What The Government’s Big-Data Dump Tells Us About The Hospital Market
By Todd Hixon
Mainly, it tells us that there’s not much of a market.
On May 8 the Department of Health and Human Services released 17,500 pages of data on the prices U.S. hospitals charge for the 100 most common hospital services. This matters because hospitals receive the largest share (31%)* of U.S. health care spending of any provider group. For each hospital and service, DHHS provided two prices: the hospital’s list price (called the “Chargemaster” price), and the price actually paid by Medicare.
In a well-functioning market, competition will equalize prices unless there is a concrete cost or value justification for differences. For example, if the gas station on the corner posts a price of $3.59/gal for regular gasoline, we know from experience that the gas station on opposite corner will post a price no more than $0.10/gal different for the same grade of gasoline, but the price can be $0.20-$0.30 per gallon higher for premium gasoline: some cars require premium gas, and it is more expansive to make. And, gasoline prices are strongly linked to cost. The $3.59 price for regular gas includes about $2.25-worth of crude oil and at least $0.40 of tax. So, about 74% of the price is pure variable cost. Gas price differences between regions are likewise based on well-understood transportation costs. The West Coast has a shortage of refining capacity, so gas has to be shipped from the Gulf Coast, which adds cost and creates higher prices.
The situation for hospitals is wildly different. Secretary of Health & Human Services Sebelius commented that “average inpatient charges for … a joint replacement range from a low of $5,300 at a hospital in Ada, Oklahoma, to a high of $223,000 at a hospital in Monterey Park, California. Even within the same geographic area … average inpatient hospital charges for treatment of heart failure range from a low of $21,000 to a high of $46,000 in Denver, Colorado, and from a low of $9,000 to a high of $51,000 in Jackson, Mississippi.”
And, hospital Chargemaster prices bear no discernable relationship to cost. Medicare prices are based on a hospital’s actual, documented cost to provide a service, plus allocations of overhead and a profit margin that the government allows. Margins on Medicare payments are thin, so take the Medicare price as a proxy for cost. Steven Brill, an investigative journalist who studied hospital pricing (link), observes that the Chargemaster price is frequently a multiple of the Medicare price, for example in Dothan Alabama the average Chargemaster bill for “extra-cranial procedures (without complications)” was $32,963 and the Medicare price was $5,777 (source).
Distribution of 2010 U.S. Hospital Income By Payer*
Hospital executives often point out that very few patients pay the Chargemaster price. As the chart shows, government programs pay over 50% of hospital charges, private insurance pays 35%, and out-of-pocket is only 3%. So the Chargemaster price is not where the action is. (However, it’s a big deal to those caught without insurance and forced to pay it.)
The real price for private patients is a negotiated discount to the Chargemaster embodied in confidential contracts between private insurers and regional hospital groups. Hospitals have been merging over the last twenty years to form regional groups with significant market power, and using that power to push back these discounts (more). Continuing the oil analogy, I wonder what would happen if one oil company bought most of the gas stations in a region to gain market power, and then raised prices? In fact, that’s roughly what Standard Oil did in the early 20th century, until the federal government brought suit and broke Standard Oil into five pieces.
While the Chargemaster is outrageous, what we really need to discipline hospital costs is either a well-functioning market for services provided to patients who have private insurance, or the federal government as a single payer (what most developed countries do). I believe in the power of markets to create efficiency and innovation, so I will go there. We need:
1) For government to play its role preventing excess concentration of market power, or abuse of that power if it’s unavoidable. We view our hospitals in a more positive light than Standard Oil, but they have created regional market power in many cases, and they have been known to use it (more).
2) To unleash the power of entrepreneurs to create transparency and choice in the hospital services market. Fortunately this starting to happen. Companies like CastLight, HealthInReach, and Pokitdok are good examples.
*Source: www.cms.gov, National Health Expenditure Accounts, 2010
[This post first appeared at blogs.forbes.com/toddhixon on May 22, 2013.]