Health Care Spending Growth under the Prospective Payment System: Evidence from Medicare Home Health Care∗

This paper explores the causes of the dramatic rise in total Medicare home health spending under the prospective payment system. In 2000, Medicare home health care introduced the prospective payment system to control the spending growth that had occurred under the fee-for-service payment system. However, total spending under the new system has continued to increase significantly. I examine the underlying forces behind the growth in the three factors that contributed to this spending increase: 1) the number of Medicare home health patients, 2) the number of episodes per patient, and 3) the payment amount per episode. Using the Medicare Claims and Provider of Services File from 1999 to 2009, I find strong empirical support that the prospective payment system provided unintended incentives for home health agencies to adjust their service provision patterns to increase profits. This led to an increase in all three factors, independent of the health needs of patients. In particular, the number of Medicare home health patients contributed the most to the total spending increase. In addition, many profit maximizing behaviors were most evident among for-profit home health agencies. Furthermore, the incentives built into the prospective payment system attracted to the market a substantial number of for-profit agencies. These new agencies pursued profitable home health provision patterns more aggressively than agencies established prior to the prospective payment system. Overall, the increase in the for-profit market share accounts for about one-third of the increase in total Medicare spending between 2001 and 2009. ∗I gratefully acknowledge funding from the Blue Cross Blue Shield of Michigan Foundation, Fahs-Beck Fund for Research and Experimentation, and Rackham Graduate School of the University of Michigan. This project is conducted with approval from the University of Michigan Institutional Review Board (HUM00045665). I am deeply indebted to my dissertation committee for invaluable encouragement and comments: Edward C. Norton, Ruth Dunkle, Martha Bailey, and Luke Shafer, and to Laura Zimmerman, Susan Godlonton, Izumi Yokoyama, Meghan Skira, Hwajung Choi, Edith Ostapik, Olena Nizalova, American Society of Health Economics 2012 participants, University of Michigan seminar participants, Agency for Healthcare Research and Quality seminar participants, and University of Pennsylvania group meeting participants for helpful comments. All remaining errors are my own. †Ph.D. Candidate, Department of Economics, University of Michigan, 611 Tappan Street, Ann Arbor, MI 48109-1220: [email protected]