Why Raising Hospital Prices is a Zero Sum Game

In the early 1960s, President John F. Kennedy said, “The time to repair the roof is when the sun is shining.” It was a clarion call, a full-throated warning against national complacency in an era of great prosperity.

It was during this same period that community hospitals stood as the dominant force in American healthcare. By the mid-20th century, some 6,000 inpatient facilities had spread throughout the country, often serving as the financial glue of their respective communities. With well-paying jobs and boards made up of dignitaries, local hospitals aroused a great chorus of civic pride.

But in recent times, the proverbial roof over America’s hospitals has fallen into disrepair. Thanks to operational inefficiencies and declining utilization, more and more hospitals are experiencing financial problems and waning influence.

As health plans, pharmaceutical companies and new care-delivery entrants gain market clout at the expense of the hospital industry, panic is starting to set in. These developments have spurred a recent uptick in hospital mergers, which look more like deals of desperation than long-term growth strategies.

Merger Motives

Mergers and acquisitions (M&A) typically serve one of two purposes. The first is to create a more efficient organization. Combining forces can help merged entities weed out redundancy and bolster innovation, resulting in superior products or services at lower prices. The second reason is to build negotiating clout and raise prices.

Most recent hospital mergers, such as the one announced late last year between Dignity Health and Catholic Health Initiatives (CHI), hint at the latter.

Expected to close in the second half of 2018, the agreement would create one of the nation’s largest nonprofit health systems, bringing together 139 hospitals across 28 states with $28.4 billion in revenue. According to a joint press release, the merger represents “an incredible opportunity to expand each organization’s best practices … and deliver high-quality, cost-effective care.”

Indeed, the Dignity/CHI merger could be an opportunity to improve quality and lower costs, but there’s little evidence these financially challenged hospital systems will accomplish either as a combined entity.

In fiscal 2017, Dignity Health experienced a $66.8 million operating loss, worse than in the previous year. Meanwhile, CHI saw operating losses grow from $371.4 million in 2016 to $585.2 million last year. Put these numbers in front of a group of MBA students (or most CEOs working outside the healthcare industry), and they’d all come up with the same M&A strategy: (1) close or combine under-performing facilities, (2) eliminate duplicate clinical services, and (3) reduce administrative overhead.

Instead, Dignity and CHI appear poised to do the opposite. The San Francisco Chronicle reports, “There are no current plans to close any facilities,” and by inference, no job cuts among the health system’s 159,000 employees. Further, the organization announced it will retain co-CEOs, a move that’s almost always more politically expedient than operationally effective.

If the Dignity/CHI merger proves to be less about improving efficiency through consolidation –  more about negotiating higher prices with insurers – they wouldn’t be alone.

Three days before the Dignity/CHI deal was announced, Aurora Health Care, the largest health system in Wisconsin, agreed to combine operations with Advocate Health Care Network, the largest health system in Illinois, a merger that would create the nation’s 10th-biggest nonprofit health system. A week after that, the Wall Street Journal (subscription) reported Ascension Health and Providence St. Joseph Health were in talks to create the nation’s largest hospital chain, with 191 hospitals in 27 states and annual revenue of $44.8 billion.

So far, none of these prospective health systems have demonstrated a willingness to make the hard decisions necessary to improve operational performance.

Hospital CEOs understand it’s much easier to expand clinical services and raise prices than it is to consolidate volume in fewer facilities or demand doctors adopt more efficient practices. And, of course, no CEO wants to be the one to tell a community its local hospital will close.

So, hospitals figure out ways to purchase expensive machines, perform more complex procedures and, ultimately, raise prices.

Why Raising Prices Isn’t The Solution

Raising hospital prices through M&A isn’t a new phenomenon. In 2016, a California-based study found that Dignity Health’s prices were 25% higher ($4,000 more per patient admission) than at other hospitals in the state, a result of Dignity using its market power to demand higher rates. This past November, a California superior court judge ruled that Sutter Health, itself the beneficiary of a 1996 merger, intentionally destroyed evidence in a lawsuit that accused the health system of inflating prices and abusing its market power.

American hospitals have long had the clout to charge whatever they wanted. But today’s purchasers, including the government and major employers, are growing impatient. They’re tired of paying exorbitant rates, especially for services that can be delivered more efficiently elsewhere. Independent “surgicenters” now offer same-day procedures at lower costs than local hospitals. Meanwhile, more patients are being referred to pharmacy-based walk-in clinics rather than going to their local Emergency Room.

Further accelerating the patient migration from U.S. hospitals are moves from insurance giants like United and Humana, which have begun acquiring physician groups, diagnostic facilities, home health practices and other forms of care delivery in bulk.

In a hospital industry that’s heavily dependent on its people, self-disruption will be the only way to lower the cost structure. It will require hospital CEOs to implement more effective approaches for delivering higher-quality care for more patients with less staff in fewer buildings.

Few organizations in any industry find consolidation and downsizing attractive. But the alternative, being disrupted by others, will prove far more painful for hospitals. Unless CEOs are willing to embrace strategies that focus on operational efficiency, their bottom lines will continue to erode as patients pursue more convenient and lower priced care elsewhere.

How To Save America’s Hospitals

Achieving higher-quality, faster access and lower costs are often perceived in healthcare as competing or self-defeating goals. They don’t have to be. In fact, they are necessary steps toward preserving the long-term viability of inpatient facilities. Over the next two months, this series will demonstrate how hospitals can achieve all three.

My next piece will focus on why it is advantageous for hospitals to help patients recover faster and even avoid hospital admissions in the first place. Nationwide, Medicare HMO patients spend an average of 1.6 days in the hospital each year. As CEO of the nation’s largest medical group, I helped Kaiser Permanente facilities reduce that number to 0.7 days per year, less than half national average. I’ll explain how we achieved these results while also improving clinical outcomes.

Nexxt, this series will address issues in the Emergency Department. In 2014, the CDC reported that the average ER wait time is 30 minutes while the average treatment time is 90 minutes. I’ll demonstrate how hospitals can greatly reduce wait times and delays in treatment while reducing costs and the risks imposed on patients.

After that, I’ll focus on the Operating Room, where the time wasted between procedures is responsible for soaring costs for hospitals and worse outcomes for patients.

The final article in the series will put the pieces all together, and propose a model for restructuring the nation’s entire hospital system.

Dr. Robert Pearl is the bestselling author of “Mistreated: Why We Think We’re Getting Good Health Care–And Why We’re Usually Wrong” and a Stanford University professor. Follow him @RobertPearlMD

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8 replies »

  1. The initial construction cost of a hospital is probably close to $2 Million a bed or more depending on whether its a Trauma Center, has a maternity suite, has Psychiatric beds for adults as well as children, and/or performs open cardiac or transplant surgery. Compounding all of this are fire regulations (only so many alcohol dispensers for hand sanitation per patient area, automatic door closer systems, etc.), backup electrical generators, independent pipes for Oxygen as well as fresh air delivery, pressurized air delivery systems (especially for contagion control) that are all driven by layered and monitored regulatory systems. Its no wonder that hospital leadership drives its adaptability culture through adding new layers of responsibility and oversight. Span of control issues abound incessantly. Parkinson’s Law prevails.

    The Power Law Distribution concept defines our fundamental social dilemma for healthcare: 10% of the population uses 70% of health spending, 35% of the population uses 25% of health spending, and 50% of the population uses 5% of health spending. It is unlikely that the current Paradigm for the healthcare of the 70% spending group can be changed with our current strategy for healthcare reform. Unless we have a national mandate to ameliorate the transition process of many citizens between the 5% spending group and the 25% spending group, there is no reason to anticipate a real change in the 70% spending group (other than rationing by a centralized, authoritarian and coercive financial process).

    • The thing about the 10% of the population that accounts for 70% of healthcare costs in any given year is that many of them are not the same patients from one year to the next. For example, it’s now been 18 years since I had my CABG. Since then, I’ve had three pretty expensive years, including the year of the CABG, and 15 inexpensive years where medical management was all I needed along with a stress echo every couple of years and a basic physical. All of my drugs are generics and about $1,100 per year altogether.

      However, I do think price transparency would be helpful especially for hospital based care that can be scheduled in advance. Alternatively, reference pricing for the services, tests and procedures that lend themselves to the concept would also be useful.

      • The best example of that occurred in California for the pricing of knee joint replacements. I don’t recall the local details, but the ultimate pricing at certain hospitals decreased by nearly 50%. Managing market share, net revenue can be offset by price transparency for certain isolated situations, but not for persons with an unusually high load of chronic disease.

        Given the usual combination of medications for coronary disease, your health should last a very long time abetted by a trustworthy medical team. The resurgent use of carefully chosen CABG interventions is another example of the inherent adaptability of our nation’s healthcare, isolated may it be.

  2. I was on the Advance Planning Committee of the Board of Trustees of a hospiral in the Bay Area some years back. I recall at one time we had more new programs than members of the active medical staff: Hospital Chaplaincy program; plasmapheresis program; bone marrow transplant program; establishing an outpatient commercial lab; purchasing nursing homes; computerizing blood banking; it even wanted to start a health plan….it was @150 new programs on the agenda!

    UC Berkeley had set up a graduate school in hospital administration. Its graduates were all over the Bay Area in mid-management and these people were smart and aggressive and wanted to make their marks. They wanted large comprehesive hospital facilities and health systems that they could write research papers about and boast about to their peers. .

    E.g. they would plan for weeks to develop strategy to approach the local CON (certificate of need) bureaucracy. Meetings with physicians were very carefully orchestrated, nothing being left to chance.

    My point is to see hospitals as human creations no different from any new endeavor or architectural structure or work of art. As such there is a surfeit of pride and ambition and ego. They want to grow big too–just as does an insurer or a plan or a pharmaceutical firm.

    My point is that all these vectors are working against the forces now trying to constrain costs; and they are very forceful and very fundamental dynamics in human psychology.

    • Bigger isn’t always better. It’s management’s responsibility to know what their organization is good at and stay within what Warren Buffett calls its circle of competence. The for profit health insurance companies, for example, want to earn enough to at least cover their cost of capital. They don’t want to get bigger just for the sake of getting bigger. While United Healthcare recently expanded into urgent care centers and ambulatory surgical centers, you won’t see them buying hospitals in the U.S.

      As it happens, for hospitals, there are surprisingly few economies of scale outside of purchasing supplies, spreading advertising costs and, perhaps, raising capital. They have to pay the same market prices for labor as their smaller competitors. The main incentive for them to get bigger is to enhance market power enough to raise prices and drive profitability that way. If anything, there are probably diseconomies of scale from the more complex management infrastructure required to run a large organization.

    • William Palmer’s point is a key one. And in my experience the non profit insurers go along with the “programitis” of the hospitals with the rationalization that it is good for the community….but we need to keep in mind the Blues are a cost plus business….More cost more revenue and higher compensation packages for hospital and insurer executives….with the wonderful self-congratulatory feeling of altruism and community responsibility.

  3. Hospitals face two key challenges in my opinion. First, they are inherently high cost businesses because they’re labor intensive and they must operate 24 hours per day seven days per week. United Healthcare says that its ambulatory surgical centers can safely do many surgical procedures for half the cost or less of what a hospital would charge for the same operation. Whether or not payers actually pay the ASC’s half of what they pay the hospitals, I don’t know.

    The second issue is that there are fewer and fewer procedures that need to be performed in a hospital. This is a huge challenge to the long term sustainability of the hospital business model. The number of licensed hospital inpatient beds is steadily declining and it appears that trend will continue for the foreseeable future even as the U.S. population ages.

    So, it appears to me that hospital systems need to scale down their number of inpatient beds and put more capital into stand-alone imaging centers and ambulatory surgical centers and charge payers rates that fully reflect the much lower cost of operating those facilities. Perhaps they can get paid even more than they do now for organ transplants and other procedures that can only be done in a hospital. It’s understandable that payers have an economic interest in driving as much care as possible out of hospitals.

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