How do Hospitals Respond to Payment Incentives?

Over the past decades, health insurers have developed payment reforms, with the goal of rewarding quality over quantity. While these reforms may add value, they require providers to gather more information on patient health conditions, which is costly. We evaluate the role of costs and revenues in coding intensity for Medicare inpatients. We consider costs by estimating hospitals’ changes in coding intensity following a 2007 reform that increased coding complexity. Hospitals with Electronic Medical Records (EMRs) reported 1.25 percentage points more high bill codes immediately after the reform, with the increase only for non-surgical admissions, consistent with the hypotheses that coding costs became an important determinant of coding and EMRs lowered these costs, particularly for medical admissions. Turning to revenues, we examine whether increased reimbursements from reporting high bill codes led hospitals to report more such codes. Before the reform, a one-unit increase in the DRG weight spread between high and low bill codes was associated with 0.63 percentage points more high codes, with no positive association after the reform, suggesting that hospitals base their coding less on revenues after the reform. We develop a simple model that ties the results together and offers one coherent way to reconcile the cost and revenue findings. Our findings imply that recent payment innovations might add cost to providers.