More on Hospital Costs and Pricing

There has been a great deal of focus on hospital costs, prices and profits.  Many hospitals claim that they lose money on Medicare because they are not paid enough.  Other hospitals appear to make a small profit on their Medicare business.  Hospitals have varying cost structures, which bears a relationship to whether or not they make a profit on Medicare’s fixed payments.  A new study in Health Affairs looks at the relationship between costs, prices and profits and comes up with a unique and plausible hypothesis.  (Health Affairs Article)

The authors first note that across all hospitals, on average profit margins on private payments have increased and margins on Medicare business have decreased over the last decade.  The researchers conclude that this is not due to cost-shifting (more accurately, price-shifting) from Medicare to private payers, but from hospitals using the increased payments they extract from private insurers to justify more spending, which makes their Medicare business look like it loses money.  Basically the chain of causation runs as follows:  strong market power allows hospitals to get high payments from private insurers; those higher payments lead to weaker cost controls which leads to a higher cost per unit of service; which makes fixed Medicare payments look unprofitable.

The researchers support their hypothesis by examining data from two hospital markets, Boston and Chicago.  Their conclusions are supported by other research demonstrating that many hospitals do have market power and they use that power to generate higher payments.  Since many, if not most, hospitals are not-for-profit, they use their higher margins for internal spending, since there are no shareholders to distribute the net income to.   This study and the other recent research on hospital pricing strongly suggest that new mechanisms to address and control hospitals’ internal spending processes and external pricing are needed if we are to reduce overall health spending.