Nex-gen reform part 2: Ending variable pricing in health care

Why we must put a halt to the most wasteful practice in the nation’s dysfunctional payment system

Last week, I laid out the case for federalizing Medicaid as a first plank in a next-gen health care payment reform agenda. Today, I will explain why we must put an end to the most wasteful practice in the nation’s dysfunctional payment system: variable pricing.

Over the past several years, the health care press has repeatedly pointed out the wild discrepancies in health care prices – both between hospitals and within hospitals. Using data obtained through the recently enacted hospital pricing transparency rule, NPR’s Julie Appleby found a routine colonoscopy in Virginia cost some insurers over $10,000 even though the statewide average was $2,763. A single hospital in Hollywood, Florida, had more than a dozen prices for different insurers, ranging from a low or $550 to $6,400 for the same colonoscopy.

Most such stories (including the NPR piece) ignore the fact that most prices for the privately insured are significantly higher than Medicare and Medicaid rates. The most recent Rand report on hospital price variation found commercially insured patients pay on average 252% more than Medicare for in-patient and out-patient services.

Another way to look at this discrepancy is that Medicare and Medicaid pay somewhat less than the cost of delivering care, while private insurers pay significantly more. The differential in some cases can be as much as ten times higher than government rates.

Health care economists enjoy arguing about how much of this difference is due to cost shifting and how much is due to price gouging. I believe the lion’s share of it is due to cost shifting, given that hospital margins even at the most profitable chains rarely exceed 8% and hover around 4% on average in good years (this year, many large chains are showing losses due to the end of federal COVID support amid slumping demand). The Medicare Payment Advisory Commission’s annual report on hospital finances shows Medicare prices at non-profit hospitals, which house about 80% of the nation’s total beds, are about 10% below the actual cost of care.

An enormous amount of administrative overhead (read: waste) is required to maintain this variable pricing system. High-ranking hospital finance officials spend their days negotiating rates with a half dozen or more private insurance plans. These high-paid bureaucrats assure each of their insurer counterparts (equally high-paid) that they are getting a bargain compared to the artificially inflated rack rate, known in the industry as the chargemaster rate. Nobody but the uninsured and the occasional Saudi prince pays that.

Insurers gladly accept these rates since it’s not their money, it’s their employer-customers’ money. They have little incentive to fight back since insurer profits, which routinely come in around 5% of the total premium cost, grow larger as the overall tab mounts.

Who are those guys?

To administer this price cornucopia, hospitals’ finance departments must create and maintain separate billing software programs for every insurer, which almost always have multiple plans (PPOs, HMOs, high-deductible plans, Affordable Care Act individual plans, Medicare Advantage; Medicaid managed care; not to mention traditional Medicare and Medicaid). Every one of those plans has different rules, different networks, different co-pays, and different deductibles. Hospitals contract out the job of managing this torrent of data and the associated billing tasks to the dozens of “revenue cycle” firms, a $140 billion industry in the U.S., according to one industry consulting group.

Never heard of the term “revenue cycle”? Neither had I until I became editor of Modern Healthcare a decade ago. At the time, I considered myself an expert in health care. I had no idea how little I knew. I was immediately bombarded by press releases and office visits from rev-cycle firms’ public relations folks hoping to win their clients a positive mention in a trade journal whose audience is primarily made up of high-ranking hospital officials.

To give you a sense of the scale of this massive billing operation, the sub-sector’s revenue amounts to more than 3% of all health care spending in the U.S. That’s one-eighth of the overall cost of administration, which consumes one in four health care dollars in the U.S. and is anywhere from 25% to 100% more than comparable wealthy nations.

Administrative waste isn’t the only downside to this price smorgasbord. The system is inherently unfair, and not just to the employers and their employee families who pay the wildly overpriced commercial rates.

Dominant hospitals in many regions use variable pricing to engage in several market distorting tactics. They offer the largest discounts from the chargemaster rates to dominant insurers and large self-insured employers in exchange for becoming the exclusive or near-exclusive provider in their networks. Small employers and insurers are forced to pay higher rates, often much higher.

Variable pricing also incentivizes hospitals and doctors to locate their operations in communities with lots of commercially insured patients and fewer potential patients on Medicaid or uninsured. This exacerbates the maldistribution of health care facilities, with new hospitals and clinics popping up in well-to-do suburbs while inner cities and rural areas suffer a growing dearth of facilities and services.

A change is needed – but what?

Single-payer advocates have long recognized the inherent unfairness and inequity in variable pricing. But their solution, Medicare for All (M4A), which would achieve uniform pricing through a single government payer, has always run up against three insurmountable political hurdles.

First, providers (hospitals, clinics, and physician offices for the most part) depend on the high prices paid by private insurers to make up for lagging public payer prices (Medicare and Medicaid), which are below the actual cost of care. The idea of switching to universal pricing at Medicare rates is vehemently opposed by most provider organizations.

Second, insurers are vehemently opposed to M4A because it would put them out of business.

And third, most employers are opposed to ending their role in providing health insurance. They earn good will from their employees by offering benefit packages that include health insurance.  They also recognize that changing jobs almost always involves changing health plans, which makes it harder for employees to quit, the so-called job lock phenomenon. And, they have a large internal constituency, usually in the human relations department, that works on purchasing plans, explaining benefits, and cooking up wellness programs, which apparently is an acceptable cost given the employee good will and job lock benefits that come from providing coverage.

It's not possible to build a winning political coalition for M4A when providers, payers and employers are arrayed against you. Even Sen. Bernie Sanders’ state of Vermont bumped up against that political reality when it tried to pass a statewide single-payer program in 2014.

The single pricing alternative

Only one state has escaped much of the administrative waste and political downsides of variable pricing. Since the 1970s Maryland has maintained a single-pricing system for the state’s hospitals, where every hospital is required to charge the same price for the same service to every one of its patients, whether they are covered by private insurance, Medicare, Medicaid or are “self-pay,” i.e., uninsured.

All-payer pricing doesn’t mean every hospital charges the same price. It means every payer at any individual hospital pays the same price. Two competing hospitals in the same city can and do have different prices. Prestigious Johns Hopkins Hospital and MedStar’s Union Memorial Hospital, less than four miles apart in Baltimore, charge different prices for the same service.

The prices are set each year by a state regulatory commission that reviews cost and utilization data and approves increases, much the way state utility commissions set electricity and natural gas rates. It uses the same methodology for smaller markets with only one hospital.  

A handful of states tried hospital price regulation in the 1970s. All but Maryland repealed those programs in the 1980s in the belief deregulation and competition would solve the rising health care cost problem. The results of that experiment are well known. It did nothing to stop runaway cost growth, consolidation, and vertical integration (buying up physician practices and opening outpatient surgical centers).

Earlier this year, I was part of a four-person team that reviewed the Maryland experience in a two-part series on the Health Affairs website. You can read the wonk’s version of our analysis here and here).

Here’s the short version. In the first few decades of Maryland’s experiment, costs relative to other states fell. But early last decade, Maryland’s system almost failed because hospitals ramped up utilization to offset the slower growth in prices compared to other states. So it added a global budget component to its regulatory scheme.

Prices are now adjusted – even mid-year in some cases – to keep total revenue within a pre-specified annual budget that grows each year at a rate that is less than inflation plus economic growth. In other words, hospitals’ collective share of state economic activity will gradually shrink so long as its all-payer pricing/global budgeting regulations remain in place.     

Payment reform requires tax reform

Maryland’s all-payer pricing/global budgeting system has proven highly successful in constraining cost growth in the state. Over the past four decades, Maryland has gone from having hospital costs that were 26% above the national average to 2% below the national average.

In the eight years since Maryland began global budgeting, the program has saved the federal government well over $1 billion compared to Medicare spending in other states. According to the Centers for Medicare and Medicaid Services’ analysis, Maryland’s all-payer/global budgeting program saved taxpayers more money than all its other experiments (accountable care organizations; shared savings and bundled payments) that were created by the Affordable Care Act.

But replicating those results in other states will come at a cost. The federal government still pays more for Medicare and Medicaid services in Maryland than it does in other states. Why? Because employers and the privately insured pay less. That’s what happens when you equalize prices.

According to a CMS analysis prepared in 2019, Medicare payment rates per inpatient hospital admission in Maryland were 33 percent to 41 percent higher compared to a comparison group of hospitals in other states. At the same time commercially-insured patients paid prices that were 11 percent to 15 percent lower than what private insurers paid in other states.

Therefore, any move to all-payer pricing must be accompanied by tax reform. The government needs to recapture much of the revenue that employers currently pay for health insurance, which becomes taxable income when their prices are lowered across-the-board.

As any economist will attest, income from reduced premiums are rightfully employee wages (benefits are a form of wages). So, to the extent employers decide to share those gains with their workers (or, in some cases, will immediately lead to higher wages because unions run the health plans), it will lead to higher income tax revenues from individuals. To the extent employers hold onto those funds, it falls directly to their taxable bottom lines.

Using the federal corporate and personal income tax schedules to raise the money needed to move to all-payer pricing is more progressive than relying on employer benefit payments. A simple example will suffice to show how tax reform tied to health care payment reform will help reduce inequality.

Imagine an employer with 500 workers whose salaries (other than a handful of top executives) range from $40,000 a year to $200,000 a year. Every one of those employees is on the company health insurance plan. Let’s further assume each person in the plan costs $20,000 (slightly below the national average for employer-sponsored family plans). For the lowest paid workers at this firm, health benefits represent the equivalent of a 50% boost in wages. For the highest wage workers, it’s just a 10% boost.

That sounds progressive. But now let’s assume that a state moves to all-payer pricing that reduces employer insurance premiums by $5,000 per plan. (The other $15,000 remains a shared employer/employee cost and remains progressively distributed.) Let’s further assume the $5,000 gain is distributed as wages. If done in proportion to costs, the lower paid worker sees his or her salary rise to $45,000 a year, a 12.5% increase. The highest paid workers will see their wages go up to $205,000 a year, a 2.5% increase. Everybody wins, but the lowest paid workers, relatively speaking, win the most.

Since federal taxes are progressive, the higher-paid workers will also pay a larger share of their wage gains in income taxes than the lower-paid workers. If the firm distributes the windfall in proportion to salaries, then the income tax take by the federal government will go up commensurately since the lion’s share of the gains will go to high-wage workers.     

The same dynamic would play out on the corporate side. Companies that have older, sicker and therefore more costly to insure employees (think Ford, General Motors, Caterpillar) will get the biggest reduction in premiums. Firms with younger, healthier employees (think Google, Apple, professional service firms) will benefit less. Yet when it comes to recapturing reduced premium revenue through the income tax system, the highly profitable firms will pay more while the money-losing or thin-margin firms will pay less.

In other words, a properly designed tax reform tied to all-payer pricing amounts to a benign form of industrial policy – one that doesn’t rely on picking winners and losers. The redistribution of health care costs is performed in a completely agnostic manner because it relies entirely on the employment marketplace. If you’re a highly profitable Silicon Valley firm with a young, healthy workforce, you’ll pay more of the nation’s health care tab going forward. If you’re a less profitable legacy manufacturing firm in the industrialized Midwest that’s been carrying a disproportionate share of those costs, your burden will be reduced.

Payment reform as delivery system reform

Finally, the all-payer pricing system tied to global budgets has the potential to force major changes in the health care delivery system. All-payer pricing will give Medicaid patients greater access to providers. Global budgets will finally provide hospital systems with an incentive to reorient their internal budgets to providing the primary care, preventive care, home visits and social support that keeps people out of the hospital. If they succeed in reducing total hospitalizations, their ability to raise prices on those who need intensive acute care will generate the funds for the global budget, which can then be spent on providing the ancillary services that reduce overall utilization and lead to a healthier population.

Finally, allowing the global budget to grow slower than overall economic growth allows hospitals and other providers to adjust to providing value-based care over a long period of time. It benefits taxpayers and the economy by freeing up resources to invest in other vital public needs.

As I’ve researched and thought about all-payer pricing reform over the past year, I couldn’t help but wonder why the Maryland model hasn’t drawn more interest from the nation’s employer community. It would allow them to keep employer-based insurance. It makes premiums cheaper for all. Sure, it requires hard-to-enact corporate income tax reform, but there will be far more corporate winners from shifting to increased government funding for health care than there will be losers, all of whom will be highly profitable with relatively low health care costs.

The Senate Health Education Labor and Pensions (HELP) committee, which will be chaired by Sen. Patty Murray (D-WA), should hold hearings next year on allowing other states to experiment with all-payer pricing/global budgeting. I would love to hear a representative cross-section of the nation’s employer community address what they see as the benefits and costs of making the switch.