October 2003
The Effects of Certificate of Need Regulation on Medicaid Nursing-Home Expenditures

David C. Grabowski
University of Alabama at Birmingham

Certificate of Need programs were first implemented in the 1970s to contain soaring healthcare costs. The regulation targeted medical facilities because it was said that market forces had failed to prescribe appropriate use in the sector. In the context of a cost-based reimbursement system, state governments had been unable to cut spending from the payment side, so CON regulation was an attempt to contain expenditures by reducing use. In order to ensure that new and expanding health facilities were medically warranted, hospitals, nursing homes, and other providers were required to demonstrate a need for new facilities and obtain approval from state review agencies. The criteria for the determination ranged from occupancy rates to the impact each new bed would have on state Medicaid budgets.

Early CON regulation presumed that Medicaid reimbursements were inducing unnecessary demand in the nursing home sector and breeding excess capacity and expenditure. However, it seems unlikely that the demand for nursing homes is very responsive to Medicaid payments given third-party insurance. Seniors who pay out-of-pocket for their own nursing home expenses certainly do not respond to Medicaid payments, but even Medicaid beneficiaries are not likely to weigh reimbursements heavily in their decision to enter a nursing home. The large co-payment seniors are required to pay and the perceived stigma of living in a nursing home both raise doubts about any correlation between Medicaid reimbursements and enrollment.

Some earlier studies of CON laws found that the regulation successfully curbed bed growth as it was intended to do. Other research suggested that CON regulation merely redirected resources to home and community-based services and in fact increased long-term care spending.

Since 1983, fourteen states have repealed their CON laws-theoretically facilitating expansions-while some have imposed moratoria on the construction of any new nursing homes. Somewhat paradoxically, fourteen states had both CON regulation and a moratorium on new constructions in place in 1998.

Following the wave of CON law repeals, no study has evaluated the success of this policy by examining the direct effect of the repeals on Medicaid nursing home expenditures. Previous studies have failed to account for unobserved and potentially misleading differences among states, such as the strength of the nursing home lobby, and no research has analyzed the most recent nursing home data available.

My colleagues Robert Ohsfeldt of the University of Iowa, Michael Morrisey of the University of Alabama at Birmingham, and I investigated the effect of CON law repeals on Medicaid nursing home expenditures, Medicaid long-term care expenditures in general, Medicaid payments per day, and the number of Medicaid days. We surveyed data on forty-nine states (excluding Arizona and the District of Columbia) from 1981 to 1998.

Regressing various measures of Medicaid spending on CON law status, we found that none of the relationships were statistically significant-that the effect of repeals on Medicaid spending could not be shown to be different than zero with any certainty. Even if the relationships had been statistically significant, the repeal of a CON law would have increased Medicaid nursing home expenditures by only 3%. We checked the stability of our results across variations of the model specification, testing the inclusion of time lags, narrower samples, and other variables. The results were the same across these models.

It was often difficult to classify states' CON status; CON laws were in some places indistinguishable from moratoria, and some states with a moratorium did see limited expansion of facilities. Pennsylvania is an interesting case. While it repealed its CON law in 1997, its Medicaid program refuses to reimburse nursing homes that expand without state approval. In essence, it has adopted a non-statutory moratorium on new facilities.  However, changing the status of Pennsylvania had no effect on our results.

While our study suggests that CON law repeals had no effect on state Medicaid budgets, this may be because the CON laws were never effective or because the nursing home market has changed. Between 1969 and 1973, five nursing home beds per 1,000 were empty, but that figure had climbed to ten per 1,000 beds in 1996. Seniors may be substituting away from nursing homes into assisted living care (ALC), but ALC facilities are relatively new and hence difficult to define and track. Still, our findings reveal that states should not be concerned that CON law repeals will explosively increase their nursing home expenditures.

William J. Scanlon
U.S. General Accounting Office

The degree to which CON laws are enforced is a critical determinant of its success as a policy tool. In some cases, local and state planning agencies' mandates are irrelevant, and instead state budget offices decide on bed expansions. The nursing home market is indeed different than others. Increases in Medicaid reimbursements do not induce demand because people know and loathe nursing homes. At the same time, people recognize that the care provided there is often necessary, again severing the link between price and quantity demanded in the nursing home market.

Home healthcare and community-based waivers increasingly divert seniors from nursing homes because the care is thought to be better and the programs are still federally subsidized. The share of the elderly living in nursing homes varies widely across states, ranging from 3 to 9 percent. In the 1980s, a study that looked at cohorts of very old, poor, unmarried seniors across states found them mostly in nursing homes where beds were available. Today, more and more of the elderly live in the community.

Many states facing fiscal crises are turning to Medicaid payment rates to contain spending. CON regulation, on the other hand, attempts to cut costs by restricting expansions, which has the potential to reduce competition and negatively impact the quality of nursing home care.

William B. Vogt
Federal Trade Commission and Carnegie Mellon University

Mr. Grabowski's work evaluates a policy of tremendous relevance. Certificate of Need regulation attempts to contain Medicaid nursing home budgets that were as high as $40 billion in 1999. His data and empirical analysis are simple, appropriate, and well described. Though he tested the stability of his model across specifications, he is wise to acknowledge its limitations.

The study finds that CON repeal increases Medicaid nursing home expenditure by 3 percent with a standard error of also 3 percent. Using these two numbers, we can construct an interval that will capture the true effect of CON repeal on state spending 95 percent of the time. From the data, we can gauge that spending increases by between -3 percent and +9 percent following CON law repeal. Mr. Grabowski's claim that the relationship is statistically insignificant means only that 0 percent falls in the interval. So, while we can reasonably conclude that CON laws have no effect on spending, it is also reasonable to believe that they reduce spending by 8 or 9 percent. The analysis also fails to correct for serial correlation, or the fact that spending in 1995 is undoubtedly related to spending in 1996.

The definition of the treatment group-those states that repealed their CON laws-is also problematic. Indiana, for example, repealed its CON regulation for only one year, so it may more aptly reflect the experience of the control group. By assigning states to only two categories, those that repealed CON and those that did not, we lose any sense of the intensity of the regulation and its effects. Limiting CON status to two classes likely mutes the true effect of the repeal.

The states that repealed CON are mostly located in the Western United States. Given that those states undoubtedly share more than just the repeal of the legislation, we should be skeptical of generalizing our conclusions to apply to the entire country.

Mr. Grabowski's work valuably contributes to our knowledge about an important policy question. It suggests that Certificate of Need regulation does not cut Medicaid spending by much more than 10 percent, but given the program's giant budget, a savings of 10 percent, or $4 billion per year, may indeed warrant our attention.

AEI Research Assistant Ximena Pinell prepared this summary.