Yardsticks and carrots
Amsterdam, April 2007
For Ministry of Finance
Yardsticks and carrots
Assessment of transitory regulation of hospital care
Joost Poort
Aenneli Houkes
Inge Groot
Roetersstraat 29 - 1018 WB Amsterdam - T (+31) 20 525 1630 - F (+31) 020 525 1686 - www.seo.nl - [email protected]
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Table of contents
1
Introduction..................................................................................................1
2
Policy options for regulation ....................................................................... 3
2.1
Policy options.....................................................................................................................3
2.1.1
Liberalisation without additional regulation..................................................................3
2.1.2
One-off extension with regulation..................................................................................3
2.1.3
Gradual extension of full liberalisation & partial regulation ......................................5
2.2
Conclusions ........................................................................................................................7
3
Scenarios for the health care market ........................................................... 9
3.1
Introduction........................................................................................................................9
3.2
Assumptions.......................................................................................................................9
3.3
Scenarios ...........................................................................................................................10
4
Assessment of regulation under scenarios ................................................. 13
4.1
Limitations to healthy competition...............................................................................13
4.2
Experiences with liberalisation......................................................................................15
4.3
Stakeholders’ positions ...................................................................................................16
4.4
Prices..................................................................................................................................17
4.4.1
Incentives for insurers ....................................................................................................17
4.4.2
Incentives for hospitals...................................................................................................20
4.4.3
Price dynamics and total costs.......................................................................................24
4.4.4
Administrative burdens ..................................................................................................28
4.4.5
Prices in market scenarios ..............................................................................................31
4.5
Volumes ............................................................................................................................32
4.6
Quality ...............................................................................................................................34
4.7
Costs ..................................................................................................................................37
4.8
Innovation and entry.......................................................................................................38
4.9
Organisation .....................................................................................................................39
5
Conclusions and policy implications.......................................................... 41
Literature
....................................................................................................................43
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1
Introduction
The Dutch system for financing hospital care is in transition. Until 2005, a budget system was
used. Over the last few years, this system has been changed into a system of diagnosis-treatmentcombinations (DBCs). These are elementary units of hospital care composed of a diagnosis and a
treatment, designed to make care more comparable between hospitals, and to give hospitals an
incentive to work cost-effectively. In this system, the actual costs, in terms of the number of
visits, hospital days, treatments and stitches is no longer relevant for financing. Hence, waiting
lists that result from restrictive annual budgets can be resolved, while efficiency is encouraged.
Hospitals and health insurers are supposed to negotiate prices per DBC (or, for instance, a fixed
price for a given DBC-volume per year). At present only about 10% of total hospital care has
been fully liberalised, corresponding with total annual revenues of about € 1.1 billion. This is
known as the B-compartment (‘B-segment’). In 2005 it consisted of 1376 DBCs, in 14 medical
specialisations; in 2006, 11 DBCs were added, while in 2007, the B-compartment will not be
expanded (Ineveld, Dohmen and Redekop 2006). For the remaining 90%, a hybrid system exists:
suppliers of hospital care receive a budget which is administratively based on DBC-volumes, but
in which DBC-prices are set to match the old budgeting parameters. These 90% consist of two
subcategories, the so-called A0- and A1-compartment.
The Ministry of Health envisages a next step in the process of liberalisation by January 1st 2008.
Over the last months, several policy options for the architecture of this next step have been
considered. These options include a gradual or instant liberalisation without additional regulation
and liberalisation in combination with some kind of yardstick competition. In the working
programme for the new coalition of CDA, PvdA, and CU, a new option was introduced, which
combines regulated and unregulated liberalisation (CDA, PvdA and CU 7 February 2007).
This report analyses the incentives and expected effects of the various policy options. Under five
different scenarios for the mid-term developments in the health care market, effects on prices,
costs, quality, and innovations are compared. Also, the expected effects on the macro budget for
hospital care, and the possibilities for future further deregulation are considered.
For this study, a number of interviews with stakeholders have been held. These interviews are
used to signal ideas, trends and views of the field. We would like to thank the interviewees for
sharing their experience: drs. J.P.A. van Haarlem RA (directeur verzekeringszaken ONVZ), prof.
dr. A.P.W.P. van Montfort (voorzitter raad van bestuur Achmea), drs. W. J. H. M. de Bie
(voorzitter raad van bestuur Sint Maartenskliniek), drs. J.C.A. Sol (financieel directeur
Oogziekenhuis Rotterdam) en mr. W.J.G. Blaauw (voorzitter raad van bestuur zorggroep
Noorderbreedte).
This report is structured as follows: Chapter 2 gives a detailed description of the policy scenarios
that are studied. These aim to be congruent with the options under consideration in the political
debate. However, it will be made clear there is still room for fine-tuning some of the parameters.
Chapter 3 describes five scenarios for the developments in the market for hospital care. Chapter
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4 analyses the expected relative effects and incentives of the various policy options under these
scenarios. Chapter 5 concludes.
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3
Policy options for regulation
This chapter describes the policy options that are analysed in this report. As will be pointed out,
these options are modelled after the options currently considered in the political debate, or
advocated by stakeholders. The dust in this debate has by no means settled, however. The option
that the coalition agreement proposes, for instance, still requires further elaboration, and most
options leave various dials for fine-tuning. Although these dials will be discussed in this chapter,
they will be ignored in most of this report for the sake of clarity. Moreover, policy options may
differ with respect to the moment they could become effective and even within policy options
there are timing issues to be addressed. For giving a clear comparison between the options,
however, this report implicitly assumes that all options can be fully introduced at the same
moment.
2.1 Policy options
In this report, three main policy options and several sub-options are considered:
1 Liberalisation without additional regulation
a. Gradual extension of the B-compartment in yearly steps
b. One-off extension of the B-compartment
2 One-off extension of the B-compartment with regulation
a. Yardstick competition based on prices
b. Yardstick competition based on costs
c. Regulation based on the budget system (Budgettair Kader Zorg, BKZ)
3 Gradual extension of full liberalisation & partial regulation (option in coalition agreement).
2.1.1 Liberalisation without additional regulation
Under options 1a and 1b, no price controls will be introduced for DBCs or institutions. If there
is excess demand for certain DBCs or in case some hospitals have regional market power, this
may cause prices to increase. Under 1a, the free compartment is extended step by step, so that
hospitals and health insurers can gradually get used to liberalised prices. If prices were to increase
dramatically, further extension could be put to a halt.
2.1.2 One-off extension with regulation
Options 2a-c aim to limit the extent of possible price increases with a form of price regulation.
All options that are considered regulate average DBC-prices per hospital per year, instead of
individual DBC-prices1. As such, they all depart from the most light-handed option as suggested by
the Dutch Healthcare Authority in April 2006.2 This yearly average price is calculated using
1
2
Henceforth, the term ‘hospitals’ will be used for all suppliers for hospital care (both actual hospitals and
so-called ZBCs, independent treatment centers).
CTG/ZAio (2006). De Zichtbare Hand: Uitvoeringstoets Ziekenhuisbekostiging, CTG/ZAio, p.14.
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predetermined ‘norm prices’3 or ‘weights’4 for each DBC. Although formulation in terms of
weights or norm prices are equivalent mathematically, this report will prefer to express the
regulation schemes in terms of norm prices, to allow for a more direct comparison with actual
prices and costs of DBCs at the hospital level. These norm prices or weights do not directly
restrict DBC-prices: hospitals are free to negotiate higher or lower DBC-prices, as long as an
overall boundary condition following from these norm prices or weights is met.
This boundary condition for hospitals is expressed in terms of a maximum average price per DBC.
This maximum average DBC-price will generally differ between hospitals, depending on their
expected ‘case-mix’ – a weighted average of different DBCs – and will be communicated to
hospitals before price negotiations with health insurers take place. The three policy options
discussed here differ in the way the ‘norm prices’ or ‘weights’ and hence this boundary condition
is determined.
If the total turnover of a hospital is larger than the maximum allowed by regulation, the surplus
will be reclaimed and put into the ‘Zorgverzekeringsfonds’ (Tweede Kamer 2005-2006).5 Out of
this fund, both equalisation payments are made for high risk insurants and premiums for
insurants under 18 years are paid. Note that this implies that reclaimed funds will accrue to all
health insurers equally.6 Box 2.1 expresses the regulation system in mathematical symbols.
Policy options 2a-c are identical in the way the maximum turnover for a hospital is calculated,
and only differ in the way the norm prices (PmaxjY in Box 2.1) are determined.
Price yardstick (Option 2a)
In option 2a, which will henceforth be called the ‘price yardstick’, norm prices will be based on
the overall development of negotiated prices. Basically, the norm price for a DBC will be equal to
the mean of the negotiated prices for that DBC in the previous year.7
This type of regulation, which determines regulated prices for a supplier on the performance of a
group of peers, is known as yardstick competition (‘maatstafconcurrentie’ in Dutch). This type of
regulation was originally developed by Andrei Shleifer (Shleifer 1985).8 The principal idea behind
yardstick competition is that a supplier is forced to compete with a benchmark based on his peers
(the yardstick), as direct competition is impossible or insufficient. Individual suppliers have a
strong incentive to outperform this benchmark, because this is the way for them to make a profit.
3
4
5
6
7
8
Terminology used in Tweede Kamer (2005-2006). "Invoering Diagnose Behandeling Combinaties
(DBCs)." 29 248 (30).
Terminology used in Agrell, P. J., P. Bogetoft, R. Halbersma and M. C. Mikkers (2007). Yardstick
competition for multi-product hospitals: An analysis of the proposed Dutch yardstick mechanism.
Utrecht, NZa.
In this calculation, the actual instead of the expected case-mix and DBC-volumes will be used.
Provided that there are no significant differences between health insurers in the ratio children/adults and
in the ratio of high risks/low risks. Section 4.4 of this report will also discuss an alternative allocation of
reclaimed surpluses.
In fact, norm prices could also be based on any other metric of negotiated prices, e.g. the mean plus or
minus one standard deviation, the 1st of 3rd quartile, the minimum price, etc. For most of the present
discussion, yardsticks are assumed to be based on the mean of the negotiated prices.
For an assessment of yardstick regulation, see for instance CPB Netherlands Bureau for Economic Policy
Analysis (2000). Yardstick competition: Theory, design, and practice. The Hague, CPB.
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By doing so, they reveal private information about their production costs and simultaneously
lower the regulated price for their competitors.
In order to give optimal incentives to an individual supplier, his own behaviour should not
influence his benchmark. Therefore, in the optimal situation, regulated prices for a supplier are
based on the negotiated prices of all other suppliers except himself. In practice, this difference
becomes less important as the number of suppliers increases.9
Cost yardstick (Option 2b)
Policy option 2b is similar to 2a, the price yardstick, but bases the yardstick for suppliers on costs
instead of prices. Total costs per hospital follow from auditing procedures, and include both
operational costs (including physicians’ fees), and capital costs (including depreciation of fixed
assets and a standardised return on equity and debt).10 Henceforth, this option will be called the
‘cost yardstick’.
These total costs per hospital, however, will not enable the regulator to determine weights or
norm costs per DBC. For this purpose, additional information is required. Norm prices or
weights per DBC can for instance be determined by using cost estimates derived in the budget
system, or by using average negotiated prices as relative weights. These can then be calibrated
using data actual total costs and DBC-volumes of all hospitals, after which an average DBC-price
per hospital can be calculated.11 Note that the standardised rate of return mentioned above only
serves to calibrate the weights or norm prices. In theory, there is no upper limit to an individual
hospital’s rate of return, provided it is very efficient.
BKZ-yardstick (Option 2c)
Policy option 2c is based on the price yardstick, but can impose an additional condition on its
outcomes, to make sure total costs match a budget constraint derived from the Budgettair Kader
Zorg (BKZ).12 Whether or not a correction on regulated prices is made, depends on the total
outlays relative to the BKZ. If total outlays are larger or smaller than those based on the BKZ,
norm prices can be lowered or raised accordingly.13
2.1.3 Gradual extension of full liberalisation & partial regulation
In the working programme for the CDA-PvdA-CU-government, a new option was introduced,
which is a combination of some of the above (CDA, PvdA et al. 7 February 2007):
9
10
11
12
13
In (Agrell & Bogetoft et al., 2007; p. 21) the Dutch Healthcare Authority proposes averaging over all other
hospitals, but in later communications, a less complicated average over all hospitals is considered.
Agrell, P. J., P. Bogetoft, R. Halbersma and M. C. Mikkers (2007). Yardstick competition for multiproduct hospitals: An analysis of the proposed Dutch yardstick mechanism. Utrecht, NZa, p. 20.
Just like under price yardstick regulation, individual benchmarks are optimal for the fact that cost cuts will
not influence a supplier’s own benchmark.
Most likely, this constraint would be equivalent to the budget for hospital care under the BKZ, minus the
outlays in the A-compartment. Hence, developments in the costs cure will not affect the yardstick.
Yet another flavor of yardstick competition that is currently considered, proposes to base the maximum
average DBC-price per hospital on fixed prices which are determined by the Dutch Healthcare Authority
(NZa) based on cost simulations (using historical cost data). Given the possible effect of liberalisation on
volumes and hence on total costs, this regulation scheme is a modification of the price-yardstick rather
than the BKZ-yardstick.
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• By 2008, an additional 10% of hospital care will be liberalised without additional regulation
(as in option 1a).
• Beyond that, extension of the B-compartment can only take place after careful evaluation of
the previous steps in the liberalisation process. In this evaluation, special attention will be
paid to the effects of liberalisation on the accessibility and quality of hospital care.
• Yardstick competition will be introduced for the remaining DBCs in the A-compartment.
The agreement is not explicit on the issue which type of yardstick competition will be chosen, but
states that: “De DBC-prijzen in het planbare deel van de ziekenhuiszorg, zullen betrekking
hebben op alle kosten die in het ziekenhuis gemaakt worden, inclusief de kapitaalkosten”.
Accordingly, this report will assume the coalition agreement option to be based on the cost
yardstick.
Box 2.1 Mathematical formulation of regulation systems
Let qijkY denote the volume of DBC i supplied by hospital care supplier j and insured by health insurer
k in year Y. Let pijkY(qijkY) denote the price negotiated for DBC i between supplier j and health insurer
k in year Y, for a given volume q. Note that this expression leaves room for different pricing
agreements, e.g. non-linear pricing and capitation.
Then the contractual turnover of supplier j in year Y, TjY, will be:
TjY = ∑i ∑k pijkY(qijkY)× qijkY
(2.1)
Let PijY denote the regulated norm price for DBC i and supplier j in year Y, and let Q*ijY be the
expected volume of DBC i supplied by j in year Y, then the maximum average price for supplier j is
defined as:
PmaxjY = ∑i (PijY × Q*ijY)/ ∑i Q*ijY
(2.2)
After year Y, the maximum turnover allowed for supplier j can be calculated as follows:
TmaxjY = ∑i (PijY × ∑k qijkY)
(2.3)
Note that this expression is independent of both the negotiated prices pijkY(qijkY), and the maximum
average price PmaxjY. The surplus that will be reclaimed can be defined as
SjY = max(TjY − TmaxjY ; 0)
(2.4)
Price yardstick
Using the mean price as the yardstick, the norm price PiJY for DBC i, supplier J in year Y can be
calculated as follows:
PiJY = (∑j ≠J ∑k pijkY−2 (qijk Y−2) × qijk Y−2 )/ ∑j ≠J ∑k qijk Y−2
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POLICY OPTIONS FOR REGULATION
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This is the weighted average price negotiated between all other suppliers and health care insurers.14 A
two year time lag is required for norm prices to be known in advance of price negotiations.
Cost yardstick
Cost yardstick competition bases weights or norm prices on actual aggregate hospital costs, including
normalised costs of capital. In principle, equations (2.1)-(2.4) continue to apply, but an additional step
will be needed to calibrate the norm prices PijY using cost data, such that total revenues of all hospitals
cannot exceed total costs of all hospitals. In fact, a cost yardstick can be implemented without the
regulator knowing the individual price functions pijkY(qijkY) (Agrell, Bogetoft et al. 2007), p. 20).15 Just
like under price yardstick competition, the optimal yardstick for supplier j should be independent of j’s
costs in order to give j maximum incentives to reveal private information and to increase efficiency.
Although Agrell et al. describe the cost yardstick in mathematical terms, no explicit recipe is given for
calculating norm prices or weights. It is stated that: ‘The weights are set by the regulator and intended
to reflect relative scarcity or cost of different DBCs’. In practice, this should resemble the relative
market prices fairly closely. Weights can be adjusted periodically, based on new products, negotiated
prices and waiting lists (Agrell, Bogetoft et al. 2007), p. 8 & 45.
BKZ-yardstick
In addition to either of the two yardsticks above, the budget according to the BKZ can be used
as an additional boundary condition. Assuming a combination of price yardstick competition and
the BKZ, this condition can be introduced by modifying (2.5) as follows:
PiJY = α (∑j ≠J ∑k pijkY−2 (qijk Y−2) × qijk Y−2 )/ ∑j ≠J ∑k qijk Y−2
(2.6)
Here α is a matching parameter, implicitly defined by:
∑j TmaxjY = ∑j ∑i (PijY × ∑k qijkY) ≡ BKZY
(2.7)
Note that these equations leave the relative structure of norm prices unaltered, and only inflates
or deflates all prices by α. This will be an important observation when assessing the regulation
options under different market scenarios.
2.2 Conclusions
This chapter described the policy options that are currently considered to accompany a further
liberalisation of hospital care. Two options without regulation (gradual deregulation versus a big
bang scenario), three flavours of yardstick competition, and the combined option as envisioned
in the coalition agreement, were discussed. The regulatory options were coined ‘price yardstick’,
‘cost yardstick’ and ‘BKZ-yardstick’. In Box 2.1, it turned out that although the general idea
behind the cost yardstick and the corresponding weights or norm prices is rather clear, no precise
recipe is given to calculate these. The BKZ-yardstick as defined in (2.6)-(2.7) is quite similar to
14
15
Note that to calculate this expression, no explicit knowledge of the contracted price functions pijkY(qijkY) is
required, as long as the total turnover per hospital per DBC (∑k pijkY−2 (qijk Y−2) × qijk Y−2) is known.
Depending on how weights are set, even information about total turnover per hospital per DBC may not
be required.
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the price yardstick, except for a scaling parameter α that endogenously determined based on
prices, volumes and the available budget.
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Scenarios for the health care market
3.1 Introduction
This study analyses the policy options described in chapter two, in the context of five scenarios
for the Dutch health care market. The first four scenarios vary in two key aspects:
1) Whether or not consumers take into account differences in quality in choosing a health
care supplier;
2) Whether or not specialisation of suppliers is widespread.
In addition to these scenarios, there is a fifth scenario in which it is included that health care
suppliers offer care in different qualities. Figure 3.1 illustrates the five scenarios.
Figure 3.1
The key aspects whereupon the scenarios vary
Scenario 1
Scenario 2
Scenario 4
Scenario 3
Quality information
accessible
Specialisation
Scenario 5
Care institutions offer differences in quality
Before describing these five scenarios, the next section describes hypotheses used.
3.2 Assumptions
In building the scenarios, the following assumptions are made:
• As long as consumers have no access to (or knowledge of) quality information they trust,
they choose their care institution on other criteria than quality, mainly travelling distance
and/or advice of their GP.
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•
•
•
•
•
•
•
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If sufficiently trustworthy quality information is provided, consumer preferences change and
consumers include quality as an important criterion whereupon they choose.
Insurants mistrust insurance companies. Only if insurants have access to independent and
reliable information about quality, insurance companies can direct them to (some) preferred
suppliers.
If and only if insurance companies can direct insurants, insurance companies will contract
selectively.
Possibilities for providers and consumers to supply and buy different levels of quality are
limited. By law, producers have to provide a “sufficient” level of quality. Doctors have to be
qualified for example. Consumers are required by law to insure themselves for a “basic
package” of care. In this “basic package”, all care the government defines as necessary is
included. Within these boundaries providers are allowed to vary the quality of healthcare.
As long as legal restrictions hamper entrance of new market suppliers and forbid making
profit, healthcare institutions will not specialise.
Outside urban areas, there is little competition between healthcare institutions. Market power
of regional bottlenecks lessens: 1) in case consumers travel further (for more quality or for a
lower price, given a certain sufficient quality) or 2) in case legal restrictions are lessened.
Consumers switch between insurance companies.
3.3 Scenarios
Scenario 1: Status quo
In 2003, a system of public performance indicators for Dutch hospitals was developed. This
quality information system is based on four kinds of quality: clinical effectiveness, efficiency,
safety and patient centeredness of care (Berg, M. et al 2005). No overall ranking is made.
Consumers themselves are supposed to judge which indicators they think are important.
Presently (January 2007) this system provides scores of all individual hospitals on 18 indicators.
These scores are accessible on the Internet. However, since the website is not well-known,
consumers hardly take this information into account. Hence, insurance companies cannot direct
them to preferred care institutions. Since insurance companies cannot direct insurants, insurance
companies don’t contract selectively.
Since legal restrictions hamper entrance of new market suppliers and forbid making profit, care
institutions barely specialise. The share of ZBCs and categorical hospitals in the total turnover of
the hospital care is small. Since care institutions are barely specialised and insurance companies
do hardly contract selectively, competition is rare outside urban areas.
Scenario 2: Consumer Choice
In this scenario reliable quality information is developed. Insurants know where to find the
information, trust it and use it to ensure that the insurance company does not send them to an
inferior hospital without them knowing it. Since insurants take into account quality information,
insurance companies direct them to preferred care institutions. Since insurance companies direct
insurants, insurance companies contract selectively.
In this scenario patients are highly sensitive to quality and demand the highest quality available,
since their insurance companies will pay for the price differences.
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Legal restrictions still hamper entrance of new market suppliers and forbid making profit, care
suppliers barely specialise (a few ZBCs). Since insurance companies do contract selectively, a
certain amount of competition exists, also outside urban areas. Since care institutions don’t
specialise, however, the level of competition is not optimal.
Scenario 3: Removing legal barriers
In this scenario legal restrictions which hamper new market suppliers and forbid making profit
are removed. Therefore, care suppliers will specialise. ZBCs are widespread.
Reliable quality information is still lacking. Therefore consumers hardly take the existing quality
information into account. Hence, insurance companies cannot direct them to preferred care
institutions. Since insurance companies cannot direct insurants, insurance companies don’t
contract selectively.
Since care suppliers specialise, a certain amount of competition exists, also outside urban areas.
Since insurance companies do not contract selectively, however, the level of competition is not
optimal.
Scenario 4: Dynamic competition
Scenario 4 combines the positive effects on competition of scenario 2 and 3.
In this scenario legal restrictions which hamper new market suppliers and forbid making profit
are removed. Therefore, care suppliers specialise. ZBCs are widespread.
In this scenario reliable quality information is developed. Insurants know where to find the
information, trust it and use it to ensure that the insurance company does not send them to an
inferior hospital without them knowing. Since insurants take into account quality information,
insurance companies direct them to preferred care suppliers. Since insurance companies direct
insurants, insurance companies contract selectively.
In this scenario patients are highly sensitive to quality and demand the highest quality available,
since their insurance companies will pay for the price differences.
Since care suppliers specialise and insurance companies contract selectively, competition begins
to become optimal, also outside urban areas.
Scenario 5 Differentiation in quality preferences
Scenario 5 is scenario 4, extended with care suppliers which differ their products in quality.
In markets for many consumer goods, e.g. radios, there is a market for all kinds of quality. Some
people want to listen to noiseless music, others prefer to pay a lot less and listen with less
advanced techniques. Some people buy a radio on a flee market with high risks of breaking down
just the other day. People calculate the risks and are prepared to take the risk, if the radio is cheap
enough. On the market for radios no one is forced to buy a radio and every quality is supplied. In
healthcare, the situation is somewhat different. For moral reasons, Dutch society prevents
consumers form obtaining low-quality care, and legal measures have been taken to protect
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consumers against incompetent practitioners. A minimum quality level is guaranteed by education
qualifications of personnel. Moreover, people are required by law to insure themselves, so that
necessary care is available to everyone. In the Netherlands “necessary” care is defined by the so
called “basic packet”. So everyone can afford all necessary care and this care is of sufficient
quality. In addition to this minimum quality guarantee different quality levels are possible
(sufficient to good).
It is taken into account that consumer preferences will vary less in some quality aspects than
others. Most people agree on the importance of low mortality risks, but they differ in their wishes
for additional services. Besides the distinction between healthcare itself and additional services is
not as clear as it may seem on first sight. Is having a private hospital room an additional service
for someone who needs rest to recover?
In this scenario, patients ask for different levels of quality-price ratios. Therefore care institutions
or arrangements differ in quality and in variety of care. Budget hospitals will enter the market, as
well as VIP-hospitals. All hospitals supply care of sufficient quality, but in budget hospitals the
quality of care is sufficient and the service provided is moderate, whereas the quality of care in
VIP-hospitals is excellent and the service provided extensive.
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Assessment of regulation under
scenarios
This report focuses on the relative effects of the policy options described in Chapter 2. However,
these options also have a lot in common. All options rely on further liberalisation of prices for
hospital care, with varying degrees of regulation as a safety net. Therefore, after Section 4.1 has
briefly discussed current market imperfections, Section 4.2 discusses the experiences with
liberalisation so far. Section 4.3 then deals with the positions of the main stakeholders regarding
the various regulation schemes.
Subsequently, the incentives and likely effects of the regulation schemes are scrutinised. Section
4.4 deals with the expected effects of the various options on prices; Section 4.5 through 4.9
discuss effects on volumes, quality, costs, innovation and organisation structure respectively. For
some of these effects, there will be differences between the market scenarios discussed in
Chapter 3. In these cases, differences will be pointed out.
Note that this assessment does not have the ambition to give an overall welfare economic
analysis of the policy options. The welfare effect of volume increases and quality increases that
are more costly, for instance, is ambiguous. Hence, comprehensive statements about the welfare
effects of the policy options would require thorough analysis of the optimality of the current
quality and volume of hospital care. Instead, this assessment focuses on the relative and partial
effects of the policy options.
4.1 Limitations to healthy competition
Except for option 1a, the gradual extension, all policy options studied in the report intend to
liberalise prices for hospital care in the B-compartment. Insurers are expected to negotiate with
hospitals about prices, and perhaps price structure, volumes and quality levels. Insurers have
strong incentives to negotiate: if they can contract good (or better) quality care at a lower (or the
same) price than their competitors, they can offer attractive policies and make a profit. Insurers
that fail to offer the quality and/or prices that the market desires, will lose clients and will
eventually have to exit from the market. Therefore, the more bargaining power insurers have visà-vis hospitals, the lower average prices and volumes, or the higher the quality of care will
become. Chapter 3, however, pointed out that there are currently a number of limitations to such
a competitive market structure.
First, as long as independent quality information is barely accessible for patients, insurers are not
able to explain to consumers why they should prefer one hospital above another (Varkevisser, M.
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et al. 2007).16 Therefore patients select their favourite hospital on advice of their GP or simply
choose the nearest.
Second, as a consequence, insurers are as yet limited in their possibilities not to contract a specific
hospital – to walk away from the negotiation table, so to speak. Moreover, some hospitals have
regional market power. The NMA (Netherlands competition authority) investigated a few
proposed mergers between health care institutions for this reason in the last two years17. As
insurers are obliged by law to offer the insured adequate care, insurers will have to contract these
hospitals, even though they may charge higher prices due to their market power.
Third, health care insurance is compulsory. Therefore, an overall increase in the costs of health
insurance hardly decreases total demand (market size). Cost increases that affect all insurers are
relatively unimportant for insurers; they only care about their market share and individual cost
differences.
Fourth, health care insurers show herd behaviour. In 2006 and 2007, insurers offered insurance
below costs, resulting in a total loss of € 300 million in 2006 (DNB 2007). Price differences,
however, were very small and as a result, price turned out to be a relatively unimportant factor in
explaining market outcomes. Between 2005 and 2006 the second cheapest insurer lost 11% of its
customers, as the second most expensive won 18%. Other factors like the number of collective
contracts and the service level of the insurance companies were of more importance, apparently.
Fifth, patients do not link the quality of the insurance company with the quality of care. Insurants
do not take into account the quality of health care when choosing an insurance company.
Sixth, insurants have the legal permission to switch. Therefore they are allowed to buy the
cheapest possible insurance until the moment they are ill and then switch to an insurance with
better quality. Interviewees signal that insurants do choose their insurance more and more on the
basis of expected costs, already. When a market would appear with ‘quality’ and ‘budget’
insurance policies, the ‘quality’ policies would become unaffordable, since only ‘heavy users’
would buy them.
Seventh, many hospitals have no insight in their own DBC-costs (CTG/ZAio juni 2006) and are
therefore not fully equipped to make management decisions to maximise profits.
Eighth, legal restrictions hamper new market suppliers and prevent hospitals from making a
profit.
Ninth, the shortage of specialists limits the possibilities to increase the volume of care in some
DBCs.
16
17
Varkevisser, M., N. Polman and S.A. van der Geest (2007) argue that if quality information is not
available, patients probably will be suspicious about incentives of insurers to direct patients to certain
hospitals.
For example in Noord-Brabant, in Limburg and in “het Gooi”.
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4.2 Experiences with liberalisation
As was pointed out earlier on, about 10 % of hospital care has already been liberalised in 2006.
Experiences in this so-called B-compartment can serve as a litmus test for what may happen
when the B-compartment is extended. Moreover, an experiment with entirely free prices was
conducted in the Sint Maartenskliniek, the results of which can also give an impression of the
possible effects of liberalisation. A mid-term review of CTG/ZAio gives an impression of the
results of this experiment (CTG/ZAio September 2006). Firstly, the Sint Maartenskliniek
increased efficiency. For example, time patients stayed in the hospital for revalidation decreased
by 15%. Secondly, the volumes supplied by the Sint Maartenskliniek increased more than
average. Remarkably, this did not affect the volumes supplied by other health care institutions in
the region. This suggests that liberalisation increases volumes. However, since the Sint
Maartenskliniek is among the leading institutions in the Netherlands in its field, the extra increase
of the volumes of the Sint Maartenskliniek may have decreased the volumes in hospitals in other
regions. Thirdly, the prices of the Sint Maartenskliniek increased more than average. This relative
higher increase took place in the A-compartment, as well as in the B-compartment. In 2007 the
prices of the Sint Maartenskliniek decreased.
The developments in the B-compartment have been monitored by the Dutch Healthcare
authority (CTG/ZAio, 2005 and CTG/ZAio, June 2006)) It turned out that in the last two years
prices in the B-compartment increased: in the first year there was a 5 % increase (in the Acompartment this was approximately 0,6%);18 in the second year there was a 0,5 % increase,
which is, however, a decrease in real terms.
This moderate price increase may, however, be somewhat misguided. The NZa signals in her
monitor 2006 (page 21) that the prices in the B-compartment stayed artificially low because of
compensations in the negotiations by a local surcharge on the A-compartment or favourable
advance payment agreements on the A-compartment. As long as parties involved have the
freedom to negotiate about the (quantities of the) A-compartment as well, they may let
negotiations about the segments influence each other. Next to that, many hospitals founded
ZBCs to profit from the differences in defrayment system between ZBCs and hospitals. These
differences will vanish in 2008 (CTG/ZAio, June 2006).
The effects of the current liberalisation in the B-compartment on the total volume of hospital
care, as well as on quality and innovation are as yet unknown. The monitor studies by
CTG/ZAio mention no volume development for the B-compartment in 2005 and 2006. The
monitor 2006 uses the quantities of 2004. According to this monitor, the B-compartment still has
waiting lists for some DBCs. Nevertheless, waiting lists have shortened in the last years. Because
until 2003, ZBCs could only be founded for DBCs for which waiting lists existed, it is plausible
to assume that ZBCs contributed to this shortening. But the recent policy “boter bij de vis”
18
The total budget of all hospitals in 2004 was (including the B-compartment) € 11.935 million. The total
budget in 2005 was € 11.302 million (excluding the B-compartment). “CTG/ZAio 2007”. The prices in
the B-compartment (volume 2004) increased by 5%, (CTG/ZAio, juni 2006), therefore the budget in the
A-compartment increased by 1,3%. The volume-effects are 69,2 million (CTG/ZAio, juni 2006 ), so the
prices of the A-compartment increased by 0,6%.
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whereby hospitals got extra money to reduce waiting lists, attributed to the shortening as well.
The comparative extent of these effects is unknown.
Nevertheless, interviewees expect volume increases to have a larger effect on total costs than
price increases in the next years. According to some of them, incentives to control volumes (e.g.
through protocols) would therefore be more appropriate to reduce costs than a price regulation.
Possibilities for government regulation in this field are, however, limited.
4.3 Stakeholders’ positions
Section 4.1 pointed at limitations that presently exist to the bargaining power of insurers and that
could subsequently lead to (localised or general) price increases under full liberalisation. All policy
options studied here (except for option 1b) aim to prevent this from happening or to limit the
impact of this. Hence, health care suppliers, i.e. hospitals and independent treatment centers (ZBCs),
can be expected to prefer one-off extension of the B-compartment without additional regulation
(option 1b). After all, the other options have in common that they can only make things worse
for them if they generated more income than allowed by the regulation schemes. If hospitals or
ZBCs can negotiate average prices that are above some market benchmark, regulation will do
what health care insurers failed to do: bridle their market power. Only if hospitals would fear that
market pressure would lead to significantly lower prices, option 1a would be preferable for
hospitals as it partially postpones competition. In De Volkskrant, chairman Joan Leemhuis from
the Dutch Hospital Association (NVZ) stated that hospitals do indeed prefer a big bang scenario
(Vos 2007).19
More surprising at first sight is the position expressed by health insurers, who also prefer a big bang
to the other options20, provided the DBC-system functions well (Vos 2007). Bas Geerdes of
Zorgverzekeraars Nederland (ZN) points at the administrative costs of gradual extension. Why
do health insurers prefer unregulated big bang to regulation systems that aim to help them
control hospitals’ market power? This will likely have to do with the intended policy to put
reclaimed surpluses into the equalisation fund (Zorgverzekeringsfonds) so that they will accrue to
all health insurers equally. This will reduce the total costs of health care, but as demand for basic
policies is fixed (insuring is compulsory), this will not entail any increase in demand for health
care insurance (this issue will be returned to in the next section). Thus, if reclaimed surpluses are
put into the equalisation fund, individual health insurers have no direct benefits from yardstick
competition, but they may have some additional administrative burdens.
The insured are likely to benefit from yardstick competition through the costs of their policies (or
their income contributions): reclaimed surpluses will reduce the need for additional funding of
the Zorgverzekeringsfonds. The tighter the yardstick, the more money is likely to flow into the
Zorgverzekeringsfonds, and the cheaper health care insurance should become. On the other
hand, consumers of health care – the insured in their other role – might fear that these cost cuts will
19
20
In the same newspaper article, specialists express themselves in favor of gradual introduction (option 1a),
as they fear that the DBC will not work any time soon.
Including the coalition agreement option Piersma, J. (2007). Iets meer markt in de ziekenhuissector. Het
Financieele Dagblad. Amsterdam.
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ASSESSMENT OF REGULATION UNDER SCENARIOS
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reduce quality or innovation of health care. Also, they might fear increasing waiting lists if some
treatments become highly unprofitable for some hospitals. If that be the case, they will not
benefit from yardstick competition after all. The following sections will investigate whether such
fears are justified.
4.4 Prices
This section deals with the relative effects of the various policy options on prices.
4.4.1 Incentives for insurers
As was stressed in Section 4.3, individual insurers will not benefit directly from yardstick
competition schemes, as long as any surpluses are put into the Zorgverzekeringsfonds. Nor will
they benefit collectively from lower costs of health care, as demand for (basic) policies is totally
inelastic by law (insurance is compulsory). Hence, the incentives on insurers under all yardstick
competition schemes (including the coalition agreement option) seem identical to the incentives
under full liberalisation. Only under the gradual liberalisation option (1a), there will be less room
for price negotiation.
Differences between the incentives under regulation and full liberalisation can, however, occur,
when insurers are highly regionally specialised. An insurer that is over-represented in a region
with high average prices (e.g. a rural region where hospitals have market power) can be looked
upon as if it subsidises his competitors via the yardstick scheme, given that redistribution takes
place nationally, through the Zorgverzekeringsfonds.
Under the condition that insurers differentiate their policy prices regionally or even locally
(ideally, per hospital), this will damage the locally specialised insurer’s competitive position. In
this scheme, competitors receive a refund according their national market share, which they can
use to reduce the price of their insurance policies for their relatively small local base of policyholders. This leverage improves their competitive position relative to the locally specialised
insurer. As a result, the locally specialised insurer faces ultra-strong incentives to negotiate (i.e.
stronger incentive than unregulated competition). Local fringe competitors, on the other hand,
face slightly weaker incentives to negotiate wherever their local market share is smaller than their
national market share. If all fringe competitors were to combine in a local buyer group, the
incentives of this group would even be severely weakened: most of the money gained at the
negotiation table would have been gained anyway through the regulation scheme.
If, on the other hand, insurers cannot or will not apply strict local price differentiation (or if they
only care about their own costs and do not care about average cost differences with others),
national redistribution gives a locally specialised insurer incentives that are similar to those under
full liberalisation (his incentive is only weakened proportional to his national market share, see
also Box 4.1). Fringe competitors also have incentives that are quite similar to those under
unregulated competition (their incentives are also weakened proportional to their national market
share). A local buyer group as a whole has reduced incentives to negotiate, much like in the
situation above (compare this to a market in which ‘the rest’ consist of a single company).
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Agrell et al. also discuss the issue that individual insurers do not benefit from surcharges if these
are paid to the Zorgverzekeringsfonds. They call this ‘a transfer from one insurer who pays too
much to all insurers’ (Agrell, Bogetoft et al. 2007). As an alternative to the
Zorgverzekeringsfonds, Agrell et al. suggest ‘to redistribute surcharges per hospital across all
locally involved insurers proportional to their size in that hospital’ (Agrell, Bogetoft et al. 2007).
Such a modification can, however, weaken the incentives for the locally specialised insurer to
negotiate sharp prices for hospitals that they expect to be subject to a surcharge: if they fail to
bargain aggressively, the regulator will bail them out partially. Whether or not the incentive to
negotiate is significantly weakened, will again depend on the ubiquity of regional price
differentiation for insurance policies.
Consider the extreme case that an insurer has a monopoly position in a region, and hence insures
100 % of a hospital’s treatments. Then, the insurer would have no incentive to negotiate once he
is convinced he cannot negotiate lower average prices than allowed by the regulation scheme: all
surplus charges will come back to him through the regulator. Instead of trying to bargain below
the yardstick price level, he might focus his attention to quality aspects or other criteria.
In case an insurer insures 50 % of a hospital’s income, 50 % of whatever he leaves behind at the
negotiation table will be refunded to him, while the other 50 % is distributed amongst his local
competitors. In case the rest of the local market is highly concentrated, this redistribution to local
competitors will damage an insurer’s position: direct competitors favour significantly from bad
bargaining. If the rest of the local market is distributed evenly over the other insurers, however,
this effect is attenuated, unless all insurers apply strict local price differentiation. Box 4.1
illustrates this in a numerical example. Note that this example is not as stylised as they may seem:
In Friesland, 75 % of patients in the Noorderbreedte hospital are insured by ‘de Friesland
zorgverzekeraar’. Table 4.1 summarises the main conclusions in this subsection. It shows that
local redistribution only gives proper incentives if insurers apply local price differentiation for
insurance policies. National redistribution gives the best incentives if the prices of insurance
policies are not differentiated locally (or if insurers care about their own costs rather than cost
differences with other insurers).
Table 4.1
Incentives for insurers under yardstick competition, compared to full liberalisation
Local price differentiation of
insurance policies
No local price differentiation
Locally specialised insurer has ultraNational redistribution of surcharges
strong incentives to negotiate;
through the equalisation fund
Fringe competitors have slightly
(according to national market
weakened incentives; buyer group
shares)
has weak incentives
Locally specialised insurer has
normal incentives to negotiate;
Fringe competitors have slightly
weakened incentives; buyer group
has weak incentives
Local redistribution of surcharges
(according to local market shares)
Incentives for all insurers are
weakened proportional to their local
market share, hence incentive for
locally specialised insurer
substantially weakened
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Insurers have normal incentives to
negotiate
ASSESSMENT OF REGULATION UNDER SCENARIOS
19
Box 4.1 Incentives under local redistribution
Assume a health care market that consists of H hospitals and I insurers. All hospitals have a market
share 1/H and all insurers have a market share 1/I. Insurer i is, however, locally specialised: it has a
‘market share’ of 50 % in hospital h, while the rest of the market is evenly distributed. The maximum
average price per DBC for each hospital is € 100, but as hospital h has market power, it manages to
charge an average price of € 110 from every insurer, including i, for a total of 10.000 DBCs. This
means h receives a surplus of € 100.000 above the allowed maximum. All other hospitals charge
precisely their maximum average price of € 100.
Then, under local redistribution, i will receive € 100.000 × 50 % thanks to the regulation scheme,
which is € 50.000. By construction, all insurers end up paying h an ex-post average DBC-price of
€ 100. As the average price for all other hospitals was assumed to be € 100 as well, every insurer faces
an ex-post average market price of € 100 per DBC. If redistribution takes place nationally through the
equalisation fund, i will only receive its market share 1/i of the total surplus of € 100.000. If the
number of insurers is larger than 2, this makes i worse off than local redistribution. For instance, if
there are 10 insurers with equal overall market shares, i will receive € 10.000 from the equalisation
fund, lowering his average price in h to € 108.
Next, assume that if insurer i had put more effort into his negotiations, he might have achieved an
average ex-ante price of € 100. That saves him € 50.000 out of pocket. However, the average preregulation price per DBC for hospital h becomes € 105. A surplus of € 50.000 is be redistributed, of
which i receives € 25.000 (instead of € 50.000) under local redistribution. Hence, half of the money
gained at the negotiation table is lost again through redistribution: the incentive is weakened by 50 %
(i’s local market share in h). Under national redistribution, however, i now receives € 5000 (instead of €
10.000). Hence the incentive would be reduced by i’s national market share (which is 10 % in this
example). Under local redistribution, this implies that insurers that are regionally specialised in expensive
hospitals face significantly weaker incentives (assuming the rest of the local market is fragmented and
insurers do not apply strict regional price differentiation).
The larger the market share of an insurer in a local hospital, the more his incentive will be
weakened by local redistribution. Such reduced incentives might on average lead to somewhat
higher negotiated prices. Under price yardstick competition, this will lead to higher norm prices.
Hence, putting surcharges in the Zorgverzekeringsfonds is expected to put more downward
pressure on prices in the price yardstick competition scheme, if insurers’ shares in hospitals are
highly skewed and policy prices are not set locally.
Under cost yardstick competition, there is no direct relation between negotiated prices and norm
prices. Hence, reduced incentives for insurers to negotiate with hospitals that have market power
will not lead to increased norm prices. Under the BKZ-yardstick, the total expenses in the Bcompartment are fixed, so that there can be no price effect resulting from the way surcharges are
redistributed. Table 4.2 summarises these relative effects discussed about, under the different
policy options. The format in this table will be used throughout this report.
One might argue that national redistribution of surcharges is in a sense unfair to those insurers
who pay ‘too much’. Note, however, that the perceived ‘unfairness’ is proportional to the
hospital-insurer-relation mentioned above and hence to the weakening effect on incentives. The
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larger the need for local redistribution from the point of view fairness, the more it will weaken
the incentives to negotiate. This is the familiar trade-off of efficiency and equity.
Under national redistribution, regional market power (as well as cost differences) gives insurers
an incentive for regional price differentiation. An insurer that finds himself ‘specialised’ in one or
more expensive hospitals clearly has the strongest incentive to differentiate prices. Alternatively,
if quality information is available, he can try to direct patients to cheaper but still good hospitals
or to spread his customer base over more hospitals or regions.
Table 4.2
Incentives for insurers
1 Liberalisation without
regulation
3 Liberalisation
& Cost
yardstick
2c. BKZyardstick
Surcharges paid to
Zorgverzekeringsfonds
or involved insurers?
2b. Cost
yardstick
Weaker than
other options
2a. Price
yardstick
1b. One-off
extension
1a. Gradual
extension
Incentives for insurers
to negotiate
3 Coalition
agreement
2 Yardstick competition
Depends on redistribution scheme
–
Redistributing
to insurers
can reduce
negotiation
incentives
and lead to
higher prices
No expected effects on prices
4.4.2 Incentives for hospitals
Price yardstick
It is generally assumed that price yardstick competition (as well as cost yardstick competition) will
have a downward effect on prices. After all, average negotiated DBC-prices in previous years
determine norm prices in subsequent years, while each hospital faces a revenue cap based on the
set of these norm prices. Loosely speaking, last year’s average will be next year’s maximum. If
hospitals with market power respond to regulation in their price negotiations, in order to prevent
having to pay a surcharge in subsequent years, prices will spiral down. After all, anticipation on
surcharges leads to lower negotiated prices and hence to lower average prices. Lower average
prices will lead to lower norm prices in subsequent years.
For this downward pressure to work, hospitals need an incentive to react to surcharges in their
price negotiations. However, this incentive is not straightforward. In Box 2.1 it was pointed out
that the maximum acceptable turnover is independent of the negotiated prices. If a supplier’s
turnover exceeds the acceptable maximum, higher prices will lead directly to a higher surplus (SjY)
that is reclaimed. If there is no additional penalty built into the system, the surcharge is simply a
100% tax on the surplus. At first sight, this would leave hospital indifferent whether or not to
take norm prices and last years surcharges into account in their negotiations. There are, however,
some more subtle incentives not to adjust negotiated prices to earlier repayments:
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1.
There may be principal-agent problems inside suppliers of hospital care. If specialists can
affect the negotiated prices of the DBCs which they provide, while surcharges are financed
through increasing general hospital costs for all specialists alike, there is a clear incentive not
to decrease prices of individual DBC-units in the next round. In such a case, the
overcharging specialist gains, while other specialists lose.
2.
Even if the surplus is raised solely from the DBC-units price above average, an additional
incentive is required for decreasing the price of overpriced DBC-units. If the surplus
turnover that results from overpricing a DBC-unit is simply taxed away, there are three
remaining benefits to continue overpricing:
a. Overpricing DBC-units increases the national average marginally. A collective
refusal to adjust prices to regulation will result in higher average prices, from which
all hospitals with a positive surplus will benefit. Hence, collective behaviour not to
adjust prices yields benefits for all suppliers that qualify for repayment, while they
do not benefit from evasion. This is a mild form of collusion that can be very
stable.21
b. Adjusting prices to repayment can have the further negative effect of overshooting:
decreasing prices more than is needed. Since a hospital is uncertain about the
average level of prices in the next year, it is rational to aim for a positive surplus.
c. Overpricing DBC-units gives hospitals a source of interest-free debt to be used as
working capital.
To counter these incentives not to adjust prices to yardstick competition, an additional incentive
has to be introduced. Agrell et al. suggest an additional penalty: ‘[…] it must repay the surcharges,
possibly with some extra penalty a (in addition to interest) […]. It is clear, however, that unless
penalties are very high, a hospital will indeed charge above the revenue cap, if it has enough
market power over local insurers to do so. ’ (Agrell, Bogetoft et al. 2007), p. 26.
Considering the above, a penalty will indeed be required for the downward pressure to work
under the price yardstick. This penalty will have to be large enough to offset the risk of
overshooting (2b), and the collective incentive to keep prices high (2a). To achieve this, a
moderate penalty seems sufficient. If, however, principal agent problems exist as described under
(1), significantly higher penalties will have to be introduced. It is questionable, however, whether
it will be acceptable and legally possible to charge penalties: when they set prices, hospitals face
uncertainty about quantities and hence about the occurrence and size of any surplus. Moreover,
capitation contracts (e.g. agreeing on a fixed payment per insured) may lead to unintended
surpluses as calculated from actual DBC-volumes.
One effect will counter these incentives not to adjust prices to the price yardstick. This is the
demand reduction caused by higher prices and is illustrated in Figure 4.1. Figure 4.1 is a stylised
example of a supplier providing one DBC at unit costs c and facing demand curve D that is
assumed to be downward sloping. Without regulation, it will set price p1 and supply q1, resulting
in a profit (p1 – c)q1. If the maximum norm price P is lower, however, profits to the size of (p1 –
21
See also Agrell, P. J., P. Bogetoft, R. Halbersma and M. C. Mikkers (2007). Yardstick competition for
multi-product hospitals: An analysis of the proposed Dutch yardstick mechanism. Utrecht, NZa, p. 48.
SEO ECONOMIC RESEARCH
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P)q1 are taxed away, and the supplier is clearly better of charging P and supplying q2. Lowering
negotiated prices can increase profits by (q2 – q1)P.
Figure 4.1
Profit reduction caused by overpricing
D
p1
P
c
q1
q2
To summarise, there are several incentives for suppliers not to adjust prices to regulation and
surplus repayment. There is one incentive to do so, the strength of which will depend on the
elasticity of demand: if demand is fairly inelastic (for instance for a supplier with substantial
market power), the incentives not to adjust prices may very well be dominant. Then, a penalty on
surcharges is required for prices to decrease dynamically. In the absence of such a penalty and
assuming fairly inelastic demand, prices cannot be expected to decrease as a result of the price
yardstick.
Cost yardstick
Under cost yardstick regulation, allowed revenues will depend on market costs instead of market
prices. Still, negotiated prices do not necessarily react to surcharges, for the aforementioned
reasons: charging lower prices than implicitly allowed based on average costs (‘overshooting’) is
equally unattractive and principal-agent problems within hospitals are equally likely. However,
there are no collective benefits to not adjusting prices, nor is the actual pricing behaviour relevant
for regulation.
All in all, prices are slightly more likely to react to regulation under cost yardstick regulation, but
more importantly, yardstick competition will not stagnate if prices do not react. Hence, the
system will become less dependent on a surcharge penalty to work.
BKZ yardstick
As under the earlier schemes, prices may not respond to surcharges in the BKZ yardstick without
serious penalties. Yet assuming the BKZ yardstick to be based on prices and calibrated to match
the cure-compartment of the BKZ, keeping prices high will be of no avail to hospitals.
Consequently, prices are expected to be equally likely to respond to regulation as under cost
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ASSESSMENT OF REGULATION UNDER SCENARIOS
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yardstick regulation, and the overall yardstick is equally indifferent to this. Only the structure of
norm prices will be affected by this.
Coalition agreement
In the policy option envisioned in the coalition agreement, effects will be similar to cost yardstick
competition (assuming regulation in the A-compartment is based on a cost yardstick). Obviously,
the prices in the extended B-compartment will not react to regulation as there is none.22
However, there can be interference between the fully liberalised and the regulated compartment,
as currently observed between the current A- and B-compartment. For instance, hospitals can
agree to invest in quality in the A-compartment, conditionally on price increases in the Bcompartment. Or, less optimistically, hospitals with some market power in the A-compartment
can threaten to decrease quality, unless price increases in the B-compartment are accepted.
Magnetic norm prices or weights
All of the above assumes that hospitals behave as independently as they can while setting prices:
they only take surcharges into account when a penalty is introduced. In the Monitor 2006,
however, the NZa concluded that in 2006 many hospitals did not know their costs per DBC. If
both hospitals and insurers are uncertain about actual prices, the regulated ‘norm prices’ could
become a starting point in their negotiations. Thus, these prices could become ‘magnetic’ for
negotiated prices, even if the underlying costs differ between hospitals.23
Under price yardstick regulation, this could again lead to a stagnation of the yardstick dynamics,
much like the stagnation described above. Under cost yardstick regulation, the overall dynamics
of the regulation scheme depends on costs rather than prices, so that a downward pressure on
costs would be preserved.
It is unsure whether or not norm prices will become a starting point in negotiations. To prevent
this from happening, the NZa prefers the use of DBC-weights to norm prices. The latter can,
however, easily be derived from the former by multiplying the weights and the average DBCprice. Hence, it is unlikely that the occurrence of a starting point will depend in the notation used
in regulation.
22
23
If this policy option turns out to favour a price yardstick over a cost yardstick for the A-compartment, its
success would also become dependent on penalties.
In the interviews, anecdotic evidence was presented that hospitals in Drenthe do indeed exhibit such
behaviour. After charging low prices initially, they expressed the intention to raise their prices towards the
‘fair’ national average.
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Table 4.3
Incentives for hospitals
1 Liberalisation without
regulation
3 Coalition
agreement
2 Yardstick competition
3 Liberalisation
& Cost
yardstick
2c. BKZyardstick
2b. Cost
yardstick
2a. Price
yardstick
1b. One-off
extension
1a. Gradual
extension
Will prices react to
yardstick competition?
Not without
substantial
elasticity of
demand
and/or a
penalty on
surcharges
Depends on financing of surcharges in
hospitals
Effect of pricing
behaviour on yardstick
Yardstick will
stagnate
unless
penalty on
surcharges is
introduced
None, only
price
structure will
differ
Norm prices or
weights become
magnetic in
negotiations
–
Possible,
would slow
down or
stagnate
yardstick
dynamics
None
Possible, but has no effect
on total costs
None
Possible in
regulated
compartment,
but has no
effect on total
costs
4.4.3 Price dynamics and total costs
Above, it was concluded that insurers face more or less equal incentives in all policy options.24
Meanwhile, hospitals have in incentive to adjust their pricing strategy and bargaining behaviour
under yardstick competition, if a sufficiently high penalty is due over surcharges. The relative
bargaining power of insurers and hospitals, and the outcome of negotiations will, however,
depend on the market scenario and the policy option considered.
Room for individual price increase and cost differences
If some hospitals have large bargaining power relative to insurers, they can increase their prices
under full liberalisation (option 1b). This will raise costs for insurers and will eventually lead to
relatively higher costs of health care insurance. Gradual liberalisation will weaken this effect as it
can only occur for part of hospital care, but it will not eliminate it.25 Yardstick competition, on
the other hand, aims to counterbalance this effect: hospitals that raise their prices above the
market average, have to pay a surcharge. This means that hospitals with market power only have
room for individual price increases as long as they do not exceed their maximum allowed
24
25
Except for option 1a, the gradual extension.
In fact, market power in the A-compartment that is constrained by regulation or budgeting, may be used
to bargain higher prices in the B-compartment (e.g. in return for quality investment in the Acompartment).
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revenues. The first row in Table 4.4 summarises this point.
However, hospitals that for some reason have higher costs face the same restrictions. The yardstick
competition scheme does not allow for average (case-mix adjusted) prices that are above the
market average, regardless of whether this results from an attempt to abuse market power, or
high costs.
In a perfectly competitive market for hospital care with perfectly homogeneous products (DBCs),
this would be similar. After all, insurers would not care what the source of high prices would be,
but refuse to pay them anyhow. However, in a market with regional cost differences or product
or demand heterogeneity, a competitive outcome can very well exhibit price differences. Such
‘justified’ cost and price differences could relate to the costs of input factors or demand
characteristics. The building costs of hospitals may for instance very well be higher in the
Randstad; also staff costs will differ across the country, reflecting differences in regional labour
market conditions.
Demand characteristics can also differ along with regional socio-economic differences. A large
proportion of non-native patients may for instance require more time or the use of interpreters.
Moreover, hospitals in cities have more creditor risks related to bills for treating homeless people
or illegal immigrants. Especially the four not-academic hospitals in the major cities pay these
costs. In 2005, for instance, MC de Haaglanden paid one million Euro for non- paying customers,
the HagaZiekenhuis 500.000 Euro and het Rotterdamse ziekenhuis 800.000. The OLVG in Amsterdam
did not suffer such credit risks, as the Amsterdam regional insurer pays for them.26 On the other
hand, hospitals in less densely populated areas may be forced to operate below their minimum
efficient scale, which increases their average costs.
The complexity of demand may also differ in a way that is not expressed by the DBC-system. In
case a hospital is able to treat very complex cases without qualifying for so called top-clinical or
top-referent budgeting, it may have a problem supplying above-average quality at average prices.
The Oogziekenhuis in Rotterdam, for instance, claims to treat the most complex patients in
certain DBCs. For some of these very complex DBCs they treat 25% of the total patient
population in this DBC in the Netherlands. Other general hospitals also write costs on the same
DBCs, but limit themselves mostly to far more simple (and therefore cheaper) intervention.
Being a categorical hospital, the Oogziekenhuis has little room for cross-subsidising with other
DBCs.
Sometimes insurers are willing to pay more for better quality. Some interviewees told that they
made agreements with insurers to guarantee that a patient would not have to come back for the
same disease. If he would, the treatment would be free of charge for the insurer. Insurance
companies are willing to pay more for this guarantee. The second row in Table 4.4 summarises
this point.
26
NRC, 14-1-2006
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Inherent dynamics of yardstick
The potential problem above becomes more serious as the dynamics of yardstick competition is
considered. For, given the fact that hospitals will avoid having to pay a surcharge and adjust their
prices accordingly27, the price yardstick scheme will cause prices to spiral downwards. Prices will
react to the yardstick and the yardstick will be tightened accordingly. Prices will mechanically
decrease each year, even after hospitals start making losses. As long as there are price differences
between hospitals, some will be priced above the average, whether or not this has to do with the
abuse of market power. And even though the system allows for cross-subsidisation between
DBCs within a hospital, some hospitals will face a surcharge which they will avoid in the next
year. The larger the penalty on surcharges, the more hospitals will avoid them. To the extent that
a yardstick induces losses or even bankruptcy for efficient hospitals the inherent dynamics seems
undesirable.
The cost yardstick is somewhat different in this respect, as it is calibrated on industry costs instead
of prices. If hospitals fail to become more efficient, the yardstick will become static. As this
implies that each year some hospitals make losses, this situation cannot persist, however.
Hospitals with high average costs will have to become more efficient or face bankruptcy. Either
way, this will eventually lead to lower industry costs.
The total budget under the BKZ-yardstick is subject to a political process. Political decisions about
the BKZ overrule any inherent dynamics of the yardstick regime. The option in the coalition
agreement, to conclude, is similar to the cost yardstick as far as the related part of hospital care is
concerned. This means that costs and prices will eventually decrease in this part of hospital care,
even if it involves substantial loss-making or bankruptcy among hospitals. The third row in Table
4.4 summarises the observations above.28
Response to industry costs and risks
Although the price yardstick system has an inherent downward effect on prices, it does leave
room for an industry wide increase in prices. If all hospitals raise their prices as a result of increasing
costs of input factors, or in reaction to increased market risks, the price yardstick will increase
accordingly.29
The cost yardstick also allows for an industry wide increase in costs. It does not, however, allow
for an industry wide price increase in reaction to increased market risks. If, for instance, the risks
perceived by hospitals are larger than those they are averagely compensated for by the cost
yardstick (through the WACC), hospitals’ incentives to invest would suffer. Similarly, an industry
wide increase in solvability to cope with the enhanced risk environment will not be
accommodated by the cost yardstick. As the number of hospitals is quite large, collusion is a
highly unlikely explanation for industry wide increases in the desired price-cost margin. Therefore
not accommodating such an increase may constitute regulatory failure. Assuming the coalition
agreement option to be based on the cost yardstick, the same point applies.
27
28
29
As long a sufficiently high penalty is due over surcharges.
It is debatable whether inherent downward dynamics is an intended and desirable.
Collusive behaviour of hospitals could have the same effect, although this seems highly unlikely in
practice given the large number of hospitals.
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Under the BKZ-yardstick and the gradual extension, responding to an industry wide increase in
costs (or desired price-cost margins) is subject to political decision making. The fourth and fifth
rows in Table 4.4 summarise these points.
Losing weights
Even though in principle, increasing industry costs can be recovered under cost yardstick
competition, the procedure of setting weight may cause some DBCs to be inherently lossmaking. After all, knowledge of DBC-costs is by no means perfect.
Agrell et al. postulate that ‘weights are set by the regulator and intended to reflect relative scarcity
or costs of different DBCs’ (p. 21). In the Dutch summary it says that costs and scarcity will be
taken into account (p. 8), and in section 4.7, it is stated that the regulator should take such
indicators into account while revising DBC-weights. It seems save to conclude from this that
scarce DBCs will receive higher weights to give an incentive for capacity expansion and entry. As
long as scarcity of a particular DBC indicates that the regulated weight is too low (loss-making),
using waiting lists for revising weights will increase the accuracy of the regulation scheme.
However, longer waiting lists may also result from the fact that a treatment is simply less urgent,
or that specialists are scarcer. If that is the case, using waiting list information to adjust weights
will by definition lead to lower norm prices or weights for others, as long as the overall condition
on total costs remains satisfied. In the zero-sum-game the cost yardstick entails, this has to imply
a norm price below average costs for another DBC. Too high weights will induce hospitals to shift
production to those ultra-profitable DBCs while weights that are set too low will most likely lead
to underproduction of such DBCs.
As the coalition agreement option is largely based on the cost yardstick, a similar effect can occur
there. Also, this could occur under the BKZ-yardstick, if the BKZ is too tight. This point is
summarised in the last row or Table 4.4.
Table 4.4
Price dynamics
1 Liberalisation without
regulation
3 Liberalisation
& Cost
yardstick
Yes
2c. BKZyardstick
Much
2b. Cost
yardstick
Some
2a. Price
yardstick
1b. One-off
extension
Can allow for regional
cost differences or
demand heterogeneity
1a. Gradual
extension
Room for individual
price increase for
hospitals with market
power
3 Coalition
agreement
2 Yardstick competition
Little, as long they do not exceed their
maximum allowed revenue
Some
No
Only the
liberalised
part
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Table 4.4
Price dynamics (Continuation)
1 Liberalisation without
regulation
Large, even
if the sector
makes
losses
Depends on
opportunities
to cut costs.
Will happen
eventually
Subject to
political
process
Possible
Natural
Mistaking in setting
weights will make
some DBCs lossmaking and others
highly profitable
Possible
–
Not allowed
Requires
regulatory or
political
approval
3 Liberalisation
& Cost
yardstick
2c. BKZyardstick
Partially
requires
regulatory or
political
approval
–
2b. Cost
yardstick
Response to industry
wide increase in
desired price-cost
margin
–
2a. Price
yardstick
Response to industrywide cost increase
1b. One-off
extension
1a. Gradual
extension
Inherent downward
dynamics of yardstick
3 Coalition
agreement
2 Yardstick competition
Depends on
opportunities
to cut costs.
Will happen
eventually
Possible
Not allowed
in regulated
compartment
Leads to over- and undersupply of
particular DBCs
4.4.4 Administrative burdens
This subsection looks into the information requirements and other administrative burdens of the
various policy options.
Liberalisation without regulation
It is obvious that under this policy option, the information requirements caused by regulation are
minimal. In option 1b, the one-off extension of the B-compartment, insurers and hospitals only
require private information for their own negotiations.30
In option 1a, however, the gradual extension itself will entail substantial information
requirements and administrative burdens. Hospitals will have to use standard cost calculation and
calculation in line with the budget system (FB-parameters) simultaneously. Each time a new set
of DBCs is liberalised, the remaining hospital care in the A-compartment will have to be valued.
This is analogous to the valuation that took place preceding the initial liberalisation of the Bcompartment. To carve out the presently liberalised B-compartment, ‘the Dutch Healthcare
Authority estimated cost prices (i.e. average unit costs) for the products, based on a survey of a
group of 12 hospitals and multiplied these cost prices with the estimated volumes’ (Agrell,
Bogetoft et al. 2007). This procedure will have to be repeated, to prevent any competitive
30
As most hospitals presently do not know their own cost structure very well, this may still be quite some
challenge.
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pressure in the B-compartment to leak away to the A-compartment. For this reason, health care
insurers (as well as hospitals) do not favour a gradual extension.
Price yardstick
Under price yardstick competition, the basic inputs for the regulation system are prices. In
Chapter 2 it was pointed out that no explicit information about price-quantity agreements is
required, as long as the volume, and the total turnover (or average price) per hospital per DBC is
known. Using this information, weighted average prices per DBC can be calculated, which serve
as norm prices in the next round. More precisely, if weighted average prices are to be used,
quantities will have to be known, and hence there will be a two-year time lag if norm prices are to
be known in advance of negotiations.
A limitation of the price yardstick may arise under innovative contractual arrangements between
hospitals and insurers. If they have not agreed on a fixed price or price functions pijkY(qijkY) per
DBC, but instead agreed on a capitation contract with a fixed price per patient or insured, a
breakdown of hospital revenues to DBCs may be problematic. As a consequence, average DBCprices would be unknown and the price yardstick would go astray. This can be resolved by
disallowing such innovative contract, but that seems highly undesirable and in conflict with the
whole idea behind liberalisation. Alternatively, the yardstick could be based on the priceinformation that is available. If a large majority of DBCs is subject to capitation this would be
problematic, but this is highly unlikely to occur in the near future. As long as DBC-volumes per
hospitals are still known, imperfect information about average prices can be used in the price
yardstick scheme.31
There is an additional puzzle to bootstrap the price yardstick, as there are no negotiated prices to
start out with. As a starting point, the price yardstick scheme could be calibrated on the costs of
DBC as analysed at the introduction of the B-compartment in 2005, or on the BKZ-prices.
Cost yardstick
The cost yardstick regulation scheme does not necessarily require data on average prices or
turnover per DBC per hospital (although DBC-volumes are still required in order to calculate
surpluses at the end of the year). Instead, information is required about the total costs of
hospitals in the regulated compartment, including a normalised return on invested capital. Total
costs and invested capital can be obtained from auditing data, but even though hospitals have
agreed on a standardised accounting arrangement, there will be imperfections to standardising
accounts and to linking them to actual asset bases. Compared to other regulation schemes such as
rate of return regulation, this causes less problems, as individual regulated revenues are not based
on the individual standardised asset base. Thus, there is much less moral hazard to misreport.
If, however, there is some ‘systematic bias’ in the reported asset base – this could result from the
fact that hospitals are averagely old – the standardised regulated return on capital will be
insufficient to recoup future investments. If this is the case, entry will also be discouraged, as
entrants cannot recover their investment costs from regulated maximum prices.
31
Alternative yardstick schemes do not require price information about individual DBCs all long as
volumes per DBC are known (for calculating the total allowed revenues in the regulated compartment), as
well as the total actual revenues.
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CHAPTER 4
A normalised return on invested capital will involve determining the Weighted Average Costs of
Capital (WACC) for suppliers of hospital care. Apart from some parameters that are supposed to
be fixed for the entire financial market, this involves estimating the volatility of the stocks of a
benchmark group of listed hospitals, and assuming a typical or preferential debt-to-equity-ratio.
Even though this procedure is common to many regulation schemes, it is equally common as a
source of controversy and costly lawsuits.32
In addition to total hospital costs, cost yardstick competition requires setting weights or norm
prices per DBC. As was pointed out above, Agrell et al. give no explicit recipe for calculating
these, but state that: ‘The weights are set by the regulator and intended to reflect relative scarcity
or cost of different DBCs’. In practice, this should resemble the relative market prices fairly
closely, although above it was argued that these prices may not be straightforward if capitation
contracts become popular. Weights can be adjusted periodically, based on new products,
negotiated prices and waiting lists (Agrell, Bogetoft et al. 2007), p. 8 & 45. As under price
yardstick competition, one will need a starting point other than negotiated prices, but after this,
negotiated prices could function as a proxy for both costs and scarcity.33 An advantage of using
negotiated prices to determine weights, is that it makes the procedure very simple and
transparent, which can be expected tot lead to less criticism and legal appeal. This would logically
lead to a two-year time lag, just like under the price yardstick scheme.
Thus, in addition to the information requirements in the price yardstick, the cost yardstick will
require audit data on hospital costs and invested capital, as well as a WACC.
BKZ-yardstick
Assuming the BKZ-yardstick is based on the price yardstick with an additional condition on total
costs, the information requirements are similar to those under price yardstick competition. Norm
prices would have to be adjusted downwards or upwards, proportionally to the budget available
under the BKZ.
Coalition Agreement
Assuming the extension of the B-compartment is ‘carved out’ using the same weights and
volumes that are used for yardstick competition in the A-compartment, the information
requirements and administrative burdens of the coalition agreement option and the cost yardstick
are similar.
32
33
E.g. Poort, J. (2001). Toezicht op de toekomst. Regulering van de regionale elektriciteitsnetten in het
maatschappelijk belang. Breukelen, NYFER, Poort, J. and J. Mulder (2004). Parels voor de zwijnen. Een
alternatieve vergoedingsmethodiek voor de destructie van dierlijk afval. Amsterdam, SEO Economisch
Onderzoek.
Prices can not only reflect costs and scarcity, but also monopoly power.
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Table 4.5
31
Administrative burdens
1 Liberalisation without
regulation
3 Liberalisation
& Cost
yardstick
2c. BKZyardstick
2b. Cost
yardstick
Minimal
2a. Price
yardstick
1b. One-off
extension
1a. Gradual
extension
Administrative
burdens
Substantial
costs of
carving out
slices of
hospital care
3 Coalition
agreement
2 Yardstick competition
Limited:
Limited:
Substantial:
Substantial:
turnover and
turnover and
costs, WACC
costs, WACC
volume per
volume per
and price
and price
DBC per
DBC per
information
information
hospital
hospital
required
required
suffices
suffices
4.4.5 Prices in market scenarios
Most of the discussion in this section is identical in all market scenarios. The issues raised in
Section 4.3.3, however, require further analysis in the light of the market scenarios. It was
concluded that yardstick competition of any kind leaves little room for individual hospitals to
increase their prices. This is the very aim of the regulation schemes, and should be seen as a
virtue of yardstick competition. The flip side of this coin, however, is that there is also very little
room for taking regional cost differences and demand heterogeneity into account, even if ‘the
market’ would be willing to accept these differences. Taking the inherent downward dynamics of
yardstick competition into account, this can cause efficient and benevolent hospitals to make
losses and eventually to go bankrupt. This is a vice of yardstick competition.34
These effects are different sides of the same coin, and it will depend on market conditions which
effect will prevail. If at a large scale hospitals have market power and abuse it to drive up prices,
or if hospitals are highly inefficient, yardstick competition will be beneficial to restrict this market
power. If on the other hand, the market is fairly competitive, and price differences can be
explained by cost differences and demand heterogeneity, yardstick competition of any kind may
not only be superfluous but detrimental as well.
Table 4.6 re-addresses the issues from Table 4.4, relative to the market scenarios. The more
competition between hospitals is assumed to be effective in a scenario, the larger the risk that
yardstick competition harms efficient and benevolent hospitals.
34
Introducing regional differences in the yardstick would resolve some of this tension, but still differences
due to demand heterogeneity and quality differences would remain unrewarded.
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Table 4.6
CHAPTER 4
Price dynamics in market scenarios
1 Liberalisation without
regulation
Market
power and
Market power outside urban
inefficiencies
Market power and
areas leads to partial price
can be
inefficiencies are adequately
increase sustained
addressed
addressed by yardstick
inefficiencies
adequately,
depending
on BKZ
Limited
market
Limited
power, might
market
still lead to
slight price power, might
still lead to
increase.
price
Budgets limit
increase
allocation
and
efficiency
3 Liberalisation
& Cost yardstick
Differentiation in
quality
2c. BKZyardstick
Dynamic competition
2b. Cost
yardstick
Removing legal
barriers
2a. Price
yardstick
Consumer Choice
1b. One-off
extension
1a. Gradual
extension
Status quo
3 Coalition
agreement
2 Yardstick competition
Some room
for price
increase and
inefficiencies
outside urban
areas; mostly
addressed by
yardstick
Yardstick can address remaining market power but can
also damage efficient and benevolent hospitals
Yardstick is unnecessary and may damage efficient
Budgets limit
Competition
hospital
allocation
keeps prices
and
down
Yardstick is detrimental & discourages differentiation
efficiency
4.5 Volumes
In most markets, especially those treated in economic textbooks, demand will increase as prices
go down and vice versa. This is also expressed in Figure 4.1. In hospital care, consumers do pay
marginally for their consumption and hence their response to price movements is not
straightforward. The volume of hospital care under liberalisation will depend on other factors.
What is more, consumers of hospital care lack the information to determine their needs fully.
Therefore, they rely on clinical examinations carried out by suppliers. This lack of information on
the side of consumers can lead to two problems, named: ‘clinical iceberg’ and ‘supplier induced
demand’. ‘Clinical iceberg’ refers to under demand, caused by consumers’ unawareness of their
own illnesses. ‘Supplier induced demand’ refers to over-demand, caused by self-interested
suppliers, who exaggerate the need of consumers in order to increase their demand.
It is difficult to prove the existence of supplier induced demand. The empirical health economics
literature (Mc Guire 2000) shows two types of empirical studies, both with big methodological
problems.
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The first studies test an “availability-effect”: does an exogenous increase in the availability of
physicians increase the demand for services? Empirical studies indeed show a positive
relationship between physician density and per capita utilisation of medical services. These
studies are however criticised because they do not distinguish between an availability effect and
an inducement effect. The improved availability of medical services may increase per capita
utilisation due to other things than supplier induced demand, such as shorter waiting times, lower
travelling costs, greater consumer choice in terms of specialisation and quality and/or less
rationing of the least serious medical cases. In other words, the correlation found may reflect
patient preferences and rationing of care, rather than supplier induced demand. To emphasise
these methodological problems Dranove (1994) argued - using the same method - that
obstetricians induce births.
Later studies tested the “income-effect”: does an exogenous decrease in fees of physicians
increase the demand of services? These studies showed evidence that physicians respond to a
decrease in their fees by increasing the volume of their services. These studies have been
criticised for their methodology as well. An income effect is possible without implying
inducement. In municipalities where rationing takes place, an income effect could indicate that
access to services is improved. Physician services become available to more people because
physicians choose to increase their workload in response to a decrease in income. In
municipalities where rationing does not take place an income effect can be interpreted in two
ways: first, it could indicate an improvement in the quality of services (for example less travelling
time, longer consultations, better information about diagnoses and treatment), secondly it could
indicate that physicians actively try to reduce the clinical iceberg. Dutch physicians are already
trying this by visiting the elderly at home to test them. Thirdly, it could mean that physicians
induce demand for their services.
Overall it is difficult to prove the existence of supplier induced demand. For our purposes,
however, the importance of knowing why volumes in hospital care increase is less important than
that they increase. And as we have seen, these studies show that if prices are reduced or
availability is increased, volumes of consumed health care will rise. Hadley and Lee (1978) report
for instance that the utilisation growth during the price freeze of 1972 to 1974 was so large that
the rate of growth of total costs exceeded the growth after the prices were unfrozen in 1975.
Agrell, Bogetoft, et al. (2007) add that several studies prove that health care demand is responsive
to cost-sharing. The introduction of such a system in the Netherlands next year, will therefore
probably be of influence of demand.
In the light of the above, any policy option that leads to lower prices or larger availability of
hospital care is most likely to increase volumes. The first experiences in the Sint Maartenskliniek
confirm this and also in the interviews this expectation was expressed repeatedly. Note that such
a volume increase does not need to be a bad thing from a welfare-economic point of view.
The only regulation scheme that is apt to address volume effects is the BKZ-yardstick. This is the
only policy option that regulates total expenses in the B-compartment, whereas the other
regulation schemes only regulate prices or prices relative to costs.
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CHAPTER 4
Agrell, Bogetoft, et al. (2007) also deal with volume effects under the cost yardstick. They argue
that a lower unit price caused by regulation can give hospitals incentives to produce larger or
smaller volumes, depending on their marginal costs relative to the regulated price. They claim
that this will shift production from less to more efficient suppliers, much like in a competitive
market. However, only suppliers with decreasing returns to scale can be expected to reduce
output voluntarily. If many suppliers have increasing returns to scale, total volumes can be
expected to increase significantly, unless insurers make contractual arrangements to limit volume
increases.35
Table 4.7
Volume effects
1 Liberalisation without
regulation
3 Liberalisation
& Cost
yardstick
2c. BKZyardstick
2b. Cost
yardstick
2a. Price
yardstick
1b. One-off
extension
1a. Gradual
extension
Volume effects
3 Coalition
agreement
2 Yardstick competition
No safety net No safety net
Only AOverall
for volume
for volume
compartment No safety net
budget
No safety net
increase that increase that
leaves room
for volume
constraint
for volume
may be
may be
for volume
increase
limits volume
increase
enhanced by enhanced by
control
increase
regulation
regulation
4.6 Quality
Fixed prices
Economic literature implies that if the prices patients pay for their hospital care are fixed
(regardless at which hospital they receive care) more competition leads to more quality (Gaynor
(2006)). The reason is that, if hospitals have to compete and price is fixed, the only remaining
option is to compete on quality. Most empirical studies validate this positive effect of more
competition on quality (e.g., Kessler, D., McClellan, M. 2000).
Free prices
When hospitals are free to set prices, theoretical predictions are less clear. Price and quality
depend on relative responsiveness of demand versus quality. Quality will decrease relative to
price when demand becomes more responsive to price or less responsive to quality and vice
versa. Empirical studies of markets where providers set prices show mixed results as well. Some
studies (e.g., Propper et al. 2003) show that where providers set prices, competition reduces
quality in case there are negotiable prices, unobserved quality and long waiting lists. Hospitals
lower the quality for services where demand elasticity is low, while raising the volume of services
where demand elasticity is high. The outcome is that hospitals cut clinical quality that determines
death rates, while carrying out more elective procedures and reducing waiting lists. Other studies
(e.g., Sari 2002; Gowrisankaran and Town 2003) show that, where providers set prices,
35
Earle et al. 2007, On Price Caps Under Uncertainty, show that if a price cap is closely above marginal
costs and suppliers face uncertainty about demand, a price cap may lead to smaller instead of larger
quantities. This effect could counterbalance the effects described in this section somewhat.
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competition improves quality. These studies find lower quality in less competitive markets. Sari
explains this by assuming that hospitals with higher market shares exercise market power by
reducing quality. Gaynor interprets these results more charitably by assuming that hospitals in
more concentrated markets take some of their excess profits in slack and that general slack may
have the unintended consequence of lower quality. When hospitals are free to set prices, the
effect of competition on quality depends on the relative responsiveness of demand to price and
quality. If the responsiveness of demand to price is larger than the responsiveness of quality,
studies expect that competition reduces prices, but also reduces quality. Care institutions will
mainly compete on price. If quality responsiveness is larger than price responsiveness,
competition will increase quality. Care institutions will mainly compete on quality. The above
indicates that quality effects under liberalisation cannot be predicted without further knowledge
of the elasticity of demand with respect to price and quality.
It is to be expected that quality responsiveness will be higher if quality is transparent to
consumers than if quality indicators are poor.
Key variables
Turning to the different scenarios and policy options, we see that the first two options (1a and
1b) have the same incentives on quality. The only difference is that gradual liberalisation has
much weaker (positive and negative) incentives than one-off extension. In most scenarios, the
yardstick variants have the same incentives on quality. Two variables are highly important for
incentives on quality. These are: 1) whether or not quality is transparent for patients; and 2)
whether or not hospitals have the opportunity to charge for higher quality. The scenarios and
price regulations differ in these respects.
If quality is not transparent
In the scenarios 1 and 3 quality is not transparent to patients. When quality is not transparent,
hospitals have no incentive to increase quality from a market point of view (this is the famous
lemon problem). Of course, people working in hospitals try to do their best, but the price system
gives them no extra incentives to do so.
On the contrary, the system directs them to decrease quality. Under the liberalisation variants 1a
and 1b, hospitals in competitive areas have to compete on prices, because patients will not be
aware of efforts to increase quality, and therefore will not appreciate those efforts. Hospitals in
competitive regions cannot afford to spend money on what patients do not appreciate. For the
same reason, hospitals with market power cannot sell their quality improvements and will
therefore not make the extra effort (in comparison with the status quo) to improve quality. Since
the level of competition is higher in scenario 3 than in scenario 1, more hospitals will feel
incentives to decrease quality in the former scenario.
Under any form of yardstick regulation the scenarios without quality transparency have even
worse effects on quality. In these cases, all hospitals – instead of only those in competitive
regions – have to decrease quality: patients are unaware of quality, and avoid hospitals that spend
money on improving quality, simply because these are more expensive. Hospitals with market
power cannot bear the burden of unseen quality either, because of lack of funding: if quality is
SEO ECONOMIC RESEARCH
36
CHAPTER 4
not included in the price of their competitors, funds that could otherwise be spent on quality will
be skimmed.
If quality is transparent
In scenarios 2, 4 and 5, where quality is transparent to patients, life is easier. In scenarios 2 and 4,
all patients are highly sensitive to quality and demand the highest quality available, since their
insurance companies will pay for the price differences. In these cases, liberalisation leads to
strong (scenario 2) and very strong (scenario 4) incentives to increase quality. In the fully
competitive scenario (4) incentives are stronger than in the scenario (2) where market power still
exists. But even in the latter scenario, hospitals with market power have incentives to increase
quality, because they can ask all these quality-sensitive patients (i.e. their insurers) more money
for more quality. In scenario 5, patients ask for different levels of quality-price ratios. Therefore,
in liberalisation, hospitals would supply the different levels of quality demanded.
The regulation variants again will restrict the demand for quality. Hospitals cannot respond fully
to client wishes, because all money earned by care that costs more than average will have to be
repaid. Of course, the average quality (and therefore price) is higher than in scenarios 1 and 3, so
some quality can be paid for. The net result is a reduced, but positive incentive to increase
quality. Table 4.8 summarises the above.
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ASSESSMENT OF REGULATION UNDER SCENARIOS
Table 4.8
37
Effects on quality
1 Liberalisation without
regulation
3 Liberalisation
& Cost
yardstick
2c. BKZyardstick
2b. Cost
yardstick
1b. One-off
extension
Incentive to
decrease
quality in
competitive
regions
2a. Price
yardstick
1a. Gradual
extension
Status Quo
Weak
incentive to
decrease
quality in
competitive
regions
3 Coalition
agreement
2 Yardstick competition
Incentive to decrease quality for all hospitals
Consumer choice
Weak
incentives to
increase
quality…
Strong
incentive to
increase
quality, as
Reduced incentive to increase quality, as regulation limits
consumers
possibilities to charge for higher quality
are more
sensitive to
quality than to
price
Removing legal
barriers
Weak
incentive to
decrease
quality for all
hospitals
Incentive to decrease quality for all hospitals
Weak
incentives to
increase
quality…
Very strong
incentive to
increase
quality, as
Reduced incentive to increase quality, as regulation limits
consumers
possibilities to charge for higher quality
are more
sensitive to
quality than to
price
Weak
incentives to
provide both
top quality
arrangements,
and budget
arrangements
Strong
incentives to
provide both
Reduced incentives to provide top quality arrangements,
top quality
strong incentive to provide budget arrangements
arrangements,
and budget
arrangements
Dynamic competition
Differentiation in
quality preferences
4.7 Costs
Section 4.4 dealt with the effects of regulation on prices. A purpose of yardstick competition,
however, is to give suppliers an incentive to become more efficient, to cut costs. This will enable
them to make a profit, since the allowed revenues are independent of their own costs. Also under
the other policy options do hospitals face strong incentives to reduce costs.
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38
CHAPTER 4
The yardstick competition schemes will, however, have somewhat stronger incentives for cost
reduction than liberalisation. Under yardstick competition, it will be imperative for a hospital
whose costs are above the market average to cut costs, while in a liberalised market, this hospital
might still ‘get away’ which charging prices above the market average to compensate for slack.36
Under cost yardstick competition, individual cost reductions in hospitals will directly lower the
norm prices, as they are based on total costs of all hospitals (in the NZa formulation this is
expressed as the average DBC-price over all hospitals). Thus, the cost yardstick gives hospitals an
incentive to reduce costs and by doing so, it decreases total costs.
Under price yardstick competition, individual hospitals also have a strong incentive (or a bare
necessity) to reduce costs. Cost cuts don’t, however, automatically lead to lower prices.
Nevertheless, in Section 4.4 the price yardstick was shown to have its own downward dynamics.
Table 4.9
Effects on costs
1 Liberalisation without
regulation
–
Individual cost
reductions
tighten cost
yardstick
automatically
3 Liberalisation
& Cost
yardstick
Industry effect
Very strong
2c. BKZyardstick
Strong
2b. Cost
yardstick
1b. One-off
extension
Moderate
2a. Price
yardstick
1a. Gradual
extension
Individual incentive for
cost reduction
3 Coalition
agreement
2 Yardstick competition
Strong,
depending
on BKZ
Very strong
–
–
4.8 Innovation and entry
The effects of the policy options on innovations are ambiguous and depend on the type of
innovation. A large number of innovations in health care will lead to lower costs for a DBC. Such
innovations are much like the cost reductions discussed in the former section. All options but the
gradual extension give strong to very strong incentives for such innovations.
There are, however, also innovations that lead to higher costs per DBC, but that are nevertheless
beneficial. Such innovations could for instance decrease the propensity for complications or later
problem that do not fall within the same DBC. Such innovations as well as prevention will be
welcomed under liberalisation, particularly if the benefits still relate to the costs of hospital care,
but they will be discouraged by yardstick competition, as it only looks at average prices of costs
per DBC, regardless of such quality aspects.
36
Section 4.4, however, argued that this can also be detrimental.
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ASSESSMENT OF REGULATION UNDER SCENARIOS
39
With respect to entry, the picture looks similar: entrants with cost reducing business models will
be encouraged in all policy options, provided the competitive landscape leaves room for entry
(e.g. little over-capacity and little room for incumbents to lower prices in reaction to entry).
Entrants with innovative but cost increasing business models will, on the other hand be
discouraged by yardstick competition and the coalition agreement option.
Table 4.10
Effects on innovation and entry
1 Liberalisation without
regulation
3 Liberalisation
& Cost
yardstick
2c. BKZyardstick
2b. Cost
yardstick
2a. Price
yardstick
Moderate
Incentive for cost
increasing innovation
and entry
1b. One-off
extension
1a. Gradual
extension
Incentive for cost
reducing innovation
and entry
3 Coalition
agreement
2 Yardstick competition
Very strong
Strong,
depending
on BKZ
Very strong
Weak
Weak,
depends on
BKZ
Weak
Strong
4.9 Organisation
If all suppliers supplied only one DBC, it would be obvious that any supplier charging a price
larger than the norm price would have to make a repayment. This then, would give a clear need
to cut costs. If the number of DBCs per supplier increases and if DBC-prices per supplier are not
perfectly correlated, revenues from ‘overpriced’ DBCs can be used to cross-subsidise DBCs that
are priced below the acceptable level. Only after all opportunities for cross-subsidisation within a
supplier have been exhausted, will the remaining net surplus have to be repaid.
As a consequence, a supplier that fears a surcharge has an incentive to merge with a supplier that
does not. For instance, imagine hospital A in a competitive region that is forced to charge
average prices below the national average. Next to it is a highly specialised high quality hospital
that attracts patients from all over the country and that could easily charge prices above the
market average. If these two hospitals would merge or would otherwise convince the regulator to
treat them as a single entity, their total profits would increase, as B’s surplus would
(administratively) cross-subsidise A’s unused room for a price increase.
Table 4.11 expresses this point. With respect to this, it should be noted, however, that yardstick
competition intends to be transitory. If hospitals expect it to be phased out in the near future, it
is doubtful whether they would embark on such organisational strategies to circumvent the
regulation system. Several interviewees, however, expressed serious doubts whether yardstick
competition will be phased out any time soon, once it is introduced.
The policy options studied in this report seem to reveal little information about the possibilities
to phase out regulation. As was shown in the previous sections, the maximum average price
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40
CHAPTER 4
under yardstick competition tends to become tighter each year: under the cost yardstick this will
be the result of individual cost reductions; under the price yardstick it will be the result of the
mere existence of price dispersion. This means that there will always be hospitals subject to a
surcharge, even if competition is working properly. In fact, as the yardstick becomes tighter the
dispersion of prices or costs around the yardstick level is likely to decrease. In other words, prices
or costs converge towards the average level allowed by regulation, which could erroneously be
interpreted as a signal that regulation is still necessary. Thus, yardstick competition may become a
self-fulfilling prophecy over time. Information about costs or prices that react to regulation
therefore seems unsuitable to judge the need for regulation.
Table 4.11
Perverse merging incentives
1 Liberalisation without
regulation
3 Liberalisation
& Cost
yardstick
2c. BKZyardstick
2b. Cost
yardstick
None
2a. Price
yardstick
SEO ECONOMIC RESEARCH
1b. One-off
extension
1a. Gradual
extension
Incentive for highpriced and low priced
suppliers to merge
3 Coalition
agreement
2 Yardstick competition
Possible, particularly if regulation is expected to persist
YARDSTICKS AND CARROTS
5
41
Conclusions and policy implications
If one general conclusion can be drawn from the present analysis of the various policy options
for regulation of hospital care, it will be that none of the options gets full marks on all
dimensions.
Price or cost yardstick competition
While the price and cost yardstick competition schemes do a good job restricting market power
and eliminating inefficiencies, they entail substantial administrative burdens. They can also be too
ruthless with respect to perfectly justified cost or price differences, such as regional cost drivers
and demand heterogeneity for hospitals. Particularly as the market becomes more competitive,
both cost and price yardstick competition may become detrimental, as these regulation schemes
tend to disallow quality and price differences that the market desires. Therefore, phasing out such
regulation schemes should remain a clear objective upon introduction. If not, regulation that
intends to be a safety net at the start, may eventually strangle the sector.
Yardstick competition based on prices and costs are similar in many respects. Attractive are their
general incentives for cost reduction and innovation, and their limiting effect on market power.
Less attractive is the possible magnetic effect of norm prices. The proposed use of weights
combined with an average DBC-price is not expected to attenuate any magnetic effect that may
result.
And finally, perhaps most importantly, yardstick competition tends to discourage quality
enhancements if they increase costs. As long as quality information is insufficient, any
liberalisation is likely reduce quality or at best give weak incentives to increase quality. When
good quality information is available, liberalisation can on average be expected to lead to higher
quality, but yardstick competition attenuates such incentives.
Differences between the cost and the price yardstick are more subtle:
• It was argued that the price yardstick will only lead to lower prices if a substantial penalty
is due over surcharges. The cost yardstick does not suffer from this problem, as
maximum allowed revenues depend on industry costs rather than prices.
• Incentives for insurers to negotiate can be reduced in both yardstick schemes, if
surcharges from a hospital were to be repaid to the insurers involved. However, only in
the case of the price yardstick can this undermine the yardstick dynamics.
• Both yardsticks leave room for industry wide cost increases. However, the cost yardstick
does not allow for an industry wide need to increase the price cost margin due to higher
risks, even though collusion is highly unlikely to drive such a process.
• The administrative burdens of cost yardstick competition are substantial and larger that
those of the price yardstick. Particularly, determining the industry’s costs of capital
(WACC) and setting weights will be tiresome.
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CHAPTER 5
A final drawback of both price and cost yardstick competition deserves special attention. Both
regulation schemes fail to control volume effects. An increase in quantities of hospital care
consumed is likely in both options (as well as under full liberalisation). And even though this is
not necessarily a bad thing, it can have profound effects on the total costs of hospital care. The
only policy option that adequately limits volume effects is the BKZ-yardstick. The latter may,
however, lead to increased waiting lists.
Liberalisation
Full liberalisation gives strong incentives for negotiation, cost reduction and gives the strongest
incentives for innovation and – provided quality information is available – quality increases.
Moreover, it naturally allows for regional cost differences between hospitals, as well as
differences in demand characteristics. It can, however, allow hospitals to abuse their market
power and to cultivate their inefficiencies. As the market becomes more competitive, these
drawbacks become less important and liberalisation becomes more attractive.
Just like the price yardstick and the cost yardstick, liberalisation is open-ended with respect to
volumes, which could lead to a significant increase of total costs.
Gradual liberalisation is the weaker version of full liberalisation, both in positive and in negative
terms. In addition, it entails substantial administrative costs.
Coalition agreement
The coalition agreement option is interpreted as a combination of partial liberalisation and cost
yardstick competition. It averages the effects of these two options: on the one hand it leaves
some room for market power and inefficiencies, but on the other it addresses the major part of
that. The occurrence of mutual influences between the fully liberalised and the regulated
compartment cannot be excluded, however. For instance, market power can be used to trade
quality in the regulated compartment for prices in the liberalised compartment.
The coalition agreement option gives strong incentives for cost reduction and cost-reducing
innovation, but weak incentives for cost increasing (quality enhancing) innovation. In addition, it
may give weak or – absent quality information – perverse incentives with respect to quality.
Administrative burdens will be substantial and are at best equal to those under the cost yardstick.
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YARDSTICKS AND CARROTS
43
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