Tunneling and Hidden Profits in Health Care
Summary: This study examines “tunneling” practices through which health care providers covertly extract profit by making inflated payments for goods and services to commonly-owned related parties. Masking profits as costs, thereby obscuring true profitability, may dissuade regulators from imposing stricter quality standards and encourage public payers to increase reimbursement rates.
Authors analyze the use of related party transactions as a form of profit extraction in the nursing home industry. Using a stacked difference-in-differences approach, authors document that services purchased from related parties are substantially inflated.
Findings: Researchers find evidence of widespread tunneling through inflated rents and management fees paid to related parties. Extrapolating these markups to all firms’ related party transactions, their estimates suggest that in 2019, 63% of nursing home profits were hidden and tunneled to related parties through inflated transfer prices.
These study findings have far-reaching policy implications. The calculations of hidden profit suggest that firms may be substantially understating their profitability. This has implications for the design of quality regulations as well as reimbursement schemes that rely on a cost-plus basis. Additionally, findings suggest that related party transactions can make litigation against health care providers less attractive by hiding or shielding assets from potential claimants.
Collecting detailed data on related party transactions and making those data subject to potential audit are for policymakers, regulators, and stakeholders to understand the financial dynamics within the health care industry and to formulate policies that promote financial integrity and transparency.
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