At one level, hospital costs are simple. People, supplies, and buildings. There aren’t big Scrooge McDuck vaults sitting around filled with healthcare lucre. . .
Frequently underutilized resources. A hospital, especially a large hospital, needs to have certain services available whether they are being used or not. Trauma teams are an example, but there are lots of small hidden resources that are also there ‘just in case’. Worse, these resources tend to be scaled to peak usage, not average or median usage. That means that at any given time there are unused resources sitting around. But woe betide if they aren’t available one of the 2 times per month they are needed. Medflight helicopters spend a lot more time on the ground than in the air.
Read the whole post. The helicopters are an interesting example. My guess is that if you divide the annual cost of the helicopter service by the number of times it is used, it comes out to hundreds of thousands of dollars, and nobody gets charged that. The people who complain about being over-billed for aspirin or bandages don’t complain about the under-billing for helicopter services.
My point–and I think that the comment supports it–is that you just cannot interpret hospital bills as if they were based on variable cost. Costs are dominated by overhead, and how hospitals choose to recover that overhead is bound to seem arbitrary.
If hospitals, insurers, regulators AND consumers allowed more of the fixed costs to remain in service beyond their accounting (depreciation) life, the math may be more forgiving. And investments would be made under the more honest assessment that the cost of providing standby assets will be partially borne by our willingness to stretch the assets usable life.
if the unused/emergency resources were billed directly to the government would that help?
And then the government dictates not only how these little-used resources are managed, but anything else they choose to dictate. Otherwise, they won’t pay.
Good, bad, or otherwise, this is something that would need to be taken into account and it would not surprise me to find out that many hospitals do not consider it worth the risk.
We have tried that already, in the form of Medicare reimbursing hospitals based upon their costs of providing service (with calculations for the share of cost due to providing services to Medicare patients). Needless to say, when an entity is paid more for increasing their costs, that provides a strong incentive to increase cost. The result seen in the US was that healthcare costs (and prices) grew much faster than in other developed nations, until the US finally wised up in the 80’s and started moving away from cost reimbursement in Medicare.
Fielding’s comment is very good. But quality medical systems in every developed country have at least comparable overhead, so the question remains why does the US stand out in terms of average costs. One regulatory question is why, if they are money losers which require cross-subsidy via the bills on other patients, what makes hospitals have to take medicaid / medicare patients at all?
Are there other industries in which line-by-line billing has seemingly arbitrary (and massive, and opaque) overhead compensators? When one goes to the mechanic, the price for a random part isn’t randomly inflated by 1000% in order to pay for the rent and tools. What incentives let to it being better to charge $50 extra for an aspirin, but not charge 10 cents for the aspirin, and a $2,000 “overhead fee”?
>why does the US stand out in terms of average costs
I’d second regularjoeski: ” USA fixed costs are 30-40% greater than other countries due to JCAOH regulations and consumer desires”
Part of consumer desire is less rationing of care. There’s a case to be made for rationing, say, end of life treatment. A problem there being that determining ‘end of life’ is a Bayesian problem. You don’t know when the last 6 months of life is until after you die.
Due to having high fixed costs, the marginal revenue for a Medicare patient is higher than the marginal cost, so most Medicare patient has a positive contribution margin. And if you are going to be reimbursed by Medicare, you have to treat anyone who comes through the the ER door, so that is where the Medicaid patients come in. It is also why hospitals were enthusiastic about Medicaid expansion under Obamacare. Most of those people were going to receive treatment at the hospital anyway, but at least if they have Medicaid, the hospital will at least receive some payment for the services of treating that indigent population. Also, Medicaid expansion might prevent some people from coming into the hospital, which also could benefit the bospital if those patients had a negative contribution margin.
It would be great if Hospitals then set up their bills differently to reflect fixed vs marginal costs. Maybe you pay an hourly fee for being in the hospital. Say $50/hour. So each day spent in the hospital costs $1200, but then services are billed at something like a small mark-up over marginal costs.
This would be much less confusing, and I think people wouldn’t be confused or outraged when they get their bill. People understand the hospital needs to clean the room, and pay for the equiptment, but they can’t understand $100 charges for Asprin.
I’m not claiming to know the answer and this is a real wondering, not a rhetorical thing. But I assume the hospital doesn’t go to the nearest drug store and buy up all the bottles of aspirin to stock up their own supplies. I wonder how much it costs to get that aspirin to the patient who is being charged quite a lot more money than they would be charged at a drug store.
Historically hospitals billed that way. The first wave of “fixes” stopped that. Also, USA fixed costs are 30-40% greater than other countries due to JCAOH regulations and consumer desires. No wards, O2 to every bed, families do not provide bedding/food.etc. Look at the hospital scenes from 1930s movies vs today. Watch 1970s hospital shows vs today. The difference in fixed costs is huge. Add in a highly regulated area and billing is like defense contractors. Same issues.
Hospitals do bill for accommodations, services, drugs and supplies separately. When you are admitted to the hospital there is a per diem room charge, and then charges for the other things provided by the hospital,. Those charges in part reflect that in some cases the ratio of costs to charges matter for how much the hospital is reimbursed (remember that insurers usually don’t pay the list amount or charged amount, but instead a lower amount). Also, doctors with privileges at the hospital will bill patients separately from the hospital as well.
A friend broke his leg skiing at Chamonix. He was helicoptered to the hospital. They charged him $700 for the ride. The cost of underwriting the helicopter is obviously handled differently in France.
I also doubt that hospital managers have Scrooge McDuck swimming pools of gold coins. I do believe that economic principles of profit maximization apply and that they use the privileged position that the thousands of regulations give them to their benefit. Due to the extreme governmental rules, regulations, and licensing laws that characterize healthcare, hospital systems are shielded from market discipline. They take advantage of this protection. This should not be a surprise.
That’s a cazy low amount for a helicopter ride. I was charged that much for an ambulance ride a couple years back.
Is that you just cannot interpret hospital bills as if they were based on variable cost.
Isn’t that true with all markets? In terms of people complaining about airlines, we have to remember that they have a ridiculous average versus marginal curves that leads to bizarre array pricing and customer service strategies. And it is impossible to have a completely competitive market here and so a consolidated airline market is necessary. (And where would second year econ paper ideas that airlines use price discrimination over marginal cost for customers? I remember at least 5 papers written that was cheaper to fly from LA to Atlanta with a stop in St. Louis than it was to fly from LA to St. Louis.)
Or everybody favorite target: Banks. There is a lot of cost running branches and ATMs that is sitting there with costs, but consumers value this convenience a lot and willing to take ~.25% less interest on savings for this convenience to avoid fees. (Our local Big Bank branch is 50% less busy than my memory of bank branches in the 1980s when consumers went into branches a lot more.)
And in terms of fixed cost we should include human capital as well. A large hospital can get all the best doctors and control the local market for certain rare surgeries. (I had a son with a tumor in his spinal cord so I know there was five doctors in all of Southern California who could perform it in area of nearly 20M people.)
And if you think human capital as a fixed cost probably explains why many tech companies go directly from no market to near monopoly very quickly.
And isn’t the ultimate high fixed cost for human capital/labor Professional Sports Leagues that seem to be defined by Monopoly markets powers. And outside of the NCAA and MLB, the other leagues, NFL, NBA and NHL, have no anti-trust protections and yet own a strong monopoly. (And there have been alternative league failures in my lifetime in all three.)
Even MLB at this point does not need the anti-trust laws as the last alternative league was a complete failure 100 years ago and they have the minor leagues complete control for decades.
All businesses face issues with fixed and variable costs, go to a bakery and as for a message on the cake longer than a certain length and you might pay $1-2 more per letter which wildly exceeds the marginal cost of the labor and materials. You could describe this price as making up for the fixed price of keeping a cake decorator on staff, but you would be incorrect in a lot of situations as unmarked cakes frequently cost the same as “happy birthday” cakes of the same type.
I think price discrimination influences more situations that they want to believe, and that cost disease seems to be spreading in areas where price discrimination is difficult to achieve for social reasons. Can you imagine the backlash if a hospital opened spots at the MRI machine for bidding and wealthy people got to go at premier times and poorer people ended up getting MRIs in the middle of the night? People already complain about paying for cable in their hospital at outrageous prices and that is a terribly minor form of price discrimination.
Is that people have to pay for the cable even though they don’t want it?
Sorry to undermine your remark, but in fact helicopter ambulance services in the USA are insanely profitable and currently (2018) attract lots of profit-seeking investment (link). They are definitely overbilled, not “underbilled.”
But of course, that is not the main point. Hospital “costs” and the bizarre ways they are characterized are the main point. Patients see $50 aspirins (and $46,000 helicopter rides– browse that link!) on their bills and think those have something to do with costs. Economists recognize that those are not “costs” but prices, then feel obliged to discuss why such prices don’t track variable costs more reasonably.
The mess you see has “causal density.” Once, long ago (i.e., before 1965) hospitals had prices which patients and their insurers paid, or for charity patients, didn’t pay. There was a certain amount of competition which tended to make the overall pricing of hospital services fairly reasonable. However, even then “component” prices were at least as screwy as in any other field of business– some things were bundled, like a few soft drinks with each airline flight; prices salient to shoppers (the $500 chalazion removal) were often lowballed with revenue made up by boosting prices for auxiliary items (the $50 aspirin), not much different than the $400 TV with the $50 VCR cable (wholesale price $1.25). Still, at a high level prices tracked costs.
Then Congress created Medicare and decided it would pay “costs,” not prices (because “greedy” hospitals might raise prices on things sold non-competitively to the government) and furthermore that Medicare would lowball even “costs” to partly finance Medicare by an invisible tax on hospital bills for younger folk. Medicare injected a whole lot of tax money into hospitals and literally paid them to develop complex devious systems for hiding their true costs and divorcing their prices from whatever those were.
Of course, private insurers pushed back– they didn’t want to pay hospital “prices” which hid too much subsidy to patients who were being treated at “cost” (theoretically, you understand). So they negotiated special price sheets, leaving uninsured patients to pay nominal prices which bore little relationship to the effective prices (either “costs” or “negotiated” prices) which other patients were “paying” (i.e., mostly having paid by third parties).
Once the game got going in earnest, insurers realized they could use opaque pricing to cheat their own customers, for example through “copay” requirements– schemes like (the now less common) 80/20 insurance/copay scheme (patient pays 20% of the bill to discourage overuse) would cite nominal prices to patients. Patients would pay 20% of a nominal price which was higher than the negotiated price the insurance company paid, so patients would effectively pay more than 20% of the actual cash value of the bill.
Hospitals became quite profitable for a while, and (a long story I won’t tell right here) non-profit hospitals have been substantially driven out of business, except for those which belong to the government somehow. Hospital profitability is now diminished, though insurance companies are doing well, but that just incentivizes hospitals to become more crooked. Note: Medicare has since changed the way it pays several times– though always planting new crops of distortions.
I could keep going for quite a while here, explaining about DRG’s and rebates and PBM’s, but suffice it to say that there are a bunch of big players who want hospital prices (medical prices in general) to be opaque and bizarre to hide their own little scams. No one has come up with a way to fix things incrementally, because the situation is Mancur Olson to the max: every player (except the individual patient) is earning some undeserved rents and paying some unmerited costs and all the counterparties are in the same boat and all the relationships are very tangled.
At a high level the problems with hospital costs are (a) lack of competition, which is reinforced by legal cartelization; (b) government interference which substitutes political considerations for economic ones; (c) rent-seeking which drives (a) and (b) and a lot of side effects; and (honestly) (d) path-dependence, such that everyone working in healthcare is wary of reform proposals which might hurt them more than “the others.”
Aaaand that’s the pricing post I stopped myself from writing when I was doing the cost post. Good stuff and generally on-point.
A couple comments and amplifications.
(1) I’m not going to fall on my sword about air ambulances. Lord knows there are some sketchy ambulance companies. I used them as an example of a low-utilization resource. That said, I encourage folks to read the linked post critically. I noticed the following:
* The author makes the usual mistake of conflating charges and prices. Yes ambulances wildly overbill. Everything in healthcare is wildly overbilled. It’s stupid but it’s the current model. Get CMS to change the regs.
* Later in the article the author quotes profit margins in the 7-10% range with one company doing 16% over 3 years. That is decent profitability, even good. Not insane. Happens when you carve out the profitable bits of the healthcare industry. It’s the same dynamic that gives you cancer and heart hospitals and urology practices that own linear accelerators for radiation therapy. Or for that matter, physicians that treat commercial patients in their surgery center and send the Medicare and Medicaid patients to the hospital for surgery. Those are the profitable bits that fund the dogs.
* The author also applies all the ‘charges’ (cough) to covering the capital of the helicopter. With none for the pilots and EMTs and billers and etc. All of whom get paid even if there are no patients or the weather is bad. Not to mention fuel, supplies, medical equipment, etc etc.
* The origin of the post is an LA Times article. Gah.
I say all that not in defence of medivac companies. But as an illustration of how so much of the writing on health care is so bad.
(2) I think there are a couple second-order ‘whys’ that make digging out from the current morass hard:
>(a) lack of competition, which is reinforced by legal cartelization;
yes, and the local nature of most health care makes that hard to overcome. Especially for emergency care
>(b) government interference which substitutes political considerations for economic ones;
Yes, justified by the ethical/social considerations around health care. Good intentions and all that.
Also, the wide variation in outcome for similar treatment. Good process can have an unlucky bad outcome and bad outcomes must be regulated to prevent recurrence. Poor luck and poor treatment are hard to disentangle except statistically. Which doesn’t help in the court room on case #33892
I agree with Hiccup’s points. Mine is that there’s an underlying driver that makes them hard to change. It’s not just ‘innovate it away!’ (which he’s not saying)
(3) “every player (except the individual patient) is earning some undeserved rents and paying some unmerited costs and all the counterparties are in the same boat and all the relationships are very tangled”
Individual patients are getting and giving too.
The Silent generation got way more healthcare than they paid for mainly at the expense of the Boomers. The Boomers are getting way more at the expense of the Xers and so on. As an Xer I expect the system to break before I get my payout.
Anyone getting immunotherapy at $400k/pop or orphan drugs at $200k/year is getting out way more than they put in.
Chronic HIV therapy. Lung transplants for smokers. Medivac for equestrian falls. All arguably ‘unpaid rents’. Paid for by the 50% of people that generate 3% of the unmerited cost.
(4) Not sure where you’re at but we still have non-profit, independent hospitals in our area. That’s pretty geography-dependent.
“My point–and I think that the comment supports it–is that you just cannot interpret hospital bills as if they were based on variable cost. Costs are dominated by overhead, and how hospitals choose to recover that overhead is bound to seem arbitrary.”
This is true IMO.
The crazy system of charges makes it seem more arbitrary since prices are marked up by say 4x then payers negotiate prices down by 75%. So people see the charges and pick up on things like $20 for a Tylenol pill. When the actual ‘cost’ is $5 and most of that $5 is the pill getting touched by a pharmacist then a nurse before getting to the patient.
I’d add to your observation that a major component is the combination of odd market factors. As an example, airlines have huge fixed costs/overhead, but are able to (sometimes) stay in business by very active and overt price discrimination. In the hospital sector you have:
1) Very large fixed costs/overhead AND
2) Substantial regulatory/ethical constraints on pricing AND
3) Substantial regulatory/ethical constraints on operations AND
4) Strong industry stakeholder groups that essentially function like regulators AND
5) Opacity of outcomes in the short and long term which interferes with price finding AND
6) Significant, sometimes massive, variability in cost to serve a given patient AND
7) A fundamentally local natural scale since it’s a service industry
And probably some other stuff I’m not thinking of at the moment. Many industries have some of those elements. Not many have all of them. Healthcare might function a bit better with only one or three of the above, but stack them together and it’s death on innovation. At least on business model innovation. You start asking questions like ‘why do we have this stupid charging model where we mark things up 3x or 5x?’ and get answers like:
* ‘CMS requires detailed billing’ (#2)
* ‘we have to charge the same amount regardless of what we actually accept (#2)’
* ‘we can’t charge a single, non-risk-based price because some patients are out in 5 days, some in 8, and a couple are in the hospital for 180 days (#6)
Not to mention ‘we’ve always done it that way’.
I suspect it’s that combination of factors that drives a lot of the cognitive dissonance around healthcare. People look at one factor and say ‘well other industries deal with that’. But they often do it in ways that would violate one of the other constraints providers run into.
Which of those 7, if removed, would offer the most flexibility to hospitals and health care providers? It seems like some doctors/practitioners can reduce a bit of overhead and some of the regulatory constraints by refusing to accept insurance payments. I saw a doctor like this recently, and after paying the doctor their staff handed me some medical codes and I applied for reimbursement from my insurer. The insurer accepted it, but since the doctor was out of network, the costs just went towards one of the buckets of my annual deductible. Anyway, I wander if patients started applying for reimbursement ( with the assistance of AI software?) from insurers instead of doctors, what impact that would have?
That’s how dentists work.
It would reduce reimbursement admin costs at the provider and replace it with patient time and effort. Sort of like self serve gas vs. full serve.
The large impact would be to create a bit of incremental price sensitivity. It reinserts the patient into the price negotiation.
Fielding, what are your thoughts on Direct Primary Care? It seems like it improves the issue of involving consumers in the price negotiation process.
I see DPC practices popping up more and more, and it looks like there’s a decent amount of investor and other supply-side activity brewing to push it out.
I doubt it could expand to cover every area of the industry, but I’d be interested to know what its ceiling is as a business model.
Makes a lot of sense to me conceptually.
I’m not a fan of our current model of pre-paid health cost (vs. true catastrophic insurance) so it’s a step in that direction.
Also, many systems are acquiring primary care practices as a way to direct care to their specialty networks. This breaks that vertical integration and keeps the downstream activity more competitive.
Finally, one approach I’ve mulled over is breaking healthcare delivery into modules to get away from the 7+ weird industry factors problem. DPC essentially eliminates #1, 2, 4, and 6 and would probably mitigate #3. I wrote a long blog reply on askblog awhile ago where I sketched the broader concept. I’m pretty sure I broke primary care out from the healthcare monolith for the reasons above. Can’t find the post with the search feature. Arnold may be able to if it’s worth the trouble.
…speaking of primary care….
http://conversableeconomist.blogspot.com/2018/10/primary-care-expanding-role-of-nurse.html?m=0
This is actually one of the few arguments for funding medical care through taxes that I find convincing. We’ve chosen to use the government for most services we want to have available but hope to use rarely. I’m thinking mostly of fire departments, but to a lesser extent SWAT teams and the military (though we have gotten into the dangerous habit of using both routinely in circumstances that really don’t call for them).
Is anyone aware of a study on the differences in cost and effectiveness between localities that fund ambulance services through taxpayer dollars and those that use private companies? I’m sure there must be a few good natural experiments out there in areas where two adjacent and very similar suburbs went different routes.
I was delighted to see the J’Myle Koretz post just above this one. I have advocated the ‘fire-department’ model for hospitals and ambulances for years.
A fire department treats emergencies on your property, not unlike a hospital which (mainly) treats bodily emergencies. For an urban fire department to send out 4 trucks and 12 trained personnel to your fire is not cheap; the accounting costs might be at least $10,000.
But they do not need to bill your insurance company in order to get paid. They do not need to collect $10,000 from .if you are uninsured, or to negotiate with you for a lesser sum. Instead virtually all urban fire departments get lump sums of tax money every fiscal year, like the military. We pay them collectively to be there. In the words of Prof Robert Evans (a great Canadian health care scholar), we rely on taxes rather than user fees. Fire departments are effectively socialized, and we are better off for it.
It is probably impossible to socialize America’s hospitals in the same way today. Covering entire hospital budgets would require hundreds of billions a year in new taxes, plus there would be future billions tied up if all hospital workers became pensioned public employees. I would be satisfied for now if we funded ambulances and emergency rooms mainly with taxes.
Whenever one reads about a Frenchman or Australian paying $500 for hospital care .would cause a $10,000 bill in the USA, this is not because those countries have figured out how to run a hospital for $500 a patient. It is because they see a hospital as a community services, with small user fees that only exist to discourage frivolous usage. We Americans are generally too caught up in making the patient pay for what they get, as a cruel and often-ineffective strategy for cost control.