Get access

Does Prospective Payment Really Contain Nursing Home Costs?


  • Li-Wu Chen,

  • Dennis G. Shea

This article was presented at the 127th annual meeting of the American Public Health Association. The authors would like to thank Joe Vasey for his assistance in the process of data analysis and Dr.Stephen Foreman, Dr. Diane Brannon, and two anonymous reviewers for their insightful comments.

Address correspondence to Li-Wu Chen, Ph.D., Assistant Professor, Section on Health Services Research and Rural Health Policy, Department of Preventive and Societal Medicine, University of Nebraska Medical Center, Omaha, NE 68198. Dennis G. Shea, Ph.D., is a Professor, Department of Health Policy and Administration, The Pennsylvania State University, University Park, PA. This article, submitted to Health Services Research on August 1, 2000, was revised and accepted for publication on March 2, 2001.


Objective. To examine whether nursing homes would behave more efficiently, without compromising their quality of care, under prospective payment.

Data Sources. Four data sets for 1994: the Skilled Nursing Facility Minimum Data Set, the Online Survey Certification and Reporting System file, the Area Resource File, and the Hospital Wage Indices File. A national sample of 4,635 nursing homes is included in the analysis.

Study Design. Using a modified hybrid functional form to estimate nursing home costs, we distinguish our study from previous research by controlling for quality differences (related to both care and life) and addressing the issues of output and quality endogeneity, as well as using more recent national data. Factor analysis was used to operationalize quality variables. To address the endogeneity problems, instrumental measures were created for nursing home output and quality variables.

Principal Findings. Nursing homes in states using prospective payment systems do not have lower costs than their counterpart facilities under retrospective cost-based payment systems, after quality differences among facilities are controlled for and the endogeneity problem of quality variables is addressed.

Conclusions. The effects of prospective payment on nursing home cost reduction may be through quality cuts, rather than cost efficiency. If nursing home payments under prospective payment systems are not adjusted for quality, nursing homes may respond by cutting their quality levels, rather than controlling costs. Future outcomes research may provide useful insights into the adjustment of quality in the design of prospective payment for nursing home care.