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Hospital Pricing Behavior and Market Characteristics

By August 8, 2011Commentary

It has become apparent that hospital unit price increases are the single largest driver of overall health spending growth.  Hospitals claim that their price increases in the private sector are necessary to make up for poor Medicare and Medicaid payments, which they claim to lose money on.  A MedPAC analysis suggested that hospitals that had high private insurer prices spent the money and had higher costs which make their Medicare margins look worse than they should be.  A new analysis published in Health Affairs casts further light on the topic.  (HA Article) The researchers looked at Medicare and private plan margins for hospitals on seven major procedures, categorizing the hospitals as either in a competitive or concentrated market.

There are two somewhat different perspectives in trying to explain hospital behavior and margins.  One is that hospitals have reasonable costs and when they don’t get enough money to cover those costs from public payers, they have to demand more from private ones, assuming they have the leverage to do so.  The other perspective is that hospitals spend whatever they can based on how much money they can make in total from private and public payers.  The researchers found that in general most hospitals in concentrated or competitive markets have a positive contribution margin from Medicare and private payments but the margin was multiples higher for private payments.  Although it cost hospitals more to service Medicare patients, their revenue is higher for private ones, leading to the larger margins.   On average, Medicare patient costs were 5.4% higher, but private payments were 68% higher and private contribution margins 831% greater.

In all cases the hospitals in concentrated markets had much higher contribution margins for private payments than did the hospitals in competitive markets–depending on the procedure the margins were 48% to 137% higher.  At the same time, in some cases the hospitals in concentrated markets had negative Medicare contribution margins while the hospitals in competitive markets had positive Medicare margins on all procedures.  The results support the notion that in competitive markets hospitals focus on keeping their costs under control and in concentrated ones hospitals spend more, knowing they can extract whatever they want from private health plans.  Other research has not suggested that there is better quality in these higher-charging hospitals.  The lesson for policy-makers is clear.  They need to immediately break up multi-hospital systems in local markets and not allow further horizontal mergers at all.  And much as we hate government regulation, we may need all-payer hospital reimbursement systems.  Maryland’s appears to have done a pretty good job.

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