Hospital pricing and the role of the government

The Detroit News

Gary Wolfram

In a major Time Magazine article, Steven Brill documents a series of medical bills that seem unrelated to the cost of providing the services and argues that hospitals, and in particular non-profit hospitals, are enormously profitable. While the profitability of hospitals is an arguable assertion, there is a reason that the pricing of hospital services and medical services in general is not transparent, and that is the large government intervention in the medical industry.

There may be hospitals that earn above normal profits, but according to the American Hospital Association one out of every four hospitals loses money on its operations, and the average operating margin is 5 percent. Hospitals as a whole provided $41 billion in care for which no payment was received in 2011. This $41 billion figure is the cost of providing care, and represents 5.4 percent of total net revenue.

Hospitals also provide a service simply by being there. If you never have to go to a hospital, you nonetheless expect them to be there in case you do have an emergency. Hospitals provide emergency care to 2.4 million Americans each year. In some sense, they are like fire or police stations. This means that hospitals must make enough revenue from the patients who do show up not just to service those patients, but also to have an operational hospital available for those who may never enter.

If hospitals were in fact earning profit above that of other industries, economic theory tells us that firms would enter the industry, increasing the supply of services, and reducing prices. So to the extent Mr. Brill is arguing that hospitals are unusually profitable, then the reason for this must be government-imposed barriers to entry. It is not a market-based problem, but a government regulation problem.

Why is pricing for hospital care so seemingly unrelated to the cost of services? Due to massive government participation in the health and health insurance industries, the list price is not what most people pay. According to the Centers for Medicare and Medicaid Services, total federal spending alone on health care service will be in excess of $867 billion in FY 2013. Medicare and Medicaid spending is about 47 percent of all national health care expenditures.

Medicare and Medicaid reimbursements are set by law and administratively. This means the Medicare rates, which are used in the Brill article as a guidepost as to the reasonable cost, are set through the political process and not the market process. Medicaid rates are also determined through the political process and under the Affordable Care Act, there will be an even greater degree of political determination of rates for health care services provided through hospitals.

In addition to Medicare and Medicaid rates being determined by the government, insurance companies bargain over rates as well. Thus, there are a myriad of rates that are actually paid while the charges by law must be uniform. While it is possible to find patients that pay the full “charge master” rate, these will be few and the total revenue to hospitals under the charge master rate is minor.

A major problem with hospital care (and medical care in general) is it is dominated by third party payments. The person receiving the care, except in extraordinary circumstances such as examined in the Brill piece, is not the person paying for the care. As a consequence, the demand for services is often unrelated to the price. The normal response to being told that one needs a heart rate monitor is not to shop around, but to ask if insurance covers it.

Gary Wolfram is an economics professor at Hillsdale College.