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Hospitals, large employers, and why health care costs so much

Why is health care in America so expensive? Many reasons, one of which is the high price of care, including at hospitals. A recently released study by RAND puts a finer point on the issue revealing a dirty secret of the health care system. The prices paid by those with private insurance are subsidizing the system:

Across the nation, hospitals treating patients with private health insurance were paid overall 2.4 times the Medicare rates in 2017, according to the RAND analysis. The difference was largest for outpatient care, where private prices were almost triple what Medicare would have paid.

This is helpful data to have more directly in the public sphere. One problem, much of the analysis of the study is misreading the problem. For example:

The RAND study shows “market forces are clearly not working,” said Richard Scheffler, a health economist at the University of California, Berkeley. “Prices vary widely and are two and a half times higher than Medicare payment rates without any apparent reason,” he said.

“Market forces” is an interesting phrase. The United States hasn’t known true market forces in its health care system for many a decade. And does one consider a 3rd party (the health insurer), negotiating on behalf of a only sometimes engaged and often unenthusiastic buyer (the employer), and negotiating with someone (the hospital) who knows the buyer isn’t terribly motivated to do what’s necessary to strike a hard deal, “market forces”?

It sounds like a system with distorted incentives.

Indeed, a dominant factor in hospital-insurer negotiations today is insurers administering self-funded employer plans, especially for large customers like WalMart or Apple, are dependent on the will of employers to tolerate the opportunity cost of hard bargains with hospitals. Coverage like that in the NY Times for this story commonly incorrectly describes such arrangements:

The insurers don’t have a strong incentive to demand the lowest prices because many, working for employers that are self-insured, are “literally spending someone else’s money,” he said. Insurers are also frequently paid based on how much the employer spends; they take in more revenue when the employer spends more.

This paints a picture of health insurers sitting around a board room table smoking cigars, lit with the cash they are making from employers as employees go to high priced hospitals. In reality, insurers receive something of a fixed fee for administering such plans based on the number of enrollees and other considerations. The employer foots the bill for the actual cost of care. Insurers rarely profit in such arrangements when employees and their dependents rack up higher health care costs.

Moreover, one of the primary dynamics in employers selecting health insurers to run their plans is the degree to which health insurers are able to administer such plans in a way that will control costs, either with discounted pricing for their network of hospitals and doctors or other programs such as case management that help higher cost patients navigate care more effectively. The insurer has explicit incentives to restrain costs if they want to retain the employer customer.

Yet, buried in the noise about market forces and assumptions of fat and happy insurers is this:

The trend toward consolidation in the last several years has also spurred higher costs, as hospitals merged into bigger, more powerful systems that dominated their local markets, demanding ever-higher prices.


Most insurers are perfectly willing to play hard ball with hospitals if their customers will tolerate it (and the hospital isn’t a local monopoly). Look how many narrow networks exist in individual market plans under the ACA. But, employers have to be willing to tell their employees: sorry, that hospital costs too much. Employers usually don’t like to do that.

Any employer who views their employees as an asset, such as tech or professional services industries, worry about retention and often won’t tolerate the HR headache of allowing a popular, but expensive, hospitals (think children’s or university hospitals) to go out of network.

It’s only when employers are willing to eliminate a popular choice for care, thus allowing the insurer to stand tough in negotiations, that true change really happens:

One outlier was Michigan, where private prices run about 1.5 times Medicare rates. The auto industry and unions that represent autoworkers have put pressure on the major Blue Cross plan to hold hospital prices down. “To keep the market in check, you need a plan to throw its weight around and employers to back them up,” Mr. White said.

What happened? The union, the purchaser of care here, gave Blue Cross a thumbs up to play tough. And they got results.

There are other employers willing to do it in some cases, such as Microsoft recently, creating a more narrow network option for its headquarters area employees near Seattle. It’s still a very generous benefit but constructed in a way that explicitly favors the use of preferred, lower cost providers.

But, that’s an exception to what many employers are doing.

And to be clear, in the current structure of our health care system there are only two ways to lower hospitals costs, absent the hospital willingly choosing to lower its prices…(hey, stop laughing!):

  1. Government action, and all the risk of unintended consequences that go with it
  2. Employers start playing hardball en masse

The “oh, insurers just aren’t negotiating hard” is a cop out.

I was a health insurance executive. I’ve seen the real heat put on insurers by large, self-funded employers to control costs, especially when renewals are up. Insurers will design entire programs to address the needs of those largest customers. What those customers say and want matters a lot to what health insurers do.

But until the employer says, “ok, you can cut that obnoxiously expensive but popular health system” the negotiation game continues with hospitals knowing insurers can rarely go to the mat.

Without such tougher negotiations we get this:

“Hospitals charge higher prices to private payers and employers because they can,” said Elizabeth Mitchell, president and CEO of the Pacific Business Group on Health. “But evidence shows that efficient hospitals can provide high quality care at Medicare rates without cost shifting. We need to examine provider consolidation and pricing and explore policy interventions- including antitrust enforcement, price caps and other options- where the market has failed.” 

It’s all a reminder that no matter which party is talking about health care reform, you can presume their promises to lower costs, especially for insurance, are hollow unless such plans do something about the actual price of health care.

Funny thing: know any Member of Congress who wants top pick of a fight with their constituents’ favorite hospitals?


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