Tunneling and Hidden Profits in Health Care

Abstract

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. While incentives to tunnel exist across sectors, health care providers may find it uniquely advantageous to hide their profits and assets by shifting them to related parties. Understating profitability may dissuade regulators from imposing stricter quality standards and encourage public payers to increase reimbursement rates. Likewise, tunneling effectively “shields” assets from malpractice liability risk by moving them off the firm’s balance sheet. Using uniquely detailed financial data on the nursing home industry, we apply a difference-in- differences approach to study how firms’ self-reported costs change when they start transacting with a related party, allowing us to infer how much these payments are inflated. We find evidence of widespread tunneling through inflated rents and management fees paid to related parties. Extrapolating these estimated markups to all firms’ related party transactions suggests that in 2019, 68% of nursing home profits were hidden by tunneling to related parties through inflated transfer prices.

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