Health Care is Not Like a Supermarket. It’s More Like a Bazaar

May 29, 2013 in Health Care "Reform", Health Policy, Medicine by RangelMD

This last week the Centers for Medicare and Medicaid released its compiled data on what over 3,000 hospitals across the country charge for 100 of the most common discharge diagnostic codes under the Diagnosis Related Group (DRG) system . . and boy did the DRG really hit the fan.  Liberals, economists, and band wagoners got all upset about the enormous pricing differentials between hospitals for the same services.

For example, Twin Cities Community Hospital in Templeton California charged an average of $123,500 for a diagnosis of pulmonary edema with respiratory failure while Kaiser Foundation Hospital in Sacramento California charged just $25,000 for the same diagnosis. “That’s OUTRAGEOUS”, they shouted. Time Magazine’s Steven Brill spends an entire article using anecdotal evidence of wild hospital over-charges before claiming that this is the reason “why medical bills are killing us.” The Huffington Post referred to hospitals as “loan sharks“. And The Motley Fool’s Morgan Housel described what it would be like to try and buy a banana if the supermarket used the same “insane” economic system as the health care industry.

Imagine a banana in a supermarket. It costs $1 for those paying with Visa, $3 for those paying with MasterCard, and $32 for those paying with cash. You can’t sign up for Visa until you’re 65, and you can only get a MasterCard if you have a nice employer or a decent income. Worse, customers have no idea that such price discrepancy exists. They don’t even know how much they’ll pay for the banana until long after they’ve eaten it . . . That would be absurd. No one would put up with it

And it would be absurd if it were true.  But, no one bothers to point out that the vast majority of patients never get billed for nor have to pay these exorbitant prices. Our insurance driven health care finance system operates more like a foreign bazaar than an American style supermarket. In the bazaar as in American hospitals, the prices for goods and services are always set much higher than anyone is willing to pay. The merchant (hospital) then negotiates (haggles) with each customer (insurance) over what they are willing to pay – in other words – to reimburse the merchant. The reimbursement is what is being negotiated and not the set price which simply serves as a starting point to the negotiation. Housel’s banana analogy implies that there are different prices for the same product based on the method of payment but this just isn’t true.

In the example above, hospital prices for the treatment of pulmonary edema ranged from about $23,000 to well over $130,000 but the amounts actually paid by Medicare were in the range of about $8,000 to about $14,000. I was unable to find a single hospital price that was lower than or equal to the goverment reimbursement amounts. This makes sense. One can’t run a successful business by starting off negotiations with a losing position. Hospital finance departments try and set their prices based on their best guesses as to what the highest paying private insurance reimbursements will be. They factor in such things as local competition from other hospitals, the size of the local insurance coverage, and the strengths of their own services which may have nothing to do with the delivery of health care. For example, one hospital could offer all private regular rooms while other hospitals have a limited number of private rooms. Patients like private rooms and so this is a negotiating strength for the hospital that has nothing to do with the cost of treatment for pulmonary edema.

The chargemasters in these finance departments obviously try and err on the side of over-pricing their services rather then risk losing out on any reimbursement. Given the complexity and uncertainty of health care reimbursement it should not be surprising that some hospitals have wildly overly optimistic pricing that has nothing to do with the actual cost of their services. It’s hardly a unique situation in capitalism. Or do you really believe that the prices for food and drink at the local metroplex are based on anything resembling reality. Except that the movie theaters actually expect you to pay the listed prices for their terrible food.

Which brings us to the center point of most of the liberal angst over this alleged hospital pricing scandal. Anecdotal evidence aside, there is no statistical evidence that any significant numbers of uninsured patients get stuck with a full priced bill for a few days of admission and treatment for pulmonary edema. Part of the reason is that up to 75% of uncompensated care – that is bad debt and charity care for the uninsured – is eventually reimbursed through various goverment programs. For example, many of the uninsured who are hospitalized for serious and disabling illness or injury can qualify for emergency Medicaid coverage that is retroactive to the date of onset and paid for at the always low Medicaid rates.

Many critics make the nonsensical implied assumption that hospitals are getting rich by charging the poor the maximum price. How does this work exactly? Are people who couldn’t even afford low cost catastrophic health insurance in the first place somehow able to get bank loans for what amounts to an unsecured mortgage? Does the hospital work out a payment plan of $50 a month for the next 166 years on a $100,000 hospital bill? It makes no financial sense for a hospital to charge an uninsured patient several times over the usual Medicare rate for a single diagnosis. The hospital’s main goal in these cases is to minimize its bad debt and recoup the operating costs for care of the uninsured that is mandated by Federal law. As mentioned, these funds usually come from the goverment and for those patient’s who don’t qualify for a goverment program most hospitals offer a discount plan for self-pay patients that is more on par with Medicare and Medicaid rates. These plans are even required by some states like California.

And just how much money are hospitals making off these outrageous prices? Medicare and Medicaid pay just under the operating costs of most hospitals. Collectively US hospitals lost almost $28 Billion in 2010 from goverment underpayment. In 2011, US hospitals lost over $41 Billion in uncompensated care (both bad debt and charity care). The vast majority of profit that hospitals make comes from private insurance reimbursements but even then the profit margin for most hospitals is relatively small. In 2004, the hospital industry hit a 6 year profit high of 5.2% though the usual profit margin is 2 to 4% and even this was not enough to prevent half of hospitals from losing money in the great recession of 2008. In contrast, British Petroleum reported a 15% profit margin for this month alone.  And how much free fuel did the oil industry give away to charity . . not counting the 200 million gallons of crude that BP dumped into the Gulf of Mexico in 2010?

According to liberals, hospitals are soaking the poor and the goverment to make profits that significantly contribute to the $2.8 Trillion that we spend on health care every year. But this doesn’t make sense. If anything, hospitals are soaking the rich by contracting to get reimbursement from private insurances at rates well above those paid by the goverment for the exact same services.

Health care is expensive because it’s a service that is heavily dependent on highly educated skilled labor and advanced technology and it’s in great demand in this country. To suggest that hospital accounting methods are to blame for any part of our almost 3 TRILLION dollar per year health care bill is political wishful thinking. It’s part of the liberal “evil corporation theory” on why health care is so expensive i.e. that hospitals can just dictate high prices to a captive audience. This is true of the out of control spending and taxation of the Federal goverment but not for the hospital industry which at least operates on some semblance of economic logic even it’s the bizarre logic of a bazaar.

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