Why Aren’t Medical Prices Infinity?

This blog continues my exploration of mysteries of health economics. The title of the blog may seem inane, but when a senior colleague asked me this question 25 years ago, it changed my life. And the answer helps us understand a lot about what is wrong with today’s healthcare system.

I was in my second or third year as an Assistant Professor at the University of Chicago when my brilliant senior (but still young) colleague Dennis Carlton asked me to explain how medical providers set their prices. I told him that we needed to throw the traditional textbook economics model of pricing out the window. This wasn’t a market where price sensitive consumers chose among homogeneous sellers, with the result that prices in competitive markets converged towards marginal cost. Instead, consumers had insurance that paid for all or nearly all medical bills. Moreover, patients were loyal to primary care physicians and their referral networks. As a result, patients rarely shopped around for the best price. This was when Dennis asked me why prices weren’t infinity. The question stumped me! I supposed that insurers would only pay usual, customary, and reasonable rates but that didn’t prevent providers from asking for infinity and occasionally getting it. Perhaps providers didn’t want to appear unseemly or were bound by ethical constraints. Or perhaps, as I ultimately responded, medical prices were inflating so rapidly that they would soon reach infinity.

The conversation ultimately led me to examine all sorts of pricing puzzles. Why did prices seem to be higher in more competitive markets (in violation of the traditional price/concentration relationship?) Why did specialists make so much more than generalists? Do any of the rules of pricing apply to medicine?

Economists have solved some of these puzzles. The seeming violation of the price/concentration relationship for hospitals was partly a statistical artifact resulting from a failure to control for quality and severity of illness. And once managed care took over, the traditional price/concentration relationship firmly established itself. The violation for physician pricing could be explained by simple economic forces in monopolistically competitive markets (i.e., markets with many slightly differentiated sellers each of whom has some loyal customers). If some factor causes prices to be higher in some areas than in others, physicians will tend to gravitate towards the high priced areas in order to share in the higher profits. It is not difficult to imagine what factors might cause prices to differ – socioeconomic conditions, culture, the willingness and ability of patients to shop around. Health services researchers offer an alternative hypothesis – that physicians in concentrated markets “induce demand” in order to drive up prices. But this hypothesis had little empirical support beyond some old studies with major statistical flaws. And even these old studies found modest inducement effects at best – not enough to explain the data. Besides, the inducement hypothesis fails to explain why some markets are more concentrated in the first place. The market forces explanation is consistent with the data with the added virtue of explaining the variation in concentration.

Economists will be hard pressed to explain the pricing data that was just reported in Health Affairs. Laugesen and Glied find that U.S. physicians earn far higher incomes and charge far higher prices than their counterparts in other developed nations. The pricing gap is larger for specialists than for generalists. These price differences cannot be explained by differences in costs, including the cost of medical education. Economists often suggest that entry barriers protect physicians against competition that might drive prices down. But it is more difficult to become a specialist in Europe and Canada than in the United States. Moreover, Laugesen and Glied provide further data suggesting that U.S. physicians are not working at capacity; excess capacity is one of the surest predictors of price competition in almost any market, even hospitals. So why not physicians? And the specialist/generalist pricing gap has not been explained to anyone’s satisfaction, especially when there is excess capacity.

Policy makers seem likely to use the Laugesen/Glied findings as an excuse to slash physician payments. But until we understand why physician fees are so high, we will never be able to accurately forecast the impact of fee reductions. Unfortunately, after 30 years of trying, we are no closer to explaining these pricing patterns. During this time, prices have climbed inexorably closer to infinity.


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26 replies »

  1. Good website! I really love how it is simple on my eyes and the data are well written. I’m wondering how I might be notified when a new post has been made. I have subscribed to your RSS feed which must do the trick! Have a great day!…

  2. Doug:

    Thank you for your post. I work for a Regional PPO and confront your Payer Payment schedule from a different perspective.

    TPA’s and self-insured employers who need rental networks will do claims re-pricing comparisons between us and other local and national PPO networks to determine which network will provide the lowest cost of care (quality and quantity omitted). As an independent PPO our challenge has become competing with the national PPO carriers who now offer their networks to TPA’s. With your schedule not being far from what we see, we are at a significant disadvantage against the carrier networks.

    What I don’t understand is why providers allow carriers, who have contracted on behalf of their book of business and business practices, to let TPA’s access their network and network discounts. This will hasten the demise of local PPO’s and shift more of your (and other providers) revenue to lower paying contracts. I’m at a loss for how providers benefit under this scenario.

    I would be interested in your opinion/view of this increasing phenomenon.

  3. Yes, sorry, left out patient portion. In my state the participating provider reimbursement (inclusive of patient portion) is $66.04. I work 3 days per week in my clinic and take home $110K. Overhead is a killer when you don’t work full time. Half my practice is Medicare/Medicaid.

    Incidentially, one of my friend’s son has just started Med school and has taken out his first of four $70,000 loans. I feel pretty confident in saying he won’t be going into primary care….

  4. Peter, I wish it were so. You wish for a system that seems to be what a “single payer” system would be where everyone is covered and all providers must participate. Good luck getting that past Congress as it’s currently structured. Today in the USA we have an insurance system called third-party payment where the insurer (Medicare, UnitedHealth, etc.) is in between the physican and his/her patient. That is the reality, and all the wishful thinking in the world won’t change it.

  5. Dr. Arnold, I guess I did not phrase my question properly. Medicine should not be a game of financial power wrestling between “oligopsonists”, “monopolists” and doctor fee strategizing, but every person seeking medical care should know that the doc will see them, not on the basis of how much the collected fee will be but on their medical condition. So if the fee now were set at a fixed rate (depending on procedure) what price in the ones you listed would you accept and which would give you a fair income? Because now if patients really want to know that the doc will see them they would need to know what fee contract the third party payer is using to reimburse the doc.

  6. Here is my problem with all these alignments and market power plays: they don’t seem to accomplish anything other than shuffling and redistributing an ever increasing amount of money collected from the people.
    Truth be said, both private payers and private providers are naturally interested in maximizing profits. Building bigger providers to fight off big payers doesn’t make any sense to me if the goal is to reduce expenditures.
    And if we are to reduce expenditures, either by quality improvements or sheer brute force, somebody will have to take a hit. It’s basic math. The way things are shaping up now, it looks like as usual, the people will take the biggest, if not the only, hit.

  7. Peter, I’d like everyone to pay me $150 for a 99213. But that’s not reality. Government payers (Medicare and Medicaid) set their maximum fees by law. In most markets a couple of large national or regional health plans usually set the fees they will pay on a “take it or leave it” basis becuase they operate as oligopsonists (which are monopoly purchasers, as opposed to monopolists, which are monopoly sellers) and are exempt from federal antitrust laws. They usually dictate prices they will pay and contract terms and rarely negotiate with physicians, who are usually disaggregated into hundreds of small practice in most markets. As nominal competitors, physicians are severly constrained by federal antitrust laws and FTC advisory opinions regarding their ability to act collectively on price negotiations. Large managed care plans are very happy with this situation as it gives them vast power to control physician fees in most circumstances. Physicians can choose not to participate with plans, but when a plan has a high market share, such actions would severly constrain the “patient pool” for such physicians. Hence most docs are over a barrel and are forced to take what the plans offer. Some health plans in some markets are much more draconian in their reimbursement than others. I won’t name names, but in most markets docs know which ones they are. I offered a hint about one in my previous post. Some at the FTC and AHIP seem to be worried about ACOs which may soon have some market clout to push back against big national payers. They don’t seem to mind that large payers are often guilty of using market power on the purchasing side with impunity.

    Let’s hope that the potential alignment of providers and payers around bundled payments and the move to give providers an economic incentive to make investments in care coordination and health IT via shared savings will start to reverse this trend. As it stands now, there is little incentive to invest in health IT (EHRs) and care coordination when the return on that investment flows to payers and not to those making the investment. This is not the way to run the railroad in my view. Until we make some fundamental changes these vast market distortions and the resulting fee for service incentives the US will keep wasting money and quality will not improve much.

  8. So if the $150 is the billed list price, like a car dealer’s suggested manufacturer’s list price (the one they never expect to get) and the low is Medicaid and the high is regional PPO ($136.60), what would be the set good price for all patients you would want?

  9. I the example I posted above, all commercial & self pay patients are charge the billed charge of $150 (~200% 2011 Medicare) for CPT 99213. The reimbursements I listed were the maximum reimbursement (copay + insurance payment) for various managed care plans, Medicare and Medicaid. Various contracts (either direct or through my IPA) prohibit collecting above the lesser of billed charge of maximum reimbursement. HMO fees vary widely as some plans pay below Medicare (the one whose CEO made over $100 million a couple of years ago) and others pay better (usually one which contract with my IPA). I did not include P4P bonuses, which relate to a couple of plans. Reimburesments range from 91% of billed charge to 24% of billed charge (Medicaid). No wonder few docs can afford to see Medicaid patients in my state.

  10. There is no place within the US and all territories where the 99213 Medicare allowable fee is about $55. The lowest (in a small portion of a territory) is $61.97 for participating providers. The average is about $69 for par and $75 for non-par.
    Are you leaving out the patient portion in the number you quote above?
    Also, although 99213 may be the most common code (I haven’t checked this assumption), it is not the median. There are far more 4 and 5 being billed than 1 and 2, particularly by EMR users.

  11. “In my area we get about $55 from Medicare”

    So how many patients in a week are Medicare? Certainly not 100%. So your example of your net pay (65% of $258,500) is unrealistic low ball.

  12. “You really should do a little more research in to how things work before you post.”

    Really, well not being a doc limits my access to the murky world of treatment codes and rules, but I imagine you saw the ? at the end of my sentences.

    “unless they are cash pay, and then you have to get creative to give them a break, because there are people like you around who will say that if I give a cash pay patient a break, that must be my true charge and I should discount everyone.”

    But if you’re accepting all those different reimbursements as Doug Arnold posted above then what is your “true charge” and what are the “services worth”? And when you’re making it possible for the “poor to receive care” which price do you establish as the base for a discount, your wish-I-could-get-it price or one of the levels of “discounted” reimbursements you accept already?

    “in your world only the government is allowed to look out for the less fortunate”

    Well, they’re the only one capable of taking on the numbers of “less fortunate”. It might shock you but in countries with government run/controlled health care, looking out for everyone and the less fortunate, there is no restriction on charity. And how do you determine what break you give the “less fortunate”, do you do a means test there in your office?

    “Thanks but no thanks to the government deciding what I can charge and what everyone must pay.”

    Well I don’t see why docs should be paid differently for the same service depending on who’s paying. Can you give me a justification? It seems you’re perfectly happy letting an insurance company deciding what you can charge. Anyway, if you don’t like being told what to charge then just go all cash and charge what you want – free yourself.

  13. You really should do a little more research in to how things work before you post.
    Those prices are the limiting charge i.e they include the copay. It is illegal to collect anything from the patient above the amount stipulated in the contract. You can go to jail if you try to collect more than the contract amount for the covered service.
    You can set your billed charge at $1500 or whatever ridiculous amount you want, it is irrelevant. You only get what the contract stipulates (unless they are cash pay, and then you have to get creative to give them a break, because there are people like you around who will say that if I give a cash pay patient a break, that must be my true charge and I should discount everyone. Yes, I know it shatters your world view, but some of us do try to make it possible for the poor to receive care and not pay what the services is worth. It’s called compassion, heard of it? Oh that’s right, in your world only the government is allowed to look out for the less fortunate)
    Wouldn’t it be better to be paid the same one charge? Stop for a minute and think through what that implies. Not all, in fact not even half of us Americans want such a system. There are others ways to fix the current problems without invoking your solution. Thanks but no thanks to the government deciding what I can charge and what everyone must pay.

  14. Average Doc works 4 days per week – any more than about 100 patients is burnout. Have to take at least a week off for CME, Have to subtract vacation, holidays, etc. More like 4×47=188 days of patient care. In my area we get about $55 from Medicare for a 99213. 188x25x55= $258,500. Overhead is more like 65% in primary care, somwhat lower in larger group practices.
    The only docs who receive what they charge are in direct pay practices.

  15. So if you see, say 25 patients per day, and work, say 250 days per year, and assuming they are all Medicare, which is likely not the case, and assuming they are all 99213, which is definitely not the case, you bring in around $474,000 (my guess would be a bit more), and if your overhead is say 50% (likely less), you take home around $237,000 (likely more) before tax.
    Not quite infinity, but not too shabby either, particularly in a semi-depression.

    On the other hand, if you could collect your full billed amount, you would take home around $750K if you worked the same number of days and saw the same number and type of patients (i.e. overhead stayed the same).
    It would be nice, and a bit closer to that infinity.

  16. Is this for real? Can I use this as a (blinded) exemplar?

    Most of mine with my Primary are 99213’s.

    That’s in the pocket for what I know of Medicare 99213’s (yeah, they vary geographically).

    I don’t see how y’all do it. Even with that illustrative distribution of a payor mix.

    Even with a chump-change Part-B copay.

    I was working with a doc this afternoon at his office on the Meaningful Use criteria. He didn’t even know what his CPTs were (he outsources his billing, and, I guess, doesn’t run backoffice reports). We were doing “Active Problem List” and he thought they were CPT codes.

    “No…those map to ICD-9’s, which then, to be sur, end up as grist for CPTs and biliing…”

    There’s gotta be a better way to do this.

  17. “Here is what I’ll get paid by various payers:”

    Does the patient make up the difference with co-pay? How do you set your billed charge at $150? Wouldn’t it be better to be paid the same one charge by all payers?

  18. CPT 99213 (office visit, established patient) is the most frequently billed CPT code. Let’s say I’m a primary care physician seeing an established patient. I set my billed charge at $150 (roughly 200% of 2011 Medicare). Here is what I’ll get paid by various payers:
    Payer Payment % Billed
    Billed Charge 99213 $150.00 100%
    Regional PPO $136.60 91%
    Large national PPO $109.04 73%
    Large national HMO A $99.42 66%
    Large national HMO B $84.27 56%
    Large national HMO C $79.80 53%
    Large national HMO D $72.00 48%
    Large regional HMO E $92.75 62%
    Medicare $75.89 51%
    Medicaid (patient>19) $55.14 37%
    Medicaid (adult patient) $35.48 24%

  19. George Halvorson offered a very elegant solution for this problem during his talk at the World Healthcare Congress this past May. As he put it, the US spends about 18% of GDP on health care, the OECD average is around 12%. If we just paid the same unit prices as that average, we could free up close to a trillion in GDP. Economists from Uwe Reinhardt to those writing in the current issue of Health Affairs have pointed out “it’s the prices, stupid.”

    There’s a relatively simple fix for this one–follow the lead of the rest of the developed world and regulate pricing for medical goods and services.

  20. Except that health care is cheaper everywhere else, with more government involvements, this argument could be taken seriously. I think that there is some reason to believe it can work for primary care, but that is not the expensive part of medicine.


  21. “I have the proff of my own experience with the shop”

    Just wondering how that worked. Did you have an accident in which you called insurance and their adjuster went to the shop and authorized fixing from shop’s estimate, then you went to the shop and said let me see the quote to insurance and how much if I paid cash/no insurance? And how much different was it and how did you know you were going to get the same job?

    So why is cash less, because body shops pad for insurance cause adjusters are stupid or don’t follow standard industry repair costs?

    “It is common practice for physicians to set as their fee for any particular service some amount that is slightly higher than what the “best” insurer pays, otherwise, as the consultants will tell you, “you’re leaving money on the table.”

    So what happens with the extra “on the table” – the part where the EOB says, “This is what insurance pays and this is the amount you owe the physician”? What is the reason for not leaving money on the table – ability to pad the bill? What’s not on the table – greed?

    “It is also common for most physicians to offer some mechanism for reducing the cost to cash pay patients – a sliding scale or simply by charging a 99212 instead of a 99213 even though the higher code is justified.”

    Does that mean you’re defrauding the insurance company by up-coding? Why would you charge less to cash pay – because you’re a nice guy?

    I agree with overhead costing money, so why don’t you go all cash? It appears you’re talking about PCP billings, but that’s not what’s driving health costs, it’s hospital charges.

    And if national health costs are inflated with third party payers then why do all other industrial nations with government control/payers health care do it for about half?

  22. I have the proff of my own experience with the shop, and the reports of others. It is not about padding the bill, it was a different quote for cash vs. insurance work.
    I’m was not addressing hospital costs in my comment. I was addressing the statement asking why physician fees are so high. It is common practice for physicians to set as their fee for any particular service some amount that is slightly higher than what the “best” insurer pays, otherwise, as the consultants will tell you, “you’re leaving money on the table.” It is also common for most physicians to offer some mechanism for reducing the cost to cash pay patients – a sliding scale or simply by charging a 99212 instead of a 99213 even though the higher code is justified. In talking with physicians it is clear that the lower fees could actually sustain their practice, but only if the overhead associated with the third party billing were eliminated.

    “Look at the charge-master and see if docs/hospitals charge less than insurance will pay”

    That is the whole point – national health care costs are inflated due to the third party payment system. It is not free-market and to say that the free market has failed is a lie designed to push an agenda.

  23. “The local autobody shop charges less for non-insurance repairs.”

    Just an off the hip doc myth or do you have proof. In fact auto insurance companies use adjusters who tell the body shop what they will pay for and what they will pay, knowing that body shops are really good at padding the bill, the insured usually has no say, except to choose the shop. Have you ever asked a hospital what their non-insured price is? Look at the charge-master and see if docs/hospitals charge less than insurance will pay.

  24. The local autobody shop charges less for non-insurance repairs. The reason the insurance covered repairs cost more is exactly the reason why physician fees are higher than they should be. I do not operate in a free-market environment. I don’t know why this myth is so hard to lay to rest. It seems that many feel somehow threatened by admitting that the free market is not responsible for the cost overruns of the current system, as if admitting that would make it impossible to achieve their dream of a national healthcare system. The problem is that when national health care for all arrives (and it will) we will not have faced the peverse incentives that exist in a third party payment system, and costs will be orders of magnitude higher than they should be and would be if the patient were given more control over how their health care dollars should be spent (ie there are ways to introduce free market forces into even a national universal health care system, but then that would mean some loss of control from the experts, and that is unacceptable to them).
    Because of the way in which the third party payment system leaves the patient out of the loop when it comes to assigning value, alternative payment methods have not been allowed to see the light of day. If you look at the direct pay models which are so loathed by the majority on this blog, you will see a variety of different financial arrangements. Some of these result in significantly less cost to the patient compared to traditional insurance. An insurance product designed around a direct pay practice would result in immediate and significant cost savings (but the concept that the money does not all have to come from the patient, even the very money the patient ends up paying directly to the family physician, this concepts seems incomprehensible to many, presumable because it would cause them to put some actual thought into their proposals for health care reform)

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