The Chaos of US Medical Costs

Medical prices vary substantially throughout the country, and causes are largely unknown.

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Number of Discharges
Avg. amount hospital billed Medicare
Avg. amount paid by Medicare

The Centers for Medicare and Medicaid Services released data on over 3000 U.S. Hospitals that received Medicare inpatient payments in 2012. The data consists of over 7 million datapoints for the 100 most frequently billed discharges, representing 60% of Medicare's total discharges.

The Health Care Financing Administration classifies the severity of a patient's illness to more fairly compensate hospitals for treating severly ill inpatients:

  • CC - Complications and Comorbidities: This is the lower tier in terms of the severity of the illness and should, but not always, require fewer resources to treat. (Comorbidities means there is at least one additional disorder co-occuring with a primary disease).
  • MCC - Major Complication and Comorbidities: Refers to patients that are expected to consume significantly more resources than the same case with just CC. Procedures are not classified as MCC unless there are at least 500 cases/year.

We've all read how medical costs consist of an alarming percentage of the US GDP -- 17.9% in 2013 to be painfully precise. From 2011 to 2012, prices went up four times the rate of inflation, with largely nebulous causes. However, the Obama Administration, hospitals, and the media have been slowly exposing data on the inner workings of health care industry.

The chart above compares Medicare reimbursements and hospital bills for common procedures.

The amount a hospital bills Medicare is not necessarily the cost a patient would pay. It simply represents the upper bound hospitals would like to receive for a payment, which is often the price they charge the uninsured. In practice, health insurance companies that promise to bring in several thousand patients have the clout to negotiate significant discounts per procedure. Even uninsured individuals capable of paying only 60% of a $40,000 asthma treatment bill are often admitted with the remaining 40% waived. Accepting what still would be a profitable patient is an viable alternative to bankrupting him and getting nothing in return.

So if hospitals are willing to cut their margins, why are sticker prices so high? The answer to this seemingly simple question is muddled by a lack of information and transparency.

Hospital administrations have attributed the exorbitant prices with equally exorbitant costs, and have made measures to cut the burn rate. Patients with less critical issues, such as asthma, are discouraged from being admitted in favor of cheaper outpatient care. The move from paper to digital has helped identify several inefficiencies. Also, some hospitals try to minimize unnecessary or redundant tests, expediting service and reducing costs. However, Dr. Hamilton Moses III, chairman of the consulting firm Alerion Advisors and an adjunct professor of neurology at Johns Hopkins University, is skeptical, claiming “it just isn't clear what has gone into the increase in hospital charges for the past decade.“

Many experts estimate Medicare payments cover 91% of a hospital's cost for a procedure, with two thirds of all hospitals actually being profitable. Hospitals argue they lose money and time servicing those with Medicare — mostly the elderly — and try to balance their bottom line with higher rates for the private and uninsured. Charging 10 or 20 percent their actual cost per service would make for an acceptable profit margin, but a 400% premium has little rational basis.

Occam's razor would suggest the idea in everyone's mind — hospitals charge an extravagant amount simply because they can get away with it. The price breakdown for an individual's bill is ridiculously difficult to get a hold of and is defined by a list of arbitrary prices set by each hospital, called a chargemaster. According to Robert Laszewski, a former health insurance company executive, “The charge masters are totally irrational...they became the baseline from which the hospitals started, but overtime, hospitals raised charges in anticipation of negotiating discounts with private health insurance companies while maintaining their revenue streams.“ Like a dealership selling a car, hospitals use the inflated sticker price to negotiate down from, rather than from their costs up.

Secondly, expenditures are whimsical — R&D, marketing, new facilities, staff, salary increases, community programs, testing centers, equipment upgrades, etc — are all built into the underlying cost. Although many of these initiatives might be noble and productive in both design and execution, they are built-into each procedure's price tag.

Lastly, hospitals have been consolidating like mad to improve operational efficiency while addressing a larger population, with 105 deals reported in 2012 alone. Despite the operational efficiencies that come with scale, average prices have gone up, indicating the savings either don't exist or are not transferred to the patients. Rather, armed with a wider selection of procedures and greater geographical coverage, larger hospitals have negotiating leverage when working with private insurers.

However, they may be some good news. Recent numbers indicate private health care spending from 2013 to 2014 increased only 2.9%, or nearly 0% after adjusting for inflation. Medicare has been flat too. Although the causes of this decline are still hypothetical, experts think that privately insured consumers are taking a role in choosing their own health care. From a hospitals angle, digitization is finally starting to identify inefficiencies, and an emphasis on screening high-risk patients early has reduced readmission rates.

Even if this data is accurate, it is important to realize that every glimmer of light is not the end of the tunnel. An unusually low rate increase should not be mistaken for the end of the medical cost spiral. The US economy contracted at a much sharper than anticipated amount in the first quarter of 2014, which reduced spending across the board. Some hospitals have been bleeding money in anticipation for new, untested fee-for-value pricing that would replace the current fee-for-service structure in about 3-5 years. It is still uncertain how financially this would turn out.