American hospitals account for the largest nonprofit sector in the United States, but while most U.S. hospitals are nonprofit, a significant portion are for-profit. Policymakers and researchers long have questioned whether nonprofit hospitals behave differently than for-profit hospitals. In a recently released National Bureau of Economic Research working paper that examines this question, we made use of a now-resolved loophole in Medicare payment policy to understand how nonprofit and for-profit hospitals exploited this loophole, and what they did with the resulting financial windfall.

What was the loophole? Medicare used hospitals’ list prices (also called “charges”) to determine how much hospitals should get in “outlier payments” — which reimbursed hospitals beyond Medicare’s usual fixed-price contract for providing especially resource-intensive care. Because the Centers for Medicare and Medicaid Services could not observe the true costs of this treatment, they relied on those list prices, giving hospitals the opportunity to inflate them.

We used a novel approach to find hospitals that gamed the system with inflated charges for outlier payments during this time period and identified 180 such hospitals. The gain for these hospitals was substantial, resulting in a windfall of $3 billion in Medicare payments and $12 billion when including all insurers’ payments over this time period. (For perspective, consider that the total spending on the Women, Infants and Children’s (WIC) program in 2022 was $6 billion.)

Both for-profit and nonprofit hospitals took advantage of the loophole. But we found that the type of ownership was highly predictive of gaming, with the for-profit hospitals more likely to exploit the loophole than the nonprofit hospitals. The for-profit hospitals also were more likely to pocket the money rather than reinvesting it in patient care.

Hospitals That Gamed the System Derived Direct and Indirect Revenue Benefits

We found that weaknesses in government contracts can produce ripple or “spillover” effects that may far exceed in magnitude the direct revenue increases, based on our comparison of the revenue trends of the “gamer” hospitals versus those of a matched set of hospitals that did not inflate list prices for outlier payments. As our analysis showed, the impact of the loophole extended beyond the increased payments from Medicare to include increased payments from private insurance too.

This spillover — adding up to $12 billion — perhaps resulted from private insurers using similar payment designs and negotiating contracts based on list prices. The higher spending by private insurers, which then likely was passed on to employers in the form of higher insurance premiums, greater cost sharing for employees, and even salary decreases, highlights the importance of considering spillover effects when determining whether investments in oversight or enforcement actions are justified.    

Nonprofit Hospitals More Likely to Use Extra Money on Operating Costs

It is unclear exactly why the for-profit hospitals were more likely to take advantage of the Medicare outlier payment loophole. We hypothesize that managers of for-profit hospitals had more incentive to maximize revenue since they could distribute profits to themselves. We also hypothesize that managers who joined nonprofits versus for-profits differed in their financial motivation.      

What is clear, though, is that the nonprofit and for-profit gamers spent the extra revenue in different ways, consistent with predictions from organizational theory. Nonprofits directed about 75% of the gaming revenue to operating costs, with no increase in compensation for senior executives. We detected a modest but statistically significant improvement in the mortality rate at these nonprofit hospitals.

In contrast, for-profit hospitals transferred all of the excess revenue off their balance sheets, with no effect on patient care. For the largest and most important gamer, the Tenet Corporation, we showed that the excess revenue dramatically increased compensation for its highest-paid executives at the peak of gaming. Compensation more than doubled, from $6 million to $12 million and stock options ballooned to $92.5 million.

The system also engaged in stock buybacks, which resulted in nearly a billion dollars transferred to shareholders. In the case of for-profit hospital systems, this evidence strongly suggests that investing in more stringent oversight is likely to carry high social value.

Loopholes Will be Exploited and For-Profit Hospitals May Warrant Greater Scrutiny

Although the findings look back to a loophole closed two decades ago, they are particularly salient now. According to the US GAO, Medicaid and Medicare made more than $100 billion in improper payments in 2023.

The issue of improper payments has taken on additional policy significance in the aftermath of large payouts to hospitals for care related to the COVID-19 pandemic. Congress authorized nearly $200 billion in pandemic-related emergency assistance for healthcare providers.

There are concerns that some hospitals and other entities abused this and other COVID-era relief programs. The appropriate policy responses — in response to such “gaming” — depend on how the marginal dollar of excess revenue ends up being allocated.

For example, if hospitals direct excess revenue to patient care, policymakers may have less to fear from loopholes. However, if the excess revenue has limited benefits for patients and workers, it would support devoting greater resources to contract design and payment oversight.

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The working paper, “Turbocharging Profits? Contract Gaming and Revenue Allocation in Healthcare,” was published June 2024 by the National Bureau of Economic Research and authored by Atul Gupta, Ambar La Forgia, and Adam Sacarny.

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