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:
- 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?
- 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?
- 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?
- 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 on price, 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.
Health care prices are arbitrary because nobody competes on price. If providers competed on price, there would be more transparency. Also, over time the market would innovate to boost quality and bring costs down. But this cannot happen overnight, or result from the efforts of just a few entrepreneurial individuals. Walmart has had 60 years or more to change the retail landscape. Imagine how medicine would look if it benefited from 60 years of competition in the absence of third-party payment and excessive regulations.
If there were only one single innovation allowed to the American medical system a good case could be made that it should be the requirement to post prices in an accessible spot (the internet comes to mind in a government-sponsored site) and establish most favored customer pricing. The first article of the General Agreement on Tariffs and Trade is the principle of most favored national treatment. If having all nations trade at the same prices is key to competitive trade why are we ignoring the obvious in health care?
Competition and transparency are the most important elements in a functioning economy. Yes, even in medical care. The growth of Medical Tourism is a response to the lack of transparency in the market place. Many of the medical tourism operators receive a kickback for referring you to a specific hospital which increases the cost, so it is important to look at multiple providers and compare their expertise, as well as the training and skills of the surgeon. If you go to http://www.medibid.com you can look at not only domestic facilities, but also overseas facilities in India, Costa Rica, Mexico, Korea, and yes, even Bumrungrad and other facilities in Thailand.
Maybe vet prices are lower because of price transparency?? I’ve never had a problem calling any vet to get a price on a procedure. You won’t have a prayer in getting an accurate price in advance if you’re price shopping in the U.S.
Excellent piece. Much better than the articles by Sherry Gleid and Uwe Reinhardt. But that, of course, is why I come to this blog.
Great! As usual. But did you address why Thailand costs only a little less than the “travel cost” in the US? Perhaps because they need, in most cases, only to undercut the “non-travel” costs? Hence they reap high profits?
@Bob,
We are getting lower costs than reported above in Thailand. Perhaps the number above includes a kickback?
An excellent piece John, but I am curious about your “casualty model”. This sounds the same as the basic HMO model, in which the third party (carrier) makes the determination of best value and punishes the insured for non compliance. Circumstances change in terms of “where the best deals are”. Can a third party react to these changes in good time?
Wouldn’t a better and more dynamic model be one in which the market determines where the best values are at all times? Some presume that the market is too inept in terms of medical savvy to make the best decisions. That may have been true in the past, but certainly not now with the plethora of quick and easy information services that are easily available.
This piece was really interesting and also re-ignited a long-standing frustration I have had with how hospitals price the services they sell. As a “hospital-based” Radiation Oncologist at St. Paul Medical Center in Dallas for about 25 years before I joined Texas Oncology back in 1992, I was convinced that most of the people in the price setting activity for the hospital were clueless about what was the actual cost of the elements that, when taken together, formed the package for which a price was quoted. And of course, the bill was cluttered with and endless number of charges for all sorts of stuff. The price was whatever they could get the carriers to buy off on, including, and most importantly, Medicare. Once a number was established, it was increased annually, by some measure or other.
I can understand the variability that can be accounted for within an institution by contractual allowances for customers whose care is being paid for by a payer of some sort, but the exclusivity that might rationally be expected on a quid pro quo negotiated arrangement seldom materialized. It appears to me that a patient (or a payer) has a much better likelihood of receiving a fair and rationally arrived at price in buying a car (new or used) than would be the case in any hospital one would care to look at.
Great post. Glad to know the market works for dogs.
When I need a hip replacement, I’m not going to call my vet!
I suspect the price of hip and knee replacements for pets is going to rise now that pet insurance is increasingly common. Something else that I’ve noticed is that rural vets charge less than suburban vets. The difference in price does not merely reflect the difference in costs. It mostly reflects the difference in what the vet believes the market will bear.
Price transparency is critical to educating the public about price variations and costs of care. However, until patients are empowered and able to negotiate on their behalf it’s just a nice to have. We should look at the value of “risk” and go back to catastrophic care with usual and customary care or packaged prices for other types of treatment that can be negotiated between providers and patients.
@Sarah,
Why are patients NOT empowered to negotiate for quality and prices?
I just figured the costs were hospitals trying to recoup what they lost treating people who can’t pay for their treatment. I read somewhere that the U.S. medical industry absorbs about $32 billion in unmet costs a year. I don’t know how accurate that is, but I assumed the way they priced things was a way to make up some of that loss. As far as luxery goes,I wouldn’t be willing to pay for that at all. If I want that I’ll pay for a trip to a spa. No, I prefer the whole out-patient thing, where you can go home the same day you’ve had major surgery. I have done that and it is much cheaper. Go to any plastic surgeon and you will get an itemized list of costs for your procedure and you get to choose what you want and don’t want based on what you’re willing to pay for. You can even finance if you qualify. Maybe that’s the model the rest of the medical industry should follow. Leave the third party out until its time to pay the bill.
Excellent post. The American Hospital Directory publishes the hospital markups, cost ratios and financial statements for almost every US based hospital. For an annual fee of approximately $400 you can access this information. A quick snapshot of the hospitals in the major cities in Texas (DFW, Austin, San Antonio and Houston) would show that the hospitals in these cities have an average markup of approximately 400% (before discounts) and a cumulative net profit of $10.5 billion over 5 years. Why would a hospital want to offer transparency when the current system works just fine (for them)?
Eral Grinols: The law you propose already exists in many states and is irrelevant. For example, New York State requires pharmacies to post a “Drug Retail Price” list, updated weekly, of the 150 most prescribed drugs.
There is a list of all such laws, pertaining to all providers, at http://www.ncsl.org/default.aspx?tabid=14512.
They are irrelevant because almost nobody pays the list price. I can go to Walgreen’s and immediately observee the price of a can of diet cola or tube of toothpaste. Why? Because I am spending my own money on it.
Let the patients control the money, and price transparency will follow.
In Guelph Canada(population about 100,000), the local veterinary college has an MRI scanner that you can pay to have your pet scanned at. The local hospital (at least as of a couple of years ago) has no scanner because the benevolent Ministry of Health has not allowed it to have one. Once the government is in charge of health care, don’t be surprised when your dog gets better health care than you do.
Guelph, Canada (population 100,000), where my brother lives, has an MRI scanner at the veterinary hospital that you can pay to have your pet scanned at. The local hospital does not have an MRI scanner because the “benevolent” Ministry of Health has not allowed it to have one. When the government assumes control of health care don’t be surprised when your dog gets better health care than you do.
The most maddening thing about American health care is that you can’t call a hospital and just ask “How much does X, Y, Z cost?” This post highlights the problems with this lack of transparency. If we want to fix healthcare, we need the entire American public to begin asking “How much?”
John –Let’s parse these prices: Hospital costs are 32% of the health premium dollar. The costs, not prices, of care include capital, labor, supplies, and overhead. Labor costs are 50-60% Nurses in California, just starting, may make as much as $140K a year, if you can get them. From 4-5 will be available on a surgical case.
But on top of costs should be a factor for under-payment by government health plans, which could multiply costs by a factor of 150%. Then, charity care can be tens of millions a year, while bad debts add another factor. I bet the vet’s surgery has none of these costs.
Two trends will help moderate prices: In the future, hospitals will begin to be paid by prices negotiated in advance, and more and more procedures will be done in an ambulatory care setting. Variations among providers are usually attributable to size, teaching program, labor market, capital debt, and amount of non-operating income from investments.
In this period of time, the fragility of hospitals will become more apparent, as Medicare and Medicaid payment arrangements will begin to erode, while aging and population growth will tend to add to costs.
Historically, hospital costs were quite low before Medicare came in and paid “costs.” This gave a seriously under-appreciated incentive to hospitals to add staff, equipment, expanded patient care spaces, and so on. Medicare is now nearly half a century old and still is badly governed (BY Congress!) and badly managed; yet providers are still being blamed for behaving exactly how they have been incented to behave. And by extension, so are the vendors and suppliers. The knee, for example, is made of titanium and crafted by hand to exactly fit your knee.
John–I have at say that this topic is not a matter to joke around about. If you want to do something, get on a bandwagon about stupid regulations and labor dysfunctions.
Patients can shop by phone anywhere, and ask their doctors to send them to a price competitive place and negotiate with the insurer to permit it. I believe that insurers will soon turn to “packaged price vouchers” for standard procedures. Then you’ll see prices drop to the amount of the voucher. Competitive forces do work when they are used.
Wanda Jones
New Century Healthcare Institute
@ Wanda
Excellent points.
John, poeple hospitals are run by tiers of vastly overpaid adminstrators whose salaries are kept secret by private insitutions. Please work on publicizing the hospital adminstrators’ salaries which run into the 7 figues and high 6 figures. They are running roughshod over American patients and hapless doctors who have zero power to challenge them under state and federal law and case law. Frequently contract disputes get turned into peer review disputes so hosptial adminstrators can exercise infinite power. When faced with decreased revenue, administrators usually cut bedside nursing care rather than their own salaries and benefits. Congress has given these ovepaid profiteers too much power and they are plundering America. Good luck to any physician who tries to predict what his or her patient’s hospital bill will be for any procedure or admission. And in Texas, hospitals have benefitted handsomely from tort reform in 2003. They improved their bottom line so they could buy doctors’ practices and build more buildings.
Physician owned hospitals built after 9/23/2010 which did not make the Medicare certificaiton cutoff will be well positioned, since they wont get addicted to government money.
Dear John Goodman,
Excellent post. But could you please explain, or send me a link, why the third payer party is inefficient.
I would like to use your article for a Dutch libertarian blog but i’m curious why a third payer is so inefficient.
From a free market perspective; why wouldn’t a third payer (like a employer or a health insurer) be cost effective? Wouldn’t the fees you pay to a insurer get lower when they compete with cost and quality making the third payer more efficient?
Yours sincerely,
Imre
Imre,
Third Party Payer systems are inefficient because they are based on price fixing by the CMS and the AMA. Prices are fixed on 7,800 medical procedures, and the AMA received $72 million per year to manage these codes. Prior to their endorsement of obamacare they received $66 million per year. These codes are the payment basis for every 3rd party payer in America. These rates underpay on some procedures, so providers feel that they need to gouge other customers to subsidize the loss leaders, or sometimes the perform unnecessary procedures “because they can”. Ultimately the answer is to visit a doctor who works for you, rather than a “provide” who works for the payers.
Things and incentives have become so mixed up due to government involvement that one can find pricing in the health care field that can seem to be absolutely ridiculous. One example can be seen in the sale of a newer model machine that checked CBC’s in physician offices. The retail price was somewhere around $23,000+ with loads of different agreements. The price actually paid ranged from $23,000 all the way down to $0. The latter entered the picture with RAP agreements, but that RAP agreement didn’t mean that the disposables were priced any higher than without the RAP agreement.
At the same time the veterinarian machine which was identical except for the label sold for less than $5,000.
Draw your own conclusions about how distorted things have become when third parties enter the picture.
And if this were not health care, it would be labeled as discrimination
Insurance companies should pay only for MAJOR expenses but for too many years, they’ve been paying for routine expenses (which is usually the vast majority of medical expenses) that every now and then, they balk at paying for very expensive treatments. A company like AFLAC serves as a great contrast!
btw pardon my use of slang but wouldn’t you call Brian a troll?
@Imre
The reason 3rd party payment is inefficient has to do with the perverse incentives it creates. If a consumer is only paying 10% of his or her medical bill, he/she only has 10% as much incentive to be a wise consumer. Likewise, doctors and hospitals know patients are insensitive to prices (and price increases) because patients are not the ones paying most of their medical bills. Therefore, under 3rd party payment providers have no incentive to compete on price – or even disclose price. Instead, they compete on providing amenities to attract patients (who don’t care about how much is being spent). These perverse incentives result in 3rd party payers creating bureaucratic formulas to contain costs. As a result, providers to attempt to maximize revenue against a reimbursement formula. In the process, doctors and hospitals lose the ability (or the incentive) to repackage, rebundle and reprice medical services in patient-pleasing ways.
All the above is a primary reason medical expenditure is growing at twice the rate of national income and medical prices are growing at three times the rate of inflation.
As a comparison, I looked at cosmetic surgeon fees. Cosmetic surgery is a good example of free market medicine because cosmetic surgery patients must pay out of pocket. Since patients pay out of pocket, doctors must compete on price and quality. I found cosmetic surgeon fees actually increased at a rate below inflation all the while medical services increased at two to three times the rate of inflation. This report is available here.
Well said Devon.
Thanks everyone for all your feedback!
Right Devon,
An additional reason why healthcare inflation outpaces cost of living is that in 1954, when health insurance became tax deductible, employers realized that a $1,000 increase in pay actually cost them about $1,250 once all of the payroll taxes are added, and that translates to $750 or so in take home pay, once the employee’s taxes are deducted. Meanwhile, $1,000 of benefits costs only $1,000, and the employee receives $1,000 of that.
Realizing that 100% dollars were more efficient that 60% dollars, employers started to shift increases in compensation towards the more cost effective expenditures, and that snowball have been growing for 57 years.
Imre, you didn’t ask me the question, but seeing as others have opined I might as well chip in as well. The question you posed was essentially why third party payers would not become more efficient by competing with each other for business.
As far as your question goes, your assumption is correct. That is to say “competing” third party payers would be more efficient (competitive) than a single monopolistic third party payer.
The problem is with the question. When third party payers evolve into something more than financial facilitators (which they certainly have done in the past few decades), they assume roles that are better (more efficiently) assumed by individual consumers. Hence, your question would only be appropriate if the presence of third party payers (as they have evolved) were a given.
Many of us who promote healthcare reform want to re-define the role of these third party payers to have them perform what they should be doing (financing or insuring benefit plans) instead of trying to fix prices and determine access.
Perhaps an analogy would be to imagine that a government set up an agency to “help” citizens purchase automobiles with the justification that very few people fully understand the engineering of the modern automobile and the type of automobile that would best fit that person’s particular needs. To pay for this “service” the agency would be paid via a tax on the cost of the car. Obviously this is not an efficient process, and neither is the similar process we have in healthcare delivery.
From the perspective of cutting health care costs, It sounds great to think of hospitals competing globally.
If and when that happens, however, the number of hospital employees will plunge. That is what has happened in factories all over America.
Hospital competition might be one more nail in the coffin for the shaky American labor market.
Michael Mandel and others have pointed out that over the last 20 years, health care has propped up American employment with its ‘non-tradable,’ non-offshorable, and over-credentialed good jobs.
The fact that hospitals are unproductive and inefficient has been a saving grace for millions of workers. As husbands lost their jobs in productive, efficient factories, their wives got unproductive jobs in hospitals, schools, and government. This has helped save the middle class, such as it is.
The trick in cutting health care costs is to be sure that the cure is not worse than the disease. We can shake our addiction to overpriced hospitals, but we have to be careful that the economy does not get die from the treatment.
I welcome comments from anyone who can solve this dilemma, or disprove it.
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