenheimer T, Pham H (2006) Specialty-Service Lines: Salvos in the new Medical Arms Race. Health Aff 25:337–343

    Article  Google Scholar 

  48. Rosko M (2001b) Impact of HMO Penetration and Other Environmental Factors on Hospital X Inefficiency. Med Care Res Rev 58:430–454

    Article  Google Scholar 

  49. Sari N (2003) Efficiency Outcomes of Market Concentration and Managed Care. Int J Ind Organ 21:1571–1589

    Article  Google Scholar 

  50. McKay N, Deily M (2005) Comparing High- and low-Performing Hospitals Using Risk Adjusted Excess Mortality and Cost Inefficiency. Health Care Manag Rev 30:347–360

    Article  Google Scholar 

  51. Devers KJ, Brewster LR, Casalino LP (2003) Changes in Hospital Competitive Strategy: A new Medical Arms Race? Health Serv Res 38:447–469

    Article  Google Scholar 

  52. McKay N, Deily M, Dorner F (2002/2003) Ownership and Changes in Hospital Inefficiency, 1986–1991. Inquiry 39:388–399

  53. Rosko M, Proenca J, Zinn J, Bazzoli G (2007) The Impact of Membership in Different Types of Systems on Hospital Cost Inefficiency. Inquiry 44:335–349

    Google Scholar 

  54. Donabedian A (1988) The Quality of Care: How Can It Be Assessed? J Am Med Assoc 260(12):1743–1748

    Article  Google Scholar 

  55. Bauer PW, Berger AN, Ferrier GD, Humphrey DB (1998) Consistency Conditions for Regulatory Analysis of Financial Institutions: A Comparison of Frontier Efficiency Methods. J Econ Bus 50:85–114

    Article  Google Scholar 

  56. Coyne JS, Richards MT, Short R, Shultz K, Singh SG (2009) Hospital Cost and Efficiency: Do Hospital Size and Ownership Type Really Matter? J Healthc Manag 54(3):163–174

    Google Scholar 

  57. MedPAC (2015) Context for Medicare Payment Policy. Report to the Congress: Medicare payment policy

  58. Coelli TJ, Rao DSP, O’Donnell CJ, Battese GE (2005) An introduction to efficiency and productivity analysis, 2nd edn. Springer, USA

    Google Scholar 

  59. Romley JA, Goldman DP, Sood N (2015) US Hospitals Experienced Substantial Productivity Growth During 2002–11. Health Aff 34(3):511–518

    Article  Google Scholar 

  60. McGinnis JM, Williams-Russo P, Knickman JR (2002) The Case for More Active Policy Attention to Health Promotion. Health Aff 21(2):78–92

    Article  Google Scholar 

  61. Aigner D, Lovell K, Schmidt P (1977) Formulation and Estimation of Stochastic Frontier Production Models. J Econ 6:21–37

    Article  Google Scholar 

  62. Meeusen W, Van den Broeck J (1977) Efficiency Estimation from Cobb-Douglas Production Functions with Composed Error. Int Econ Rev 18:435–444

    Article  Google Scholar 

  63. Greene WH (2003) Econometric analysis. Prentice Hall, Upper Saddle River, NJ

    Google Scholar 

  64. Stevenson R (1980) Likelihood Functions for Generalized Stochastic Frontier Estimation. J Econ 13:58–66

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Department of Economics, Eastern Washington University, 311 Patterson Hall, Cheney, WA, 99004-2429, USA

    Germán M. Izón & Chelsea A. Pardini

Authors
  1. Germán M. Izón
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Chelsea A. Pardini
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Germán M. Izón.

Rights and permissions

Reprints and permissions

About this article

Check for updates. Verify currency and authenticity via CrossMark

Cite this article

Izón, G.M., Pardini, C.A. Cost inefficiency under financial strain: a stochastic frontier analysis of hospitals in Washington State through the Great Recession. Health Care Manag Sci 20, 232–245 (2017). https://doi.org/10.1007/s10729-015-9349-8

Download citation

  • Received:

  • Accepted:

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10729-015-9349-8

Keywords

JEL classification

Msc classification

Search

Navigation