Medicare’s reimbursement schedule is an important policy lever to affect physician behavior. Physicians can potentially respond to changes in Medicare reimbursement through several mechanisms: by changing their volume of care, their practice intensity (e.g. the types of procedures they provide), or their relationships with other providers (e.g., vertical integration with hospitals). These various responses can have implications for costs, quality, and access to care.1 Understanding how volume and intensity margins interact with vertical integration behavior is increasingly important as United States physicians experience a wave of vertical integration—in 2021, 48.4% of physician practices were owned by hospitals, compared to only 13.6% in 2012 (Physicians Advocacy Institute, 2022, Physicians Advocacy Institute, 2019). While a large literature has studied volume and intensity responses, only a small, recent literature has begun to study the impact of reimbursement on vertical integration. Further, we know of no research evaluating all three mechanisms in the same context.

We investigate how office-based physicians respond along these multiple dimensions to a Medicare reimbursement increase. We exploit a plausibly exogenous Affordable Care Act (ACA) policy that increased reimbursement rates for office-based care in four states (Montana, North and South Dakota, and Wyoming) in 2011. We estimate a triple difference (TD) analysis comparing physicians within affected states who were more and less exposed to the reimbursement increase and comparing similar physicians in unaffected states. Physicians responded to the rate changes along two margins. First, the reimbursement change affected integration—physicians with larger office-based reimbursement increases were less likely to vertically integrate and more likely to continue providing office-based care than physicians with smaller reimbursement increases. Second, physicians who continued practicing in an office setting increased the volume of services provided.

Our identification strategy leverages variation in reimbursement rates across time, physicians, and geographic areas. The ACA policy we leverage raised reimbursement rates on different office-based services unequally. Thus, even within a specialty, physicians in the four treated states were differentially exposed, depending on the bundle of services each physician performed. In these states, the reimbursement increases that physicians faced ranges from 3% to 15%.

In addition to this variation across physicians, we also exploit variation across areas. For each county of our four treated states, we use covariate matching to identify similar counties in control states. We compare physicians in treated states to physicians from control states with the same specialty and who would have experienced similar reimbursement changes had they practiced in the treated states. The identification assumption for our triple-difference strategy is that physicians within specialty with similar practice styles prior to 2011 in treatment and control areas would have evolved similarly in terms of practice style and vertical integration, absent this ACA policy. Our results hold even if we just use variation in physicians in a traditional difference-in-difference, instead of using additional variation across geographies.

We find that the increase in office-based reimbursement caused an increase in the volume of care provided in an office-setting. This is driven by two mechanisms. First, the increase in office-based reimbursement caused a relative decrease in vertical integration. Office-based physicians can practice in either a traditional office setting or in a hospital-affiliated facility. Medicare reimburses procedures differently, depending on whether the procedure is administered in an office or in a facility. In our setting, physicians experiencing larger reimbursement increases specifically for services provided in the office setting were less likely to vertically integrate and more likely to continue providing office-based care. The second mechanism we observe is a change in the intensive margin of care—conditional on practicing in the office setting, physicians tend to increase their overall supply of care. We also look for changes in intensity of care (i.e., the types of procedures provided),2 but find no evidence for a systematic response on that margin.

We separately evaluate the responses of physicians operating in areas with varying population densities to explore the external validity of our results to other less rural states. We find that our results are largely robust across areas, suggesting that these results have some external validity. We also explore heterogeneity across physician specialties and ages. Supply responses appear largest among primary care physicians and surgical specialists. We further find that while physicians near retirement exhibit an increase in office-based care, vertical integration behavior is muted. This pattern is particularly striking for surgical specialists near retirement age who additionally exhibit an overall increase in Medicare participation, suggesting that for these physicians, increases in office-based reimbursement can delay retirement.

To explain why the reimbursement increase might both decrease vertical integration and for inframarginal physicians increase volume, we build a simple model of physician supply based on the model in Clemens and Gottlieb (2014). Physicians trade off profit against disutility of effort and choose between a independent office-based practice and vertical integration. This model combines our empirical estimates, suggesting that vertical integration accounts for a third of the total increase in office-based volume while the change in volume of inframarginal physicians accounts for the remainder. We use insights from our model along with Medicare reimbursement rate changes over time to understand how responses to reimbursement changes over time.

This paper contributes to the literature evaluating how healthcare provision responds to changes in reimbursement.3 Most specifically, this paper relates to two strands of that literature on the impacts of Medicare reimbursement for outpatient care: first, the recent literature investigating how reimbursement impacts vertical integration and second, the broader literature estimating volume and intensity responses to Medicare reimbursement.

The relatively new literature on vertical integration and reimbursement tends to find that physicians vertically integrate when the reimbursement for care in facilities goes up relative to reimbursement for care in offices, though there are some counterexamples for specific procedures. The most closely related paper in this literature is Dranove and Ody (2019). This paper finds that increases in facility-based Medicare reimbursements relative to office-based reimbursement leads to vertical integration. Similarly, using longitudinal trends in site-specific payment rates, Post et al. (2021) finds that relatively higher Medicare reimbursement in facility settings is associated with vertical integration for primary care physicians and medical specialists. This literature suggests heterogeneity across providers and specialty: Post (2021), Sloan et al. (2021), Song et al. (2015), Masoudi et al. (2019), and Alpert et al. (2017) look at different segments of the market and some find responses while others do not.

In the large literature estimating volume responses to Medicare reimbursement for outpatient care, even the studies using clearly exogenous geographic level changes in reimbursement estimate both positive and negative volume elasticities. The seminal paper in this literature Clemens and Gottlieb (2014) exploits a 1997 nationwide change in the boundaries Medicare used to geographically adjust reimbursements. They find a positive response to reimbursement driven by volume and service intensity. However, Rice (1983) and Rice and McCall (1982) use similar older variation within Colorado in the 1980s and estimate a negative elasticity. Additional papers using non-exogenous reimbursement changes have found similarly mixed results (Brunt and Hendrickson, 2021b, Brunt and Hendrickson, 2021a, Brunt, 2015, Hadley et al., 2009, Callaghan et al., 2016, Gruber et al., 1999, O’Neil et al., 2016, Shahinian et al., 2010, Jacobson et al., 2010, Yip, 1998).

This paper contributes to the literature in two ways. First, we provide novel evidence on the impact of office-based reimbursement changes on vertical integration behavior using plausibly exogenous increases in reimbursement. Our analysis suggests that the recent wave of vertical integration may be driven in part by the relatively low reimbursement rates in the office setting. Further, we find that increases in office-based reimbursement have a particularly large impact on the vertical integration decisions of primary care doctors and surgeons. These results are important for policy-makers considering the implementation of site-neutral payment that would equalize reimbursement across offices and facilities (Centers for Medicare and Medicaid Services, 2018, Cassidy, 2014).

Second, this paper is able to study vertical integration and volume of supply responses in the same context, tying together two previously separated literatures. Past studies have documented a variety of responses to reimbursement rate changes in different contexts.4 Studying both responses in the same setting provides a more complete characterization of the full impact of site-specific reimbursement changes, since one need not reconcile differences across settings and time-periods. As policy-makers consider changes to Medicare reimbursement policy, our analysis suggests that increases in office-based reimbursement would increase volume in that setting, but this would be partially offset by decreased facility volume driven by decreases in vertical integration.

The rest of our paper proceeds as follows. Section 2 describes background information on the Physician Fee Schedule and the ACA policy change. Section 3 describes the data. Section 4 outlines our triple-difference empirical strategy. Section 5 presents the results. Section 6 introduces a model and discusses the mechanisms. Finally, Section 7 concludes.