Class 16 — Hospital prices

Thursday, October 22

This recap comes from a recording of class, transcribed with Whisper and summarized with Claude, with a light edit from me. It’s meant as a convenience rather than a careful document, so the phrasing will sometimes be a little off. If something here looks wrong, please tell me and I’ll fix it.

What we covered

Where U.S. hospitals came from and why that history still shows up in prices, then what the word “price” actually refers to. Charges and the charge master, the different payers and what each of them pays, and the variation across hospitals in the same market. We started on ownership at the end.

Key points

• Hospitals here began as charity care in dense areas, and nothing about that arrangement required anyone to think about price. Before 1900 you went to a hospital because you had nowhere else to go, and people who could afford a physician were treated at home. There’s no money in treating very sick, poor patients, so the institutions doing it weren’t trying to make any. Medicare and Medicaid then paid on a cost-plus basis from 1965 into the 1980s, which is exactly the stretch when hospitals took on most of their expensive technology. You report your costs, you get paid those costs plus a percentage. A guaranteed percentage of a bigger number is more dollar profit, so there was no reason to push back when a supplier asked for more. Nobody was inflating costs on purpose. They just had no reason to negotiate hard. Insurance was close to prepaid from the patient’s side over the same period, so nobody there was watching price either.
• A hospital price is whatever comes out of a negotiation with an insurer. The hospital wants a high number, the insurer wants a low one, and where it lands depends on which of them needs the other more. Two equally matched parties split the difference. Hospitals can’t set a price alone because their patients arrive through insurers, and being in network means agreeing to a price in a contract. The process is also less formal than you’d expect. It isn’t the two CEOs in a room, it’s mostly here’s what you paid last year, costs are up eight percent, can you pay eight percent more, how about six. Medicare’s rate works as a floor, since a hospital generally won’t go below it to join a network and insurers know that. And when the negotiated price rises, the insurer passes most of it into premiums, which is why you want an insurer large enough to negotiate hard but not so large that it stops caring what it pays.
• A charge is not a price. Every hospital keeps a charge master, a spreadsheet with a number for everything it might do or use, and that number isn’t negotiated, isn’t its cost, and isn’t what it gets paid. A hospital can set it to whatever it likes. The 2011 itemized bill on the slide charges about $18 for one blood glucose test strip, and a hundred strips cost less than half what that bill charged for five. What makes the charge matter anyway is who faces it. An uninsured patient gets the sum of the charges as a bill, and so does an insured patient who ends up out of network. That second case is what the No Surprises Act was written for. Go to an in-network hospital whose emergency department is staffed by an out-of-network practice, or have an out-of-network anesthesiologist brought into an in-network surgery, and the physician’s service reaches you as a charge. The Act takes the patient out of it and sends the provider and the insurer off to settle on a price, which in practice means arbitration. Hospitals keep charges high for two reasons. The gap between the charge and what they actually collect is what gets reported as uncompensated care, and some contracts are written as a percentage of charges because nobody negotiates ten thousand services one at a time.
• Those contracts come in two common forms, a markup over Medicare’s rate or a percentage of the hospital’s own charges, and a hospital can prefer one even when both pay the same on average. The difference is risk. Medicare’s payment is fixed once the DRG is set, so an extra day or an extra unit of blood is pure cost to the hospital. Charges rise with whatever gets used, so a percentage of charges moves with the resources a patient turns out to need. Hospitals in a stronger bargaining position are more likely to get the percentage-of-charges contract, so market power buys insulation from risk as well as a higher price.
• Prices for the same procedure vary enormously inside one market, and quality doesn’t explain it. Medicare pays nearly the same amount to every Atlanta-area hospital for a hip replacement, with the small differences coming from the teaching and disproportionate-share adjustments in the DRG formula, while negotiated rates at those same hospitals run from roughly $12,000 to $26,000. Quality is the natural explanation, so test it on a lower limb MRI, which is about as close to a homogeneous product as health care gets. The image doesn’t change with where you have it taken. Prices still run from a few hundred dollars to a couple of thousand. What’s left is market power and the site of care. The same image costs far more inside a hospital than in a physician’s office that happens to have an MRI down the hall.