Addressing government and market failures with payment incentives: Hospital reimbursement reform in Hainan, China
Introduction
Throughout the world policymakers are searching for ways to improve the efficiency and financial sustainability of health care systems. Prominent among the proposed strategies is the introduction of stronger market forces to the health sector. Yet policy experience and empirical research in the industrialized countries have well established that there are important market failures in health care financing and provision, including adverse risk selection, moral hazard, and supply-side market power. In light of these potent market failures, governments are frequently called upon to intervene. In the area of financing, for example, experience has shown that if a health care system is to achieve universal coverage, government must help organize social risk pooling.
Government intervention, however, is far from a panacea. Systems that rely on government facilities for health care provision, for example, are often plagued with inefficiencies from bureaucratic and monopolistic public management. In light of both market and government failures, there has been a trend towards “regulated competition” that attempts to harness competitive forces for efficiency and innovation while relying upon government-specified rules of the game to uphold social solidarity and correct market failures. Reforms in this spirit include organizational reforms such as hospital autonomy, corporatization, and separation of the roles of purchaser and provider, as undertaken for example in Britain's National Health Service. Others include selective contracting and payment reforms, such as the widely emulated Prospective Payment System in the US. Whereas there is emerging evidence on the effectiveness of these different policies for addressing market and government failures in advanced economies, empirical evidence is very limited for developing countries. Often, these reforms require sophisticated managerial, financial, and institutional support, such as advanced information systems and administrators who understand economic incentives. It therefore remains unclear to what extent the experience of advanced economies can directly translate into sound policy advice for developing countries.
A particular challenge for most developing and transitional countries is the institutional transformation from a system originally based on heavily subsidized public providers. Although such a national health service offers implicit insurance and therefore widespread access to care, many transitional and developing countries seek to replace this system with formal social insurance schemes and separation of purchaser and provider, at least for the urban population. Governmental budget pressures can further spur reform that decreases providers’ reliance on subsidies and expands cost recovery through user charges. To prevent patient charges from compromising access to necessary services during this transition, pricing and payment policies can be important government policy instruments.
Distinctive as a developing transitional economy, China is an important case to study. Chinese pricing of health services has sought to guarantee universal access to basic services by pricing such services at or below average cost. Adverse side effects of this policy came to the fore during the economic reform era. Public health care providers such as hospitals, once heavily subsidized, came under financial pressure as shrinking government budgets led to dramatic cuts in subsidies. To compensate providers, they were allowed to charge payers (e.g., employers or patients themselves) more than average cost for other services, such as high technology diagnostic procedures and many prescription drugs. This pricing scheme is potentially a second-best government intervention, trading off pricing efficiency for equitable access. Unfortunately, the distorted incentives implicit in this price system can lead to large adverse side effects when combined with supply-side market power in health care. As could be predicted, Chinese hospitals began to view high technology medicine and prescription drugs as their financial salvation, and exerted pressure through physicians to increase demand for these services. These forces are suspected to be at the root of much of China's rapid health expenditure cost escalation.
Although one logical solution to the cost inflation dilemma is to rationalize prices and assure universal access instead through formal social insurance, current financing reform in urban China will only cover 50 percent of the urban population when fully implemented. If prices are adjusted to reflect the full cost for basic services, access could become a problem for the uninsured population and could potentially lead to social unrest as well as affecting the health of the population. Therefore, as long as China's urban social insurance system does not cover the entire (urban) population, it is inevitable that FFS will remain a dominant form of payment for the uninsured, and maintaining the implicit cross-subsidization of basic care through distorted prices may represent the best feasible solution. Unfortunately, this policy leaves in place incentives for cost escalation.
In this setting, payment policy for the insured may be a useful instrument for Chinese policymakers to pursue cost control. In particular, replacing fee-for-service (FFS) payment according to the distorted pricing system with aggregated pre-payment for patients covered by social insurance can mitigate the incentive for cost escalation. Payment reforms should be carefully monitored and evaluated, however, to determine whether providers genuinely reduce cost growth or instead shift costs to patients not covered by pre-payment, which could exacerbate access problems for the uninsured.
The primary objective of this paper is to assess empirically the impact of payment reform on services originally subject to different pricing distortions, using the experience of Haikou City in Hainan Province in China. Although Hainan is a small province, Haikou is one of a handful of Chinese cities that has several years’ experience with city-wide risk pooling and payment reform. Unlike other cities, which introduced insurance and payment reforms simultaneously, Haikou introduced insurance reforms in mid-1995, whereas payment reform began in January 1997. Thus, during the first year and a half of Hainan's insurance reforms, all hospitals were reimbursed on a FFS basis. This temporal separation of insurance and payment reforms allows us to isolate their effects on health expenditures. A second critical strength of the Hainan case is the ability to decompose inpatient expenditures into components that were subject to contrasting pricing incentives under FFS. In particular, we have patient-level data on spending for expensive drugs and high technology diagnostic and medical procedures, which were very profitable under FFS, and standard bed charges, which were not. By contrasting the impact of prepayment on expenditures in these different categories, we can gain an understanding of how effective payment policy might be in addressing the adverse side effects of government pricing distortions. Furthermore, since only a selected subset of Hainan hospitals became pre-paid in January 1997, there is a ‘control group’ consisting of those hospitals of comparable size and structure that remained under FFS reimbursement. We employ a pre-post study design with control group—a difference-in-difference empirical strategy—to identify the effects of supply-side payment reform on different sub-categories of expenditures.
Consistent with theory and empirical findings in advanced economies, we find that prepayment is associated with a slower rate of growth of expenditures on services that were profitable under FFS, especially spending on expensive drugs and high technology procedures. In contrast, expenditures on standard bed charges, not subject to the same pricing distortions, were basically unaffected by the payment reform.
The effectiveness of payment reform in moderating drug spending is especially of note, since drugs are the most rapidly growing component of total health care expenditure in China. Unfortunately the data do not allow us to analyze overall efficiency and welfare effects (since we lack data on outpatient expenditures and spending of the uninsured). Results should therefore be interpreted with caution. Nonetheless, the results are encouraging and should be quite policy relevant as Chinese reforms expand into new localities throughout the nation.
The paper is organized as follows. The next section provides background on China's urban health care system and the causes leading to reform, the experiences of health insurance and provider payment reforms in various reform sites, and Hainan's reforms in particular. The following section describes the natural experiment, the data, and our empirical methodology. The penultimate section presents results. The Conclusion section discusses policy implications and limitations.
Section snippets
China's urban health system reforms
Established in the 1950s, China's health protection system for urban residents consists of an extensive subsidized public delivery system—implicit coverage—and two explicit health insurance programs, the Government Insurance Scheme (GIS) and Labor Insurance Scheme (LIS) that together currently cover half the urban population. Financed by government budgets through general revenues, GIS covers government employees, retirees, disabled veterans, university teachers, students and their dependents.
Data
Our analysis of the impact of payment reform is based on inpatient claims data for insured patients treated at 14 hospitals as reported to the Guo and Ge (1998), Hainan Social Insurance Bureau (1997a), Hainan Social Insurance Bureau (1997b). The study period spans the two years from mid-1995 to mid-1997 (i.e., including half a year of claims after the payment system reforms began in January 1997).
Although the original data set included over five thousand inpatient admissions, elimination of
Results
Average expenditures per admission in the FFS and reform hospitals (Fig. 1) seem to follow a similar rising trend in the pre-reform period, with a trend break for the reform hospitals coinciding with the payment reform in January 1997.4 We focus on
Conclusion
Taking advantage of a natural experiment of payment reform in Hainan Province in China, we employed a difference-in-difference methodology to assess the impact of provider payment in addressing government and market failures and controlling cost. Consistent with theory, we find that prepayment is associated with a slower rate of growth of expenditures on services that were profitable under FFS, especially spending on expensive drugs and high technology procedures. Expenditures on standard bed
Acknowledgements
The authors are grateful to William Hsiao and two anonymous referees for valuable comments, to the Social Insurance Bureau of Hainan Province for co-operation in conducting the study, and to Blenda Wong for capable research assistance.
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