Healthcare Pricing in America — Costs, Portfolio Theory and Pricing Models

Healthcare prices in the United States are one of the most expensive in the world and keep rising. Healthcare spending has a huge effect on personal and corporate finances in this country and that is mostly detrimental in terms of financial and sometimes even in terms of health outcomes. Additionally, COVID may end up having a dramatic effect on the finances of healthcare providers in the short term and that may end up driving prices even higher.

The quantitative research team at Medxoom keeps exploring this topic on a regular basis, especially from the viewpoints of employer groups which end up spending more than $20,000 per employee family on a yearly basis. Some of that money could have gone into employee raises except for the fact that most employers are not able to figure out how to optimize their healthcare costs!

What we found was that most utilization of healthcare is sub-optimal from a financial sense and these is always an opportunity to optimize more.

So what can you do?

1. Understand the characteristics of your healthcare spend

There is a whole lot of variance in healthcare prices, and that is sometimes a good thing! Where there is variance, there is an opportunity for optimization. All of this has been researched and documented, notably by the RAND Institute and KFF. We went a step beyond empirical studies and came up with models to estimate prices across the nation. What it looked like for a variety of procedures is represented in the graphic below.

Fig 1. Estimated private payer reimbursements for an inpatient healthcare procedure across hospitals in the United States

In terms of portfolio planning, the mean return and variance provide an opportunity to balance and optimize returns, and that is very well understood in the world of finance. H Markowitz won a Nobel prize in economics for his renowned work on the simple and elegant MPT. He talked about constructing simple portfolios using a variety of expected returns and risks, and there are similar parallels that can be used in the world of healthcare from a consumer standpoint.

Whenever you consume healthcare, you have choices in terms of expected costs and variance in terms of your healthcare spend portfolio. So what does your healthcare portfolio consist of? It is the basket of healthcare providers, hospitals and pharmacies that you consume from. Employers need to understand this and act on it.

People also question whether quality is a choice as well. We contend that quality is more of a constraint than a choice. Decide on a set of providers that meet a certain standard of quality and then choose the lowest cost providers. Our research also does not find healthcare quality to be a significant determinant of healthcare costs across providers.

We also need to be wary of over-consumption. There are providers and hospitals that can force you into consuming more than needed and there is evidence for that.

2. Understand pricing models in healthcare, learn to shop, and negotiate

We went deep into the pricing mechanics of healthcare plans and uncovered some models. When it comes to what is being being paid for healthcare, Medicare is the king of cheap prices. Medicare accounts for enormous volumes and cash flows in the healthcare economy. So what does that imply? People who are in the business of healthcare, take a look at what Medicare pays, all the time, and that includes insurance plans and hospitals. How do we know that? Look closely at Fig 2., where we list amounts paid by private insurance plans vs amounts paid by Medicare for various procedures across two distinct provider groups. There are linear relationships that clearly emerge in the picture, and there is something even more evident, prices at Provider Group A (red dots) are not only cheaper but also exhibit less variance.

Fig 2. Comparison of prices paid by private insurance plans to amounts reimbursed by medicare across a basket of procedures for two different provider groups

The implications of this are enormous, if you walk into the wrong door, it can cost you a lot more across the board.

3. Ask for your healthcare claims data and start to analyze spend

We keep running into customers that express a general lack of awareness about being able to procure healthcare pricing data that rightfully belongs to them. As an employer, you should have access to your claims data and if you don’t, you should switch to a plan that provides you with transparency. Will you work with a bank that refuses to provide you with details of your transactions and charges? Why do we tolerate such behavior from healthcare plans and administrators.

4. Build powerful models

Healthcare cost estimation is not magic. We use a family of models that we have developed and refined over time. There are formulas that take into account historical pricing, physician work for a procedure, geographic adjustments, malpractice insurance costs and hospital financial performance metrics etc. as key factors. We do not need billions of data points to estimate prices, we just try to come up with models with as few data points as possible. One of the keys to working around data constraints was to develop a scoring engine that can estimate Medicare and private payer pricing for all providers and hospitals in the country at scale.We try to encapsulate market, plan and employer level pricing dynamics in the form of analytical models that are simple to understand.

There are a host of apps that provide cost estimates for 10000+ procedures and actually make it more difficult to comparison shop. Healthcare shopping is different and the market has not solved the problem. People want to go to higher quality providers that are generally cheaper than the rest, in the context of their healthcare plan or as a cash paying patient. You do not need billions of data points to get you to the right provider but you definitely need to utilize the the data that is specific to your plan. What might be cheaper for others may not be cheaper for you all the time.

5. Shop around, ask for the best rates and compare rates to Medicare

Employers blindly rely on rates negotiated by plans with providers which tout discounts on sticker prices and the sticker prices are never generally known. Do you shop for anything else in your life solely based on discounts without knowing the sticker price? Strangely that seems to be the norm in US healthcare.

So how do you shop for healthcare and determine if you are paying more or less? One of the best ways to do that is to look at what Medicare pays and compare that to what you end up paying across your portfolio of healthcare claims. Empower yourself with that knowledge and then go ahead and negotiate with your benefits administrator. Knowing the best price in the market is sometimes the best way to drive a hard bargain ;-) If you need more help, feel free to get in touch.

Cheers!