Kaiser Permanente’s Former Chairman Might Not Understand Why Healthcare Prices Are Different
A version of this Health Alert appeared at Forbes.
Consumer Reports has published an article demanding that we get “mad about the outrageous cost of health care.”
Hey, I’m all for that. The article goes through the usual list of subjects, e.g. $37.50 for a single Tylenol, having two or three MRI scans when one will do, etc. The article also asserts that “health care works nothing like other market transactions. As a consumer, you are a bystander to the real action…” I could not agree more. However, I was a taken aback by a statement from George Halvorson, the former Chairman of Kaiser Permanente:
“There is no such thing as a legitimate price for anything in health care,” says George Halvorson, former chairman of Kaiser Permanente, the giant health maintenance organization based in California. “Prices are made up depending on who the payer is.”
It is the last sentence that is so wrong that I thought it deserved a blog post, especially as it came from one of the most accomplished healthcare executives in the United States. Prices made up depending on “who the payer is” is not unique to health care. It is a characteristic of almost all markets.
In undergraduate economics classes, they teach the characteristics of a “perfectly competitive market.” One of those characteristics is that suppliers are price-takers. One apple vendor, more or less, will have no impact on the market, so one vendor entering or leaving the market will not change the price, especially as an apple is an undifferentiated commodity. This refers to the “law of one price.”
However, this perfectly competitive market also relies on assumptions, and (hopefully) before the economics class is over for the semester, the lecturer will have knocked them down and described how real markets function.
One characteristic of most real markets is price differentiation: Charging different prices to different buyers. One important type of differentiation is peak pricing and slack pricing. This is used by Uber, the substitute taxi service, to change prices quite quickly — something that traditional taxis, with regulated fares, cannot do. It is also used by airlines and hotels.
What else is like an airline seat or a hotel room? A hospital room or operating theater! A patient who shows up at a period of slack demand can pay less than a patient who shows up during a period of peak demand. However, like an airline or hotel, the hospital cannot openly disclose the minimum price at which it will supply a room or operating theater. If it did, everyone would want that price.
That price would cover the variable costs of using the room for the period required, but it would not cover the overhead required to keep the hospital open. Mandating disclosure would only result in anger and frustration. As it is, we all know that our neighbor might have paid $100 less for his flight or hotel room, but we accept it because it is the result of a voluntary market transaction.
That is why much of the debate over transparent prices in health care is misconceived. Forcing hospitals to disclose all their transaction prices would result in the same chaos that would ensue if the government forced airlines or hotels to disclose all their transaction prices.
So, the fact that different prices are paid by different payers is not what makes health care different — not in the slightest. What makes it different is that the payer is not the consumer, but the government or an insurer. That is what should make us “mad about the outrageous cost of health care.”
Let me add one additional point. While the prices for health care are important, where we must start is to provide both the patient and the provider the dollar amount that the patient is expected to pay for the service provided considering the health plan (or not) that they have and where they are with paying deductibles in those plans.
If we do that, everything will change. Providers will have less bad debt, A/R and DSO — good for their business. Patients will pay as they do anywhere else, when they purchase the good and will experience less paper work (anyone like their EOBs?) and will hopefully experience less medical bankruptcy knowing what is expected of them rather than a rude awakening.
The insurance companies need to wake up NOW, not in three years and provide this information at the point of service, just like consumers experience at the pharmacy counter.
But much of health care – Especially hospital services – is different since the consumer is not making a ‘voluntary’ purchase -whereas a hotel room or plane ticket does have more of a consumer discretion element.
Most health care wil not provide the consumer any pricing information upfront whether or not the pricing is differentiated – at least I am told the price of a hotel room at check in and around he price of an airline ticket before closing my purchase.
Except in a real emergency – which excludes much of the things that take people to EDs – patients have a lot of choice. As long as policy does not result in overly concentrated provider markets, any patient with a scheduled surgery should be able to exercise choice.
In my case, the plan I administer serves a population in mainly rural locations which all have overly concentrated provider markets – indeed in some cases it is a virtual monopoly situation.
Knowing Halvorson from Minnesota days, perhaps he was simply expressing an opinion that those who have more should pay more, though perhaps a bit tongue in cheek.
Aside from George’s questionable statement, however, whether we like it or not, society has suggested that medical care is a social utility, and therefore not a true market good. That doesn’t mean that a rational and economically competitive pricing structure can’t still be designed. Given that reality, I don’t believe that providers’ customers are the patients, or the health plans, but society in general, and that calls for a non-discriminatory price schedule by provider that is transparent and consistent. Such a schedule can certainly reflect “choice” elements where choice is possible (I.e., an MRI provider can charge half as much for procedures at 3 AM as opposed to 1 PM) but the price should not vary based on who the insured is, or what third-party financing arrangement they happen to have. For non-emergency procedure type services, the consumer is then free to consider their financial parameters (self-pay, cost sharing of their insurance arrangement, potential balance billing if their insurance doesn’t allow the price of a particular provider, etc.) when shopping for a provider based on convenience and quality, which will certainly be features of such a system. True emergency care, up to the point where a person can make a conscious and medically appropriate decision to move providers, should be based on a nationally (societal based) fee schedule that all providers and third-party financing arrangements must agree to accept as payment and to allow as covered charge, respectively.
Such a system would save massive amounts in administrative costs at the provider level, eliminate the illegitimate rents siphoned off by the BUCAHs and other networks simply for having “discounts,” and allow for innovative and creative options from new players in the administrative and insurance arenas, including plan design, customer service, supplemental benefits, etc., by thus dropping the current severe barriers to entry from vested interests.
The key in pricing is consistency
Sure prices can fluctuate based on supply and demand
But those prices need to vary consistently based on supply and demand
And this consistency must be based on a solid and realistic foundation based on costs to provide the health care services
We have to get a handle on prices for they impact premiums
With group premiums for a family at $16,000 a year not including co- pays and deductibles we are at the point in which the premiums themselves are very pricey
Without affordable premiums the cost of the medical care is irrelevant – at least for insurance purposes – for without insurance one is not even in the game
Don Levit
With the dynamic pricing models used by airlines and hotels, the customer can ascertain the price before he commits to purchase the seat or the hotel room. With hospitals, more often than not, patients cannot even get a binding estimate of their out-of-pocket costs for care that can be scheduled in advance. I think there is a new law going into effect in Massachusetts today that requires hospitals to provide binding estimates for such care. For care that must be delivered under emergency conditions, there needs to be special rules limiting how much can be charged especially if the patient is uninsured or the provider is out-of-network.
Different prices paid to hospitals by different payers are mainly a function of relative market power between the parties. Dynamic pricing models used by airlines and hotels are based on legitimate fluctuations in demand by time of day, week, month, etc. Also, different levels of service and amenities such as first class, business class and economy class for airlines and size of rooms, views, concierge floors, etc. for hotels justify differential pricing. For hospitals, nobody wants major surgery in the middle of the night unless it’s a dire emergency. OR capacity utilization is irrelevant in this context. Discounts for imaging in the middle of the night would likely find some takers though.
So we need to make it such that binding estimates are standard. On the other hand, I recognize that if the hospital and physicians are in-network, you can count on paying your entire deductible, so patients are not truly incentivized to find the best value for money.
I agree that pricing is a function of supply and demand. However, you left out the later lessons from undergrad Economics which is the elasticity of demand. When faced with things like death or excruciating pain the demand curve is a vertical line. The consumer will agree to pay whatever the provider wants for relief.
Also unique to the health industry is the fact that the provider has little to no recourse if the patient fails to meet the financial obligations that promised at the time of admission. You can’t repossess their pacemaker, or re-break the bone you just set.
To state that “there is no legitimate price for a health transaction” has some truth. As long as the transaction is in the context of absolute in-elasticity of demand with a significant amount of speculation as to whether the provider ever gets paid, price becomes best guess as to what the provider can get paid.
Thank you. However your logic would also lead to not allowing homeowners to decide how much to pay or what color to paint or how to furnish their house, because when it catches fire they cannot negotiate with the fire department.
kaiser is a unique case, as they are self insured. They are the perfect model according to senators on governing committees
Other insurers do negotiate hard with providers, but are purely profit based middlemen, so they do not pass on the savings.
Hospitals and insurers cannot disclose negotiated prices – a term of their contract agreement.
Providers list prices have no basis in reality because only the uninsured are charged that price, and that price is the public face of the provider to beg for more from govt agencies.
Uninsured individuals usually can negotiate 1/2 off the charges if pay cash. This indicates how much list prices are inflated vs what insurance companies pay.
It’s all a racket, especially after hospitals and hospital management companies went public to be only profit driven. The consumer doesn’t shop around, so get chewed up by the system.
This is why the shakeup caused by ObamaCare was so necessary. Each party had designated secure turf and conspired to maximize profits, especially from the largest customers – Fed and State insurers.
I think I understand what you mean by “self insured” but it is not the way it is usually used. We usually use it to mean a large employer. I think you mean payer-provider integration, or staff-model HMO.
Note to Larry (and others):
One of the barriers to full disclosure is the fear that a patient may decide not to proceed with a certain procedure if they know the real price in advance.
Just to use a tiny example in my own life:
My cardiologist recommended an echocardiogram for me last summer.
I know more about health care pricing than 99.99% of the public, but I did not ask him what the cost would be. I feared that if the answer was “$700”, I might decide not to go ahead.
That would have hurt a relationship that I value highly. And it might have been a stupid thing to do.
So I went ahead, and with my Medicare Advantage plan the cost to me was trivial.
But if I were uninsured or had a high deductible plan, this could have been a problem.
Anyways, I bring this up because both providers and patients may not want all costs disclosed.
Whereas I have no emotional relationship with Delta Airlines or Holiday Inn. I will eagerly slash my bill with them or change providers to save $10.
Hi John:
George Halvorson is right. For over 20 years I have been preaching that the fundamental problem in American health care is the absence of cost-based pricing.
Sorry, John, your attempt to model health care pricing on elastic airline seats won’t fly. Too much of a stretch.
Seriously, the Dartmouth crowd is now trying to peg prices to Medicare, bur even Medicare prices have nothing to do with costs.
Markets normally function by repaying the provider of the goods or services a reimbursement of the provider’s cost plus an agreed-upon mark-up. That first part of the equation–the cost–is missing in our health care economic model, so we cannot get to the second part of the equation, which is a social agreement on what constitutes a reasonable mark-up.
It brings to mind the ancient economic lesson: The Highwayman halted the carriage at gunpoint and ordered the unarmed inhabitants to turn over all their valuables, which they agreed to do. The Highwayman took them and left. This is a simple economic exchange–the passengers traded their goods, without walking out, putting up resistance or shopping for a better deal, for the Highwayman’s forebearance. Was it fair? As an economist, I am sure you can make the argument that the exchange was bargained for and settled upon by the parties, hence the market decided. Defending health care pricing is like defending the Highwayman. He takes because he can, not because of the rational actions of well organized markets.
En garde!
Charlie Bond
I agree entirely with Charlie Bond on this. Let’s take two hospitals across the street from each other. One decides to charge significantly for the room and less for “incidentals” while the other adopts the reverse philosophy. Each decides its pricing entirely on its view of meeting a revenue target and its view of the optimal way to meet or exceed the target. Neither develops its pricing with any reflection of cost. Hence, one charges $3000/day for a room and 5 cents for a band aid – the other charges $1500/day for a nearly identical room but $5 per band aid.
Since the consumer has no way of knowing how many days he/she will use a room nor how many band aids will be used while there – the consumer has no ability to comparison shop.
Thank you, but your definition of market is so off-base I have to advise you to read Steve Landsburg or someone like that. The supplier (hopefully) knows his costs and his risk-adjusted required return on capital (RAROC) so he will exit the market if he does not hit that bogie.
But the buyer is indifferent to those factors. No salesman says “I have to charge you $100 for this because it cost me $70 to make and I need a margin of $30 so that I can make a return on capital.” He says “It’s worth more than $100 because it sings, it dances, it whistles, and you are a lucky man today.”