How hospitals gamed a Medicare loophole to reap billions

A new study reveals details on how U.S. hospitals exploited a loophole in the Medicare outlier payments program, reaping billions of dollars in excess revenue.

Published as a National Bureau of Economic Research working paper today, the study adds new evidence to a headline-grabbing Medicare scandal, finding that for-profit hospitals funneled much of the windfall to executive compensation and shareholder payouts.

From 1998 to 2003, an estimated 180 hospitals engaged in “turbocharging” by rapidly increasing the list prices they charged patients to inflate Medicare payments—many more than believed at the time. The hospitals that exploited this loophole gained about $3 billion in excess payments, said Ambar La Forgia, an assistant professor at UC Berkeley’s Haas School of Business.

“Medicare was warned about the loophole as early as 1988, and failing to close it had significant fiscal consequences 15 years later,” said La Forgia, who wrote the paper with Atul Gupta of the Wharton School and Adam Sacarny of Columbia University.

The researchers also found that the consequences of the scandal reverberated through the health care system. “This scheme also drove up costs for other insurers because their hospital payment systems had similar loopholes,” noted Sacarny.

FOR-PROFITS VS NONPROFITS

Importantly, the study highlights significant differences between how for-profit and nonprofit hospitals utilized this extra revenue—and the impact on patients. For-profit hospitals, predominantly driven by Tenet Healthcare Corporation, used the windfall to dramatically increase compensation for their highest-paid executives.

“(Tenet) also engaged in stock buybacks, which resulted in millions paid to shareholders. Back-of-the-envelope calculations suggest that roughly a billion dollars were funneled toward their executives and shareholders,” according to the researchers.

In contrast, the nonprofit hospitals allocated the excess Medicare funds to operating costs such as inpatient care, which the study found was associated with modest improvements in quality, including a reduction in patient mortality rates.

“In particular, we find that nonprofit hospitals appeared to increase quality and admit sicker patients, while for-profits admit healthier patients with no detected improvements in quality,” they wrote. “These results highlight that payment loopholes can influence quality and reallocate patients across hospitals.”

On average, hospitals that gamed Medicare by turbocharging obtained nearly $17 million in excess outlier payments, which translates to a 10% increase in total Medicare inpatient revenue between 1998 and 2003. At the peak of the episode in 2002, turbocharging hospitals raised their effective Medicare payment rates by 22%.

The research also found that the financial impact extended beyond Medicare, with a similar increase in payments from other payers, which include private insurers. Hospitals increased their “chargemaster rates”—a list of prices for services—which are used in negotiations with private insurers. This strategy had long-term implications, as the study found persistent increases in hospital charges even after the loophole was closed in 2003.

In the aftermath, the Department of Justice sued dozens of hospitals and hospital systems for fraudulent billing under the False Claims Act. Tenet agreed to pay $788 million to settle the allegations. While federal agencies called turbocharging fraud, the researchers point out that hospitals claimed it was “flawed public policy, not fraud or illegal activity.”

“This dispute, therefore, perfectly illustrates the type of ‘gray’ area frequently encountered in government contracts, which is exploited by firms to their advantage. Given the legal uncertainty, federal agencies mainly sued hospitals where whistleblowers stepped forward with evidence of payment manipulation. In the analysis that follows, we provide systematic evidence that the scope of gaming went far beyond the hospitals that were sued,” the researchers write.

The findings underscore the need for stronger contract design and oversight in government-funded programs to prevent exploitation and ensure that funds are used to improve patient care rather than enriching hospital executives.