Perspectives on Hospital Pricing: Where Did This System Come From?

Ellis Weeker , MD, FACEP

Gary Li , MD

Regional Director

Published July 18, 2013

In a previous post, Dr. Gary Li and Dr. Ellis Weeker discussed the current controversy surrounding hospital pricing. Data published in May 2013 by the Centers for Medicare & Medicaid Services (CMS) shows that hospital chargemasters (master pricing lists) can be widely divergent, even among hospitals in the same cities, and often increase the cost of common procedures.

But how did our hospital pricing get so unhitched from reality? And what exactly do chargemaster prices for services and supplies reflect?

In the second installment of our four-part series, Drs. Li and Weeker discuss some driving forces behind hospital pricing.

Weeker: As to divergent and high hospital charges, I think the problem is largely historical. Healthcare pricing has developed not as a single system but several.

Li: For example, hospitals are dealing with different reimbursement structures from Medicare, numerous private insurers, and self-paying patients. Each of these plays a role in pricing.

Take Medicare. Unlike private insurers, it essentially pays the same amount to each hospital with modest regional adjustments to factor in cost of living and so on. So let’s say hypothetically that a knee replacement costs $100,000 at one hospital, but across town at another, they only charge $80,000. If CMS has determined that the actual cost of the procedure (plus reasonable overhead) is $40,000, that’s what’s paid to both hospitals.

Weeker: And federal law prohibits the hospital from trying to collect the balance from the patient. With Medicare, the hospital gets the contracted price and no more. Relatively modest payments from Medicare and Medicaid reimburse the majority of care provided by hospitals. So there’s an incentive to increase chargemaster prices for non-Medicare patients so more will be collected from insurance companies and self-payers to compensate for perceived low margins from Medicare.

Li: Right—quintessential cost-shifting. And when insurance companies are negotiating discounts for a particular service, they often start at the chargemaster level and go down from there.

Weeker: So there's yet another reason to increase charges.

Li: Yes. The benefit for insurers is that it’s good marketing for them. They can tell their customers, “Look, we’ve negotiated these hospital charges down to just 25 percent. So you’re getting a great deal with us."

Weeker: Of course, there are patients who don’t benefit from this system of discounts and negotiation. Ironically, it’s the uninsured — the group least able to pay — that are most likely to see the full chargemaster price on their bills.

Li: So this could create a situation where an uninsured patient is charged $10,000 — the chargemaster price — for a procedure, while an insurance company, due to its negotiating power, might be billed only $5,000 for the same item.

Weeker: As a practical matter, there are many individuals and entities with system dependencies built upon the existing pricing system. For understandable reasons, they don’t want to see a lot of changes. If you are a hospital and you have built your whole system around certain charges and a certain amount of revenue, you don't necessarily want to make lots of changes to the system.

Li: It's not something anybody planned or even intended. It just evolved over time. And now that hospital pricing has truly come into the public consciousness through the efforts of journalists and government agencies, it should be interesting to see how things play out.

In part three of our hospital pricing series, Dr. Weeker and Dr. Li envision hospital pricing ten years down the road.

In this series:
Physicians Discuss Price Transparency in Medicine (Part I)
Perspectives on Hospital Pricing: Where Did This System Come From? (Part II)
Envisioning Transparency 10 Years From Now (Part III)
The Impact of Increased Transparency on Emergency Care (Part IV)

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