When is closing a hospital a good idea?

Typically when a business closes, it is a sad event, but one business’s demise often makes way for more efficient competitors to gain market share. This is rarely, how hospital closures are seen, however. In the press, a hospital closure is met with fears of decreased health care access and quality for the local community.

There is some merit to these fears because, unlike a typical business closing, the hospital market is not your typical free market. First, Medicare and Medicaid fix prices for their patients. Often, Medicaid payments will cover a hospital’s variable, but may not be sufficient to cover the average cost of care if the hospital treats too many Medicaid patients. Secondly, there are problems of moral hazard for insured individuals. Finally, many non-profit hospitals are not run in a profit maximizing fashion. Non-profit hospitals are often overseen by a community board whose goal is not profit maximization.
To evaluate how hospital closures affect social welfare, a paper by Capps, Dranove and Lindrooth (2010) examines the closures of hospitals in three urban markets (Phoenix, Tampa, and Tuscon). The authors found that the hospitals closures increased aggregate welfare.

“the cost savings from the closures we studied more than offset the reduction in patient welfare. However, we also found that because some of the cost savings are shared nationally, several of the closures led to a decline in total surplus in the local community.”

The drawback of the hospital closure is that patients, who preferred being treated at the closing hospital, will have to go somewhere else. Because the volume of patients at the closing hospitals was fairly low, this effect will be relatively small. In the five closures in this study, one affected Medicaid, indigent and self-pay patients the most and the four other closures affected HMO and PPO patients. Additionally, closing a hospital decreases patient choice. If patients gain utility from increased treatment locations, then a hospital closure decreases and individual’s welfare even if it would not be their top choice for treatment.

The cost savings of the hospital closing occur because the patients can be better allocated to other existing hospitals that have bed vacancies. To estimate the closure’s cost impact on surrounding hospitals, the authors estimate the surviving hospitals change in: i) the number of admissions, ii) the patient mix, iii) the number of emergency room visits, and iv) the hospitals occupancy rate. [To make these calculations, the authors use discharge data from the State Inpatient Database of the Healthcare Cost and Utilization Project (HCUP-SID)].

As I mentioned above, the authors find that the closures are welfare enhancing. One of the reasons for this, however, is likely because the occupancy rates of the hospitals that closed was only 55% to 63%. If a high occupancy hospital closed that had a patient mix of mostly Medicaid and indigent patients, then the results of this study may have shown that the closure was in fact welfare destroying. Further, the local communities did not capture all the welfare benefits. States only captured between 30% and 54% of the cost savings, and local communities only captured between 8% and 29% of the cost saving. Additionally, the study ignores the effect on quality. A study by Buchmueller, Jacobson and Wold (2006) found that longer travel times to hospitals increased the probability of death from an acute myocardial infarction.

Nevertheless, demonstrating that many hospitals closures are welfare improving is an important contribution.

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