Hospital Cost Containment and Length of Stay: An Econometric Analysis

1. Introduction Concern in the United States over the rising share of national resources consumed by health care costs has become widespread in recent years. Hospitals, accounting for approximately 40% of this expense, have been a primary focus of cost control strategy, as both government and private insurers have pressured them to absorb an increasing portion of the financial risks associated with their treatment decisions. A predominant response to these pressures has been reduction in the number of days that patients remain hospitalized. Perceptions of compromised medical care quality following this practice and others have prompted policy makers to consider stricter regulation of the conduct of health care providers and insurance organizations. The length of hospitalization issue has become prominent with the general public and for some procedures has been widely criticized for being extreme. Maternity and newborn care, for example, became a heavy target for insurers who in many cases were limiting reimbursement for stays to only 24 hours. This case became very controversial, eventually rising to high political ground and resulting in recent Congressional action requiring insurers to cover 48 hours of hospitalization for these patients. The U.S. Congress as well as numerous state legislatures currently face a number of articles of proposed legislation that directly or indirectly regulate the length of hospitalizations. These include measures that give physicians more authority over treatment decisions, that make health plans legally liable for their actions, and that establish appeals procedures for treatment not deemed medically necessary or appropriate by health plans. While controversy surrounding length of stay reductions have focused on the quality of service being delivered by the health care system, attention given to the economics of this strategy is limited. It is unclear to what extent length of stay reductions are responsible for decreasing hospital costs. Presumably, the inpatient days that are now being eliminated are the least costly ones. A provocative stance has been taken by Reinhardt (1996) who argues that the strategy of length of stay reduction in the United States is single minded and unproductive. He hypothesizes that the hospital is not the expensive setting that is commonly perceived. Researchers have tracked carefully the trends in hospital lengths of stay and have explored the effects of various reimbursement strategies on hospital utilization. Previous studies have also addressed the potential tradeoff between length of stay and quality of care. If quality has not diminished, then longer hospitalizations may have been largely superfluous. This is a clinical issue. Little empirical effort, however, has been aimed at determining what costs are actually saved by these measures. This paper aims to provide evidence on this point. Rather than asking what health interests might be foregone as a result of shorter hospitalizations, the inquiry here is what economic benefits are being gained. This research takes a hospital cost function approach to measuring the cost savings achieved by U.S. hospitals through reduction in length of hospital stays. The remainder is organized as follows. Section 2 provides background to the problem and the next section describes an econometric model for addressing it. Section 4 presents the data and describes the functional form. Section 5 discusses empirical results and section 6 provides discussion. The final section concludes. 2. Background and Institutional Framework Broad attempts at controlling hospital expenditures began in the 1980s. The most notable single event was the step taken in 1983 by Medicare, the government program of health care funding for the elderly, and hospitals' largest third-party payer. Medicare adopted the Prospective Payment System (PPS) that altered the basis of reimbursement from reasonable cost to prices based on historical costs for specific diagnoses across hospitals. …