For decades, hospitals have insisted that they charge the privately insured more to offset losses from Medicare patients. A health care regulator blows the whistle on that myth.
by Thom Walsh June 19, 2023
Medicare’s hospital insurance trust fund is officially projected to be exhausted within five years. To close the gap, President Joe Biden has proposed a tax on families earning more than $400,000, while also calling for large cuts in how much the government reimburses Medicare Advantage plans. Meanwhile, Republicans, from Paul Ryan to Ron DeSantis, have a long history of efforts to defund the program. But what if both sides are missing the point? America does face a big-time health care financing crisis. But Medicare is not the reason.
Yes, Medicare faces a shortfall, but it’s modest. The cost of the main hospital insurance trust fund, which currently comes to just 1.6 percent of GDP, is expected to rise by only half a percentage point by 2045 before flattening out and even falling thereafter with the passing of the Baby Boom generation. By contrast, the continuing cost of the tax cuts implemented under George W. Bush and Donald Trump is more than seven times as large as a percent of GDP. Or to take another measure, according to the “intermediate” range projections by the system’s actuaries, gradually increasing payroll taxes by less than one percentage point before 2045 would keep the trust fund solvent indefinitely.
But even if Medicare is basically fine, the outlook for private health care plans, which cover the majority of working-age Americans, is not. The biggest reason is that the prices these plans and their members pay to doctors and hospitals are out of control. According to researchers at RAND, the prices paid by private payers for hospital care are nearly two and a half times higher on average than the prices paid by Medicare for the same treatments in the same hospitals. And the gap keeps increasing. According to a 2020 study by the Congressional Budget Office (CBO), the cost per enrollee for hospital and physician services under traditional “fee-for-service” Medicare rose by just 0.2 percent more than the rate of general inflation from 2013 to 2018. By contrast, the per-person costs in private plans rose by nearly double the rate of general inflation.
Because of those high and rising prices, the cost of health care consumed by a typical middle-class family of four with a typical employer-sponsored preferred provider organization (PPO) plan reached $30,260 in 2022, according to the Millman Medical Index. This cost is borne almost entirely by the families themselves because, as any economist will tell you, even when the employers nominally cover the premiums, they do so by paying less in wages and other benefits. It’s a burden on middle-class families that is rising far faster than their ability to pay, increasing by nearly $9,000 for the typical family of four between 2010 and 2018 and by another $5,000 in just the past two years. Commercial health insurance doesn’t have a trust fund, but if we accounted for it the same way we do for Medicare, it would show a huge, unsustainable long-term deficit.
Why aren’t we talking about this? The biggest reason is the power of a myth, promoted by monopolistic hospitals, other health care providers, and private insurers, that continues to pervert the thinking of both Republicans and Democrats when it comes to health care finance. It’s time to unpack that myth and show how it obscures what’s really driving up health care prices.
According to groups like the American Hospital Association, hospitals and doctors charge so much more to treat patients covered by private insurance because they lose money treating Medicare and Medicaid patients and need to make up the difference. It’s a talking point that’s been around for decades, and lots of people involved in the practice of medicine, as well as policy makers and regulators, fervently believe that it’s true.
I was once one of them. In the early 1990s, I was a physical therapist in private practice. At the time, Medicare cut its reimbursement rates, and the program would pay me only about 80 percent of what I usually charged for treating commercially insured patients. This made me feel like I was losing money every time I treated someone on Medicare, and to make up for that “loss,” I felt that I was more than justified in raising my rates for patients with private insurance.
But while I told myself I was simply shifting costs to close a deficit, that was not what was really going on. As many studies now show, that story might provide a comforting rationalization to providers when they raise prices, but it has little basis in reality.
How do we know this?
For one thing, it turns out that there is no correlation between what hospitals get for treating Medicare and Medicaid patients and what they charge for treating everyone else.
Medicare, for example, has periodically increased reimbursement rates and expanded enrollment. But when this happens, hospitals and other providers don’t cut their rates for treating privately insured patients. Instead, most providers raise prices, while others do not.
Similarly, passage of the Affordable Care Act expanded Medicaid coverage in many states but not in others. Subsequently, some states expanded coverage and some did not. Yet private prices did not rise or fall in lockstep. Instead, they continued to rise at most, but not all, hospitals throughout all states.
Or again, when Medicare and Medicaid rates go down, providers don’t uniformly raise prices for everyone else, as they would if they were simply trying to make up for inadequate government funding. Medicare prices were cut in 1990 and 1993 as part of deficit reduction plans. But in many cases providers responded not by raising prices for commercial plans but by cutting them, in hopes of getting more privately insured patients.
In 2020, the CBO reviewed hospital prices before and after an increase in public-payer reimbursements. It found continued wide variation in what hospitals charge and concluded that there was “no evidence that the share of providers’ patients covered by Medicare or Medicaid played any part in price variation.”
If cost shifting is not the explanation for why providers keep raising the prices they charge for treating people with commercial health insurance, what is? The answer, it turns out, is increasing monopoly power. In places where hospitals still face competition from other hospitals, the prices they charge private payers are much closer to Medicare and Medicaid prices because otherwise they would lose business to their rivals. To make ends meet, such hospitals must carefully control their expenses, and when they do, according to a landmark study by Jeffrey Stensland of the congressionally chartered Medicare Payment Advisory Committee, they can make profits even while treating patients with Medicare and Medicaid.
But when hospitals lack competition and start prioritizing margins over mission, they increase the prices they charge for treating people with commercial insurance just because they can.
Here’s how that plays out behind the scenes in the normal course of business. Every hospital maintains what it calls a “chargemaster.” It’s a price list for every diagnostic test, treatment, procedure, bandage, and aspirin. But virtually no one pays these “retail” prices, except sometimes the uninsured. Medicare and Medicaid set their own prices for different procedures, and hospitals and doctors, by law, must accept these prices when they treat people covered by these programs. By contrast, the prices providers get for treating people with commercial coverage is a matter of backroom, usually secret, negotiation with different commercial insurance plans.
Every year in every health care market around the country, health care plans meet with local providers and propose a deal like this: “We will bring you lots of new paying patients by including you in our preferred provider network, but we ask in return that you give us and our members a discount off your chargemaster prices.” When this works, the plans are, in effect, acting as purchasing agents for their members and negotiating volume discounts on their behalf. But the whole process breaks down when one hospital dominates the local market and most of the doctors’ practices are under its corporate umbrella. In that case, the local provider monopoly can just dictate what prices it will accept.
And that’s what’s happening around the country. Approximately 80 percent of U.S. hospital markets are now highly concentrated. Studies by the Yale researcher Zack
Cooper and others show that as concentration rises, so does the money that hospitals charge for treating patients with private insurance, and with no increase in quality. That’s the crisis facing American health care, not anything to do with the finances of Medicare or Medicaid.
So why does the myth of the cost shift persist? Because it serves the interests of some very powerful forces in health care. First, it provides monopolistic hospitals and other profit-maximizing providers with a way to shift blame onto the government for their price gouging. And second, it perversely provides a sleight of hand that serves as a very convenient way of disguising their profits so they can avoid paying taxes.
Here’s how that works. Most hospitals in America, even the richest ones, are chartered as charitable, nonprofit organizations. This status exempts them from paying most federal, state, and local taxes. The Kaiser Family Foundation calculates that the value of tax exemptions for nonprofit hospitals reached $28 billion in 2020. In exchange for these subsidies, hospitals are supposed to provide significant community benefits, such as caring for the indigent, training doctors, or investing in public health. Yet instead of meeting these obligations, many simply claim that their “community benefit” is the difference between the reimbursements they receive from government payers such as Medicaid and Medicare and the monopolistic prices they extract from everyone covered by commercial health insurance.
And remarkably, many state governments not only accept this lie but help enable it. For example, in Vermont, health care is regulated by the five-member Green Mountain Care Board, of which I am a member. By law, each year we must calculate how much more Vermont hospitals would have made if Medicaid and Medicare paid the same as private payers. In 2021, the figure came in at $516,828,045.
The most accurate way to characterize this number would be to say that it is a measure of how much Vermont hospitals used their monopoly power to overcharge private payers that year. After all, Medicare fully compensates hospitals for their actual expenses, taking into account, for example, whether they are rural or teaching hospitals or treat large, underinsured populations. So, in reality, the half a billion dollars reflects the fact that the prices Vermont hospitals charged private payers in 2021 were an average 214 percent higher than Medicare prices. But the hospitals spin a different tale. They characterize the number as an official estimate of how much they are underpaid for treating Medicare and Medicaid patients, and then use that as an excuse for not living up to their obligations to the public. Eric Schultheis, a staff attorney at the Vermont Office of the Health Care Advocate, looked at how each of Vermont’s fourteen hospitals calculates its community benefit. He reports that an average of roughly 70 percent of the purported benefit is a claimed insufficient payment from Medicare and Medicaid, with one hospital claiming 96 percent.
Moving to a single-payer, “Medicare for All” system could help to restrain prices. But that’s not politically possible for the foreseeable future and would not by itself address the problem of hospital monopolies and their growing political and economic power over government. So where does that leave us?
Obviously, if monopoly is a root cause of the problem, stepped up antitrust enforcement can be at least part of the solution. The Department of Justice recently took a step in the right direction by rescinding prosecutorial guidelines that had previously allowed many more hospital mergers to go forward than they should have.
Congress also needs to pass legislation that gives the Federal Trade Commission authority to take antitrust actions against nonprofit hospitals. Additionally, state attorneys general and other regulators need to crack down on anticompetitive behavior by monopolistic hospitals. Such behavior includes imposing “gag” and “anti-steering” requirements on health care plans so they cannot share a hospital’s prices with their members or direct them to lower-cost providers.
Regulation is also needed to stop the common practice of hospitals forcing their salaried doctors and other health care professionals to sign noncompete clauses, which suppresses competition. At the same time, regulators need to make sure that they do not stifle new entrants into health care markets through unnecessary licensing requirements and “certificate of need” processes that many states impose on anyone who wants to build a new hospital.
But antitrust enforcement cannot fix it all. For one, even in highly competitive health care markets, prices are not set rationally. As classically described by the Nobel Prize–winning economist Kenneth Arrow, purchasers of health care, unlike purchasers of, say, ice cream, have a hard time measuring the value of what they are buying and are also usually insulated from its real costs through insurance coverage. Similarly, insurance companies don’t necessarily care what hospitals and doctors charge as long as they can pass the cost on to their customers in the form of higher premiums, co-payments, and deductibles.
Finally, just breaking up big hospitals is not always the answer because in rural areas, there often are not enough patients to support more than one hospital. Moreover, when properly regulated, health care can be more clinically effective when it is delivered by large, integrated institutions. When all the different specialists involved in patient care work off a common medical record and coordinate their treatments, that can help to reduce medical errors and dangerously fragmented, inappropriate care. VA hospitals and clinics, for all their faults, consistently turn in superior performance on patient safety and adherence to evidence-based medicine because they operate as a system.
In places where hospitals still face competition from other hospitals, the prices they charge private payers are much closer to Medicare and Medicaid prices.
What reforms can reconcile these trade-offs? As this magazine has argued before, the best politically possible answer is to outlaw price discrimination in health care. Hospitals and other providers need to start charging the same prices for the same treatments regardless of who the patient is or what health care plan he or she is on. The price of a treatment should reflect the cost of treatment, not the relative market power of different providers and insurers as it largely does today. Competition in health care should be over who can deliver the highest-quality care most effectively and efficiently, not over who can become a monopoly first.
The CBO has calculated that just capping commercial prices at today’s already inflated levels and limiting future growth would result in a savings of 3 to 5 percent in the first 10 years. But we could do much more than that and still allow hospitals to earn the margins they need to finance their missions. Nationwide, hospitals in 2020 charged an average 250 percent more to treat commercially insured patients than Medicare patients, and in three states the surcharges ran at or above 310 percent of Medicare prices, according to a RAND study by Christopher Whaley. Put concretely, in these three states, an MRI scan that cost Medicare $1,000 would typically cost private payers more than $3,100. Yet in three other states, Hawaii, Arkansas, and Washington, hospitals did just fine with surcharges averaging “only” 175 percent above Medicare prices.
Of course, many providers might be tempted to make up for lower prices with higher volumes, such as by ordering more unnecessary tests or performing more unnecessary surgeries. That’s an all-too-common phenomenon in American health care, as documented by the Dartmouth Atlas project at Dartmouth Medical School, where I teach, and by many other researchers and health care reporters.
The solution to that problem is to require hospitals not only to charge everyone the same prices for the same treatments but also to cap their total revenues within a global budget. This is the approach the state of Maryland has recently taken, so far with very promising results.
Can a public process like Maryland’s find the “right” prices? Medicare goes to excruciating lengths, using a process that involves providers themselves, to estimate the cost of care and then sets rates to cover cost plus a small margin. The results are far from perfect. Medicare overcompensates some kinds of specialists (cardiologists, radiologists) and under-compensates others (primary care physicians) relative to their actual contributions to public health. But overall, the prices Medicare pays reflect the cost of care and are adequate to sustain a well-run hospital. According to the National Association for State Health Policy, 39 percent of hospitals could break even today without any need to cut their budgets if payments from their private payers were reduced to what Medicare pays for the same treatments. Almost all would get by handsomely if we limited their monopoly rents to 175 percent of what Medicare pays—provided, of course, that they didn’t overcompensate their CEOs, bloat up their administrative staff, or go on vanity building programs.
Despite all the bipartisan fixation on the future of the Medicare trust fund, Medicare is not the problem. It pays providers adequately and would be fiscally sustainable with only modest tax increases. The big problem is with commercial health care plans, and it’s brought to you by too much unregulated, monopoly pricing power. If we are to make the American health system work for the vast majority of working-age people and their children who rely on private insurance, legislators and regulators need to take aggressive action now to end corporate concentration and price discrimination in health care and cap hospital prices using global budgets.