By Chapin White, Amelia M. Bond, James D. Reschovsky
Center for Studying Health System Change, HSC Research Brief No. 27, September 2013
Across 13 selected U.S. metropolitan areas, hospital prices for privately insured patients are much higher than Medicare payment rates and vary widely across and within markets, according to a study by the Center for Studying Health System Change (HSC) based on claims data for about 590,000 active and retired nonelderly autoworkers and their dependents. Across the 13 communities, average hospital prices for privately insured patients are about one-and-a-half times Medicare rates for inpatient care and two times what Medicare pays for outpatient care. Within individual communities, prices vary widely, with the highest-priced hospital typically paid 60 percent more for inpatient services than the lowest-priced hospital. The price gap within markets is even greater for hospital outpatient care, with the highest-priced hospital typically paid nearly double the lowest-priced hospital. In contrast to the wide variation in hospital prices for privately insured patients across and within markets, prices for primary care physician services generally are close to Medicare rates and vary little within markets. Prices for specialist physician services, however, are higher relative to Medicare and vary more across and within markets.
Making Sense of Price Variation Within Markets
Several factors can be ruled out as explanations for the wide price variation within markets, including:
* the costs of doing business—labor costs within each market are about the same;
* the complexity of the services being provided—differences in service complexity are taken into account by benchmarking to Medicare prices, which are adjusted for complexity; and
* the type of coverage—all enrollees are in private plans with similar benefits.
What, then, can explain the price variation? The hospital industry has argued that higher-priced hospitals treat the most complex patients and have higher costs because of their teaching programs and capital investments. While this may explain some variation within a market as riskier patients seek care at tertiary hospitals, benchmarking to Medicare should mitigate this influence. Indeed, many analysts believe that Medicare’s additional payments to hospitals for medical education exceed the additional costs.
The more likely culprit is variation among providers and private insurers in negotiating leverage. Negotiating leverage depends on the ability to walk away if an agreement cannot be reached. In terms of negotiating leverage, primary care practices fall at the bottom of the heap. Primary care physicians tend to practice solo or in smaller groups, and they are more numerous than specialists and more substitutable, making them the least able to dictate prices to health plans. Primary care physicians are, in economics jargon, price-takers. A private insurer does not need the participation of all primary care physicians in a market. Instead, an insurer needs only enough primary care physicians to provide access to enrollees, and no single primary care practice is needed to reach that threshold. As a result, few, if any, primary care practices can command prices that significantly exceed their competitors’.
The specialty physician market is generally more concentrated, with fewer specialist practices in each specialty than primary care physicians. Moreover, specialty practices tend to be larger. Studies have found that many specialty practices have become larger in recent years to gain negotiating clout, among other reasons. Many of these practices are large enough that insurers would be unable to offer adequate local access to the specialty without them, giving them substantial leverage with insurers.
Hospitals are in an even stronger negotiating position than specialist physicians. Hospitals typically are large entities that provide a high volume of patient care, giving a hospital or hospital system leverage that physician practices rarely, if ever, have. At the top of the negotiating heap are the must-have hospitals that offer some unique combination of reputation, location and services. Private insurers understand that employers will not continue to offer their products if must-have hospitals are excluded from the provider network. Even in metropolitan areas with many competing hospitals and hospital systems, these must-have hospitals can command unusually high prices. Also, hospitals increasingly have merged into systems, which may allow affiliated hospitals in a market to negotiate collectively with insurers. And, many hospitals are employing physicians and purchasing physician practices and then including physicians in their negotiations with insurers, which may result in more leverage for both the hospitals and the physicians.
Given the growing evidence of significant intramarket price variation, especially for hospitals, purchasing strategies designed to guide patients to high-value providers clearly offer potential savings. Approaches such as reference pricing, where the payer sets a maximum allowed amount for a specific procedure in a specific market, have produced savings and put downward pressure on prices of outlier providers in some markets. Other innovations in benefit design, when accompanied by information to enrollees about differences in what they will have to pay when using different providers, clearly have roles to play in such approaches.
To get a very rough sense of the magnitude of potential savings from such purchasing strategies, actual plan spending was compared with hypothetical spending with a price ceiling equal to the 50th percentile of the current price distribution in each market. The 50th percentile price, or median, for a given market represents the price at which half of the services in that market were provided by higher-priced providers and half were provided by lower-priced providers. The second set of hypothetical price ceilings are multiples of Medicare prices: 1.0 and 1.5.
The potential savings from capping prices at the 50th percentile scenarios only represent 5.5 percent of physician and hospital spending in the plans. To put the savings in perspective, the average annual growth in per capita spending for employer-sponsored health insurance has been between 7 percent and 8 percent per year. So, the savings from rolling out an aggressive program of active purchasing might only slow trend by less than a year. However, even small percentage gains can make a significant difference given the enormous amount many large employers spend on health care. Additionally, active purchasing may begin to give large purchasers a more direct role in health care payment and delivery decisions. Active purchasing strategies will face challenges, including resistance to change from providers, insurers and enrollees.
More significant savings are possible if prices are limited to a level below what is now considered normal. By far the biggest opportunity for savings appears in the hospital outpatient setting, where setting a ceiling on prices equal to Medicare would reduce spending by 48 percent and a ceiling equal to 1.5 times Medicare would reduce spending by 26 percent. But, such a dramatic change might require governmental rate setting and force hospitals and specialist physician practices to cope with significantly constrained revenue.
Even though overall U.S. health spending has grown more slowly in recent years, premiums for employer-sponsored health insurance have continued to rise at an unsustainable rate. And, increases in provider prices explain most if not all of the increase in premiums. If this trend continues, employers will face increa
sing pressure to restrain spending growth, either reducing benefits, shifting costs to employees, or using some form of active purchasing to mitigate price increases. Insurers are consolidating and becoming more adept and experienced in implementing active purchasing. But, at the same time, consolidation continues apace on the provider side, recently including the employment of many physicians by hospitals. As a result, health plans may face only stiffening resistance to attempts to rein in high prices.
By Don McCanne, M.D.
This study confirms once again that health care prices for privately insured patients vary widely across and within health care markets. This study is particularly helpful because it shows where most of the problem is.
It is not with the primary care physicians. They are “price-takers.” They have very little negotiating clout with the insurers. They are forced to accept the insurers rates if they want to be in the insurers’ networks. Thus prices for primary care physicians tend to be uniformly low.
Specialists tend to be more concentrated and thus have greater clout with the insurers. In the more concentrated markets, specialists can command higher prices, resulting in regional variations in pricing depending on their market power.
But the biggest problem is with the hospitals and their outpatient services. They have an even stronger negotiating position than the specialists. This is especially true of the “must-have” hospitals that are in great demand. With increasing merger activity, ever more hospitals are becoming must-have.
Suppose the insurers insisted that hospital prices were capped at the 50th percentile of current spending, bringing down the high prices commanded by the must-have hospitals. This study shows that would still not be enough to meet the average annual growth in per capita spending.
With the pressure to slow the increase in insurance premiums insurers are likely to find other ways to shift more of the costs to patients when costs are already intolerable.
What can we do? We can put the hospitals and their outpatient services on global budgets, just as we do with our police and fire departments. This is what a well designed single payer system would do. Fair rates would be negotiated with physicians which would include correcting the the primary care underpayments and specialist overpayments that result from our current flawed approach of allowing market concentration to artificially move rates away from optimum value.
Note that the reference standards for this study are the much lower Medicare rates – rates that private insurers pay only for primary care physicians. Instead of market power, we should be using people power through our representative government by enacting a publicly-financed and publicly-administered national health program – an improved Medicare for everyone – ensuring payment of legitimate costs and fair margins for the health care delivery system.