Economics

Making Sense of Health Care Prices

Take a look at the chart below. It shows representative prices for a knee replacement for different patients in different settings. The most shocking thing about the chart is that prices for essentially the same procedure are all over the map. Here are some obvious questions:

  1. Why is the price of a knee replacement for a dog — involving the same technology and the same medical skills that are needed for humans — less than 1/6th the price a typical health insurance company pays for human operations? Why is it less than 1/3 of what hospitals tell Medicare their cost of doing the procedure is?
  2. How is a Canadian able to come to the United States and get a knee replacement for less than half of what Americans are paying?
  3. How are Canadians getting knee replacements in the U.S. able to pay only a few thousand dollars more than medical tourists pay in India, Singapore and Thailand — places where the price is supposed to be a fraction of what we typically pay in this country?
  4. Why do fees U.S. employers and insurance companies are paying vary by a factor of three to one, when foreign, and even some U.S., facilities are offering a same-price-for-all package?

It’s amazing how often people cannot see the forest for the trees. Think how many volumes have been written trying (and failing) to explain why our health care costs are so high. Sometimes the answers to complex questions are more easily found by asking the simplest of questions.

[But first, a side bar. A study by Miriam Laugesen and Sherry Glied, published in Health Affairs, claims that the reason the U.S. spends more on health care than other countries is the Americans pay higher prices — in particular, higher physician fees. This claim is extraordinary, considering that doctors’ net incomes are only about 10% of health care spending and the amount by which U.S. doctor fees exceed foreign doctor fees is only a couple of percentage points.

Commenting on the study, Uwe Reinhardt says what we have often said: in terms of real resources used, we may not be spending more than other countries. Greg Scandlen is appropriately critical for different reasons. But everyone seems to have missed the far more interesting point: a lot of U.S. patients are not paying more than what foreigners pay.]

Let’s turn to the canine question. When you recover from your knee replacement surgery, let’s say you spend two nights in a hospital room, with all the comforts of a luxury hotel. Fido recovers in a cage, which presumably costs much less. But even with meals, two nights in a hotel should come in under $1,000. The price difference we are trying to explain is about 27 times that amount.

Then, there is the difference in surgeons’ skills. Presumably, the surgeons who operate on humans are more talented, and therefore more valuable. But do you know that an orthopedic surgeon in Dallas typically gets paid an amount equal to about 10% of the $32,500 an insurer pays to the hospital. That’s less than the fee the sales rep gets for selling the artificial knee to the hospital. (I’ll revisit this scandal on another day.)

I suppose you (as a patient) would get more attention than Fido from nurses and support staff for the one or two days of recovery. Guess how much a nurse gets paid in Dallas? It’s about $30 per hour. Steep. But nowhere near the explanation we are searching for.

Let’s take the actual cost hospitals tell Medicare they incur for this procedure. It’s about $15,000, not including surgeon’s fee. But if veterinarians can do it for a third of that amount, it’s hard to see why the human hospital cost isn’t at least half of what it actually is.

The only explanations I can come up with for why human knees cost so much more are (1) government regulations, (2) malpractice liability and (3) the inefficiencies created by the third-party payment system. It looks like these three factors are doubling the cost of U.S. health care.

Let’s take regulations first. In terms of rules, restrictions, and bureaucratic reporting requirements, the health care sector is one of the most regulated industries in our economy. Regulatory requirements intrude in a highly visible way on the activities of the hospital medical staff and affect virtually every aspect of medical practice. In Patient Power, Gerry Musgrave and I described the burdens faced by Scripps Memorial Hospital, a medium sized (250-bed) acute care facility in San Diego, California. Scripps had to answer to 39 governmental bodies and 7 nongovernmental bodies. It periodically filed 65 different reports, about one report for every four beds. In most cases, the reports required were not simple forms that could be completed by a clerk. Often, they were lengthy and complicated, requiring the daily recording of information by highly trained hospital personnel.

Then there is the malpractice system. Estimates place the burden of the system at between 2% and 10% of the cost of U.S. health care. But it’s hard to separate out the effects of malpractice from the effects of regulation. Remember, both institutions are trying to do the same thing: reduce the incidence of adverse medical events (no matter how imperfectly). If a hospital fails to follow a regulation, and that failure leads to a patient death, the failure would undoubtedly be the basis for a malpractice law suit. So the existence of the malpractice system helps encourage compliance with regulations — making them more costly.

Finally, there are the inefficiencies produced by the third-party payment system. We have previously pointed out that when providers do not compete for patients based onprice, they typically do not compete on quality either. In the hospital sector, they tend to compete on amenities instead. But the way you compete on amenities is to spend more on amenities. And this adds to costs. To appreciate what your health insurance premiums are buying these days, consider this item from a previous post:

Concierge service. Jacuzzi tubs. Bacon-wrapped scallops or New York strip steak prepared by professionally-trained chefs and brought to your room.

These amenities can be found at most new hospitals in Colorado and across the country. Gone are the days of sterile, white hallways, fluorescent lights and cloth curtains separating patients in the same room. The newest hospitals offer bountiful natural light, warm-colored walls and floors, soothing art and private patient rooms with large windows and relaxation videos.

Sky Ridge Medical Center in Lone Tree features fireplaces on every floor. Children’s Hospital Colorado in Aurora offers video games in patient rooms. The cafeteria at the new $435 million St. Anthony Hospital in Lakewood includes a soda machine that can make 100 different types of drinks.

Now let’s consider medical tourism. If you ask a hospital in your neighborhood to give you a package price on a standard surgical procedure, you will probably be turned down. After the suppression of normal market forces for the better part of a century, hospitals are rarely interested in competing on price for patients they are like to get as customers any way.

A foreign patient is a different matter, however. This is a customer the hospital is not going to get if it doesn’t compete. That’s why a growing number of U.S. hospitals are willing to give transparent, package prices to foreigners; and these prices often are close to the marginal cost of the care they deliver.

North American Surgery has negotiated deep discounts with about two dozen surgery centers, hospitals and clinics across the United States, mainly for Canadians who are unable to get timely care in their own country. The company’s “cash” price for a knee replacement in the United States is $16,000 to $19,000, depending on the facility a patient chooses.

But, and this is what is interesting, the same economic principles that apply to the foreign patient who is willing to travel to the U.S. for surgery also apply to any patient who is willing to travel. That includes U.S. citizens. In other words, you don’t have to be a Canadian to take advantage of North American Surgery’s ability to obtain low-cost package prices. Everyone can do it.

The implications of all this are staggering. Many U.S. hospitals are able to offer traveling patients package prices that are competitive with the prices charged by top-rated medical tourist facilities around the world. (You don’t have to travel to Thailand, after all.) However I would insert this note of caution: Although a hospital with excess capacity gains by charging the marginal customer the marginal cost of care, it may not cover the full costs that must be covered to stay in business if it charges every customer that price. So the prices we are looking at may not be long run equilibrium prices.

The final question is: Why are U.S. employers and insurers over-paying by so much and why does the amount they overpay vary so much?

In part, because in the entire medical marketplace, prices don’t clear markets the way they do in other sectors of the economy.  Even MRI’s vary by over 650% in a single town. Furthermore, most providers don’t even know how to price their services because they don’t know what their costs are.

A more basic problem is that insurers are unwilling to adopt what I call the “casualty model” of insurance and what today is more commonly called “value-based purchasing.”  Value-based purchasing means that the insurer picks one or more high-quality, low-cost surgical facilities and directs patients to those sites. Patients are free to go elsewhere, but they pay the full marginal cost of those choices when they are exercised. This may include asking the patient to travel.

Being penalized financially for refusing to travel to another city for surgery will not sit well with a lot of employees and their families. But I suspect that this will be only a temporary inconvenience in the evolution of the health care system. Once a few people begin to move to take advantage of lower prices and higher quality, price and quality competition will emerge system wide. At that point the hospital marketplace will begin to resemble a normal market.

John C. Goodman, PhD, is president and CEO of the National Center for Policy Analysis. He is also the Kellye Wright Fellow in health care. His Health Policy Blog is considered among the top conservative health care blogs where health care problems are discussed by top health policy experts from all sides of the political spectrum.

 

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43 replies »

  1. @Beth Morgan, I think the revenue cycle is so bad because hospitals do not post prices up front. When people get the bill, they are understandably upset.

    In any other enterprise, providers decide how to manage credit risk. I worked for a few years as an independent consultant, negotiating fees with many clients who were much bigger than me, in my home office. Only once did I not get paid in full, on time. I wrote it off.

    When terms are agreed in advance, the payer has a much greater sense of ethical obligation to pay, even in the absence of legal redress.

  2. Nurses getting paid $30.00 an hour steep? Think about that next time you push your call bell and wait…

  3. Could this be why the number of food-stamp beneficiaries in Oregon has increased dramatically in the last few years? Since 2008 the state has seen a 60% boost in the number of food-stamp recipients, which means that more than 780,000 people (one out of five Oregonians) get groceries compliments of Uncle Sam.

    As if this weren’t bad enough, the feds are also giving the state a two-year grant to test an “innovative approach” to the food-stamp “client eligibility review process.” This will make it even easier for people to get food stamps because it grants state officials a waiver that allows them to grant the benefit without interviewing the candidate.

    From today’s news, your right we are way to stingy with welfare, how dare someone have to actually apply or prove they need help. Obama and the Liberals are here to feed us all.

  4. what would you like to compare?

    How many people are dependent on the government for food?
    How many people are captives in squalid government housing?
    Unemployement rate?
    Teen Pregnancy?

    I would bet any Liberal ran portion of America is towards the top of the list.

  5. straw man argument, you liberals like to brand everyone that doesn’t agree with every half witted policy as cruel and evil.

    It is the same BS you pulled with welfare reform, if Clinton passes the bill people will be dying in the streets and we are evil and greedy for not helping them. And what happened, people got off welfare and started supporting themselves living far better lives than they ever would have on your twisted and corrupt welfare schemes.

    Society would be better off if you never passed public housing.

    Society would be better off and more compassionate if liberalism never existed.

  6. I guess it’s better to leave future generations the legacy of a cruel, unforgiving, hateful and deeply divided nation, instead of debt.

    Someone should inform George H. W. Bush that after careful analysis, we concluded that a kinder and gentler nation costs to much.

  7. Medicare debt being passed onto future generations = 40 Trillion+
    Medicaid debt being passed onto future generations = $0

    Some of us don’t like to screw other people over for our own greed and comfort. Future generations of Americans should be respnsible for their generation and the decisions they make, not 100 trillion of IOUs from the most selfish generations of America.

  8. Yes, because the States are doing such a stellar job with Medicaid. Not only there will be no dead people receiving millions in benefits, there will be few live people receiving anything significant as well.

  9. Does anyone believe the government could actually do this? Just this week alone I have seen three or four stories about dead people receiving millions in benefits. Ineligibile disaster relief victums getting paid. Federal government needs removed from anything having to do with Insurance. Let the states step in and handle it.

  10. Every year give the government funded patient part of the money to hold in their own health savings acount. Have some fraud control and identity control. (The computer might manage to help with this.) They can keep what they do not spend. Frivolous utilization will plummet.

  11. There is no such thing as a sustainable welfare program, if you insist on giving people stuff for free more and more will come to rely on the free to the point those that provide can no longer afford to provide.

    There must be consiquences to not providing for oneself or it will never last.

  12. “and step in with optional support when people are unable to pay for their own care.”
    ___

    The “Free Market Uber Alles” contingent takes it as a given that “unable” uniformly means “unwilling.”

  13. “This is not about WHO pays because we all know that it will never be the patient for the majority of Americans.”

    I agree. It is not about WHO. It is about HOW.
    In essence, every dime spent on health care is paid by the people in aggregate, whether through taxes, premiums or directly out of pocket. What we refer to as “charity” care or “free” care is also paid by the people, since charity dispensers turn around and either bill tax payers directly for their charitable contributions, or shift the costs of charity to paying customers.

    The question in my mind is whether we pull our resources together to the best of our abilities, and pay for everybody needing care, regardless of what they put in or taken out, or we let each and single one of us negotiate whatever they can with whatever means he/she can muster, and step in with optional support when people are unable to pay for their own care. Is this where the free market comes in?

  14. Again, I don’t disagree.

    But I take issue with “free market principles” as some panacea. Read some J.D. Kleinke (medical economist).

    Markets properly exist to serve humanity, not the other way around.

  15. Wow, I couldn’t have asked for better responses to prove my point exactly. You are incapable of seeing the possibilities that exist (not that you would have to prefer those possibilities, it just would nice if they could be acknowledged as existing so that there could be a true debate on the merits of each direction).
    “Place the blame where it belongs in the aggregate” – who? you didn’t say. Blame the victim? Who would that be Bobby? You didn’t identify who you think I place the blame on. Well I’ll tell ya – I blame those how continue to believe in a system the removes the patient, physician and insurer from the combined clinical and financial consequences of their choices. This is not about WHO pays because we all know that it will never be the patient for the majority of Americans. It is about undoing a system filled with perverse incentives for all three members of the third party system. There is a way to do this using free market principles (a way that is superior IMHO to a system in which the patient is passive), that is what so many are unable to see.

  16. “proponents of universal government healthcare are unwilling (unable?) to admit that “free market” includes options that look very different to the current failed system.”

    Universal government healthcare uses the private sector but negotiates prices because health care is not and never will be a perfect market. When was the last time you got to “negotiate” with a third party payer? “Free market” for docs just means they get to control what people pay, not insurance companies or government, and anyone not being able to afford their guild’s fixed prices can just go away and die – like fido.

  17. ” you obviously do not understand the effect that the third party payment system has on the total cost of health care in America.”
    ___

    Not to summarily dismiss your assertion, but I see a very large “blame the victim” component here. 3rd party payors were supposed to comprise a value-adding, division-of-labor, knowledgeable cost-restraining intermediary function necessary in a domain whose irreducible complexity made (and continues to render) “astute, price-sensitive consumerism” an absurd concept beyond the most routine of preventive care (all due respect to John Mackey et al. Yeah, John, were we all not such Shitty Shoppers we’d not have this mess).

    Place the blame where it more properly belongs in the aggregate (and spare me the tired totemic anecdotes of the Reality Show demographic egregious over-utilizers — the zero copay call-911-for-my-hangnail hypochondriacs and otherwise putative Munchausen-wannabees). The days of viable for-profit risk cherry-picking and cost-shifting draw nigh to an end. They will not go quietly, as we are seeing.

    And, having said all that, I would agree in principle with the HSA concept, which, spread widely and rationally, might indeed serve to abate the largely False Dilemma Free Market vs Socialism canard.

    Anyone looking for easy, permanent solutions had better stock up on the eyedrops (Walgreens over-the-counter ones not covered by your Flex plans, thank you very much).

  18. I fail to see why any average person would care what any particular test or procedure or office visit actually costs. If you have to ask “why don’t more people care?” then you obviously do not understand the effect that the third party payment system has on the total cost of health care in America. The only two options that make sense are universal government run healthcare or true free-market healthcare. But it is frustrating to have a discussion about the merits of each proposal because the proponents of universal government healthcare are unwilling (unable?) to admit that “free market” includes options that look very different to the current failed system.

  19. I am about to attend a bylaws committee meeting at the hospital. We will consider several inconsequntial amendmend driven solely by CMS and JCAHO, scripted by them and essentially mandated by them. Lots of time went into these and other regulations controlling medical care in general and doctors in particular. Lots of time and money.

    Dogs receiving new knees are healthier that people is because we are putting new knees into people that should not get them and would not get them if they had to pay for them out of pocket. Certainly most would never borrow to pay for the surgery, yet that is what they expect the gov’t to do.

    The results in vet surgery undercut the validity of all the supposed safeguards in human surgery. They are merely liabilty defense factors.

    Get rid of third party and government payors and you get real savings and real markets.

  20. Dr. Goodman– I recently did some research into revenue cycle and I was pretty amazed to see how low the collections rate for patient pay balances is– only around 50%. Curious to hear whether you think that has an effect on overall charges. Seems like if a provider knows that some large percentage of the money they ask patients for is never coming then they have no choice but to bump up the initial asking price in order to clear more from those who do pay, right?

  21. I’ve wondered many of the same questions. When I look at some of my hospital bills, I can’t believe how much some of the tests cost!

  22. “It really pays to screen, so that you only treat healthy patients” as said by steve.

    Hmm, that is a very loud statement depending on how to interpret it.

    Perhaps PPACA is the next Darwinian experiment by humans. You think so?

  23. I am really amazed, after reading the article and after looking the facts and figures in the chart. Canadians are really having advantage of the treatment in US.

  24. Just as an aside, while US hospitals may be able to occasionally offer discounted surgeries to deter patients from medical tourism (a practice I’m not quite sure I understand – are they running a loss leader in the hope that the patient will impulse buy a little elective surgery at the register?) I can’t imagine any US hospital offering the same level of luxury as Bumrungrad in Bangkok.

    Of course, I know that nobody chooses their hospital based on the selection of apres-surgery snacks, but Bumrungrad is a frickin’ palace. My girlfriend’s sister works as a pediatric surgeon there, and the first time I went in to say hello I thought I’d stepped into a hotel.

  25. Nice posts-comments. The true ‘cost’ of providing a knee (TKA) is variable and frankly unknown even by most hospitals. This should be relatively easy to identify when taking into account supply, labor, and other fixed and variable constituents of cost. The physician fee is the least variable due to contracting etc. The variability in knee prostheses purchase price alone is extremely broad, and represents the bulk of total cost. Nonetheless, fixed bundled payment representing the ‘true’ costs would go a long way to help this.

    Health care is one of the only industries not understanding the true costs (see Kaplan and Porter’s article in Sept. HBR: http://hbr.org/2011/09/how-to-solve-the-cost-crisis-in-health-care/ar/1

  26. “but I don’t see how arbitrarily setting prices is any less inflationary or less susceptible to fraud,”

    If I say i am willing to pay $40 for a 99213 where does a provider have an opportunity to fradulently effect the reimbursement? I remove all opportunity for the provider to inflate their cost to increase reimbursement.

    If I don’t increase my $40 reimnursement there is no inflation. If your reimbursing cost plus, except in times of depression, inflation will guarantee annual increases. How often does labor not go up? Power bills, rent, etc.

    If your not suggesting the opayee be free to declare their cost how exactly do you propose we determine cost? Are you suggeting we send auditors to every provider in the country?

    In regards to paying everyone the same wouldn’t a fixed fee for service do that?

  27. These are pretty easy.

    1) My partner and I consulted when a local vet school started a heart surgery program. Dogs take much less pre and post care. The costs of the implants probably are not being churned like they are for people. For people, you need to staff the hospital around the clock for all possible complications. Dogs are usually healthier than people having surgery.

    2) Canadians are paying Medicare rates. Since TKAs, total knees, are done in assembly line fashion, hospitals make money at Medicare rates. They also save money because follow up will be in Canada and paid for by Canadian taxpayers. Also, it really pays to screen so that you only treat healthy patients.

    3)Why is Medicare only a few thousand dollars more than Medical tourism costs? I guess it helps if you can pay your staff $4 an hour. Foreign countries set price controls on drugs, often, so they are cheaper. You can be sure they screen and treat only healthy patients. Much cheaper.

    4) Profit.

    Steve

  28. Medicaid beneficiaries have trouble finding doctors because there are plenty of payers that pay better rates. Medicaid is a disgrace.

    Perhaps cost+ is inflationary, but I don’t see how arbitrarily setting prices is any less inflationary or less susceptible to fraud, which is a different issue. I am also not suggesting that the payee be free to declare its costs and be reimbursed 10% on top of that.

    The main point here is that they are all paid the same. Those who control costs within reasonable quality parameters will thrive. The others will eventually die.

  29. “I guess I need to question Mr. Goodman’s statements and figures. Why wouldn’t a cash pay uninsured get that price?”

    Because they didn’t ask/demand for it before. If refused they didn’t take their business to someone who would give them that rate. Much lower prices are available if people would demand them and hold over priced providers accountable by taking their businesses someplace else. This applies to Hospitals, pharmacies, dentist, everything.

    Why would anyone fill a generic drug for a higher price then what Wal Mart sells it for across the street? Its done tens of thousands of times every day

  30. “Why is the price of a knee replacement for a dog — involving the same technology and the same medical skills that are needed for humans — less than 1/6th the price a typical health insurance company pays for human operations?”

    You have to ask? First, fido’s owner gets to choose between death for fido or surgery for fido. Second, yes overhead and total reimbursements are lower for vets than humans – maybe if fido got to choose (and pay) he’d choose Taj Mahal surroundings same as his owner. Ask Americans if they want to be treated like fido.

    “How is a Canadian able to come to the United States and get a knee replacement for less than half of what Americans are paying?”

    “A foreign patient is a different matter, however. This is a customer the hospital is not going to get if it doesn’t compete. That’s why a growing number of U.S. hospitals are willing to give transparent, package prices to foreigners; and these prices often are close to the marginal cost of the care they deliver.”

    I guess I need to question Mr. Goodman’s statements and figures. Why wouldn’t a cash pay uninsured get that price?

    I didn’t know U.S. hospitals are short on knee replacement surgery. I guess the reason Canadians can wait if they don’t like the price is because maybe it’s not such an emergency and FREE in Canada is a real alternative.

  31. Why do Medicaid beneficiaries have trouble finding doctors?

    Or are we now admitting that Medicaid reimburses below cost?

    Why did governemnt move away from cost plus pricing in almost all enterprises? Becuase cost plus 10% fosters inflation. By not controlling cost the payee actually makes more. This is why anyone arguing to do away with FFS should be ignored until they have a proven substitute. Medicare admin for example use to be cost plus and it was rife with fraud.

  32. Does the Vet have an anesthesiologist or even a CRNA in the room at the time of surgery? Did the circulating nurse write “not this leg” on the good leg? Did the prosthetic hip cost the same? Was there someone to count the sponges at the end of the procedure? Was there the same number of pre/intra/post operative xrays and MRIs? Was there a pre-operative eval with cardial clearance? Did the dog get a physical therapy eval prior to discharge? Does the dog need coumadin and the monitoring that goes with it? Does the Vet have to pay staff to pre-authorize the hospitalization and surgery, send out the bills to insurance, and maintain expensive medical records systems? Is every employee and team member caring for the dog covered by malpractice insurance that carries the same premium as for the human? Did the vet pass his JCAHO certification? Whats the $/sq.foot for construction of a vet surgery comparable to a hospital? Did the Dog have a CNA to change it’s bedpan, a Nurse to push the med cart, an ICU team on standby, a CEO, CFO, COO, VP of patient care to worry about him? How much laundry did the dog generate? How much of his food was made in the kitchen? How much did his hospital bed cost, and the anti-DVT device that he didn’t wear after surgery? Was there a flat screen TV, phone and internet access in his cage?

  33. What would cause lack of supply, considering that here almost all suppliers are private and that we are a very innovative nation? Shouldn’t hospitals rejoice in a minimum 10% guaranteed profit considering the miserable margins they say they have now?

  34. Margalit what do you do when people start to complain about lack of supply, i.e. Canada and UK?

  35. Careful, there, Dr. Goodman. If you keep this up you’re gonna uncover more than anyone wants to know about the world’s best healthcare system.
    (While you’re at it, look into the large and growing challenge of drug shortages.)

  36. “The only explanations I can come up with for why human knees cost so much more are (1) government regulations, (2) malpractice liability and (3) the inefficiencies created by the third-party payment system.”

    Strangely, the only explanation I can come up with is the exact opposite – lack of regulation.

    In the chart above, take the lowest cost report, which presumably excludes the bacon wrapped shrimp, add the lowest physician fee to it, and mark it up by a solid 10% to come up with a very reasonable $17.5K price. Pay that to one and all, i.e. regulate prices.

    In the alternative value-based purchasing scenario, since shrimp has been excluded from competition, they will all have to compete on “quality”, and the fearless will compete on price. Sooner or later they will reach dog prices, and if we can’t afford those either, there’s always the “other” dog-needing-life-saving-too expensive-surgery option.

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