Hospital charges have increased much faster than hospital costs over the past 40 years. More than half of the hospitals in the United States have charges that are more than three times their costs, and for 10% of hospitals, those charges are more than six times their costs. (based on Medicare Cost Report data) The numbers are even more dramatic with for-profit hospitals, with half of them setting their charges at more than 440% of their costs, and 10% of them setting charges at over 800% of costs. This was not the case back in the 1970s when charges were generally only 10 or 20% above costs. What has changed to cause this tremendous discrepancy between costs and charges?
The driving force behind the charge increases has been changes in the payment systems, many of which perversely provide incentives to increase charges. A little history… back in the 1970s Medicare, Medicaid and Blue Cross, which was the dominant private insurer at the time, all paid hospitals based on their share of the hospital’s costs. Because the cost allocation was in part based on relative charge levels there was a focus on charges but that was a relative focus rather than an absolute increasing focus. This provided little or no incentive to increase charges. As Medicare shifted to prospective payments for hospital services and other insurers increased their share of the private health insurance market the incentives changed dramatically and hospitals started to increase their charges in response to these changes.
One glaring example is the way Medicare paid for outliers (very expensive cases) partly on the basis of “costs”, but these “costs” were imputed from charges and hospitals were paid more for their outliers if they rapidly increased their charges. In addition, the copayments required from outpatient hospital services were 20% of the charges, so hospitals increased their charges to maximize these copayments. At the same time, many insurers contracted with hospitals to pay a percentage of charges and liked to advertise that they were receiving a large discount from charges. It was easier for hospitals to provide a large discount if the charges were increased. The combination of all these forces resulted in large increases in hospital charges.
While some of these perverse incentives in the Medicare payment system have been corrected, have hospitals responded by reducing their charges? Unfortunately, it does not seem like it. It is a well-known phenomenon in economics that prices are “sticky” on the down side, i.e., prices readily increase but seldom come down. As hospitals begin to focus on providing services in the community and engaging in population health these payment concerns and incentives will need to shift to provide value-driven care for all patients.
With rapid delivery and payment reforms once again occurring, I hope we will see a change and charges begin to come down. It is bad social policy to have charges set so high, since it places a burden on those who can least afford it – the uninsured or patients with high copayments. Some hospitals have responded that “charges do not matter, since very few patients pay them.” I would argue that they do matter a lot for the unfortunate patients who are burdened with paying them.
The hospital field explains that charges are high in order to offset underpayments, bad debts and charity care and for cross payer price negotiation purposes. However, in the 1970s they were surviving with more reasonable mark-ups. So again, I ask what has changed and how to we fix it? Also, with the implementation of the Affordable Care Act (ACA) bad debts and charity care dropped substantially as more people gained insurance, but we have not seen corresponding change in charges. What will happen now as the ACA undergoes likely changes that could impact the number of uninsured?
With so many hospitals being not-for-profit and all having a charitable mission to provide care, they shouldn’t be charging patients three, four or more times the cost of the services being provided. The hospital field must find a way to bring charges more inline with costs. The charging practices began as a response to the perverse incentives built into the Medicare, and other, payment systems but now that these have been corrected, hospital charge ratios should also corrected. The health care system is undergoing tremendous transformation so how can new incentives be realigned to drive high quality care, yet lower costs… and charges?