PPO “Discounts” Off Billed Charges Mean Nothing


A fascinating study by Alan T. Sorensen in 2003 on PPO discount patterns is an instructive read. The State of Connecticut’s data of the state’s hospital industry provided Sorensen a rare opportunity to study payer-level differences in negotiated discounts for hospital services and gives the reader insight into certain myths the managed care industry (including carriers, TPAs, agents and brokers) have successfully foisted upon clueless consumers for the past 35 years.

What follows is a summary of Sorensen’s findings which exposes some basic fallacies we all have been educated to believe:

“Payer size appears to affect bargaining power, but the economic significance of the effect is small. Much larger than the effect of payer size is the influence of payer’s abilities to ‘move market share’ by channeling patients to hospitals with which favorable discounts have been negotiated.”  

Interpretation: Size matters little, steerage matters greatly. However, when you look at the provider panels of PPO networks, you see almost every hospital in town on the network – therefore little or no steerage – we don’t have PPOs anymore, we have APOs (All Providers Network).

“Pauly (1998) has noted (and the data herein confirm) that even very small managed care organizations (MCOs) often negotiate substantial discounts from hospitals.”

Interpretation: Size matters little     

“Results from an econometric model suggest patient channeling is relatively more important than payer size in determining discount magnitudes; in particular, the impact on discounts of a one standard deviation increase in a payer’s ability to channel patients is roughly eight times larger than the impact of an equivalent increase in payer size.”

Interpretation: Size is not as important as steerage   

“The second difficulty inherent in this study is that hospital’s listed rates may vary, so that reported discounts may reflect percentages of unequal bases. For instance, if two hospitas charge $200 and $180 (respectively) for the same procedure, and a payer negotiates a 10% discount at the first hospital but no discount at the other, the data will indicate that the payer has a more favorable discount agreement with the first hospital even though it pays the same price at either facility.”

Interpretation: Discounts off Billed Charges mean little when comparing PPO discounts      

“The point estimate suggest that increasing a payer’s hospital payments in a county by 10% would enable that payer to extract an additional one tenth of a percentage point in discount negotiations with hospitals. Although this effect is statistically distinguishable from zero, its apparent economic significance is very small.”  

Interpretation: Huh? Pay a hospital 10% more to get an overall discount increase of .0010? Sure, “its apparent economic significance is very small” to someone. But it is definitely not small to consumers who end up paying for all of this.


Alan T. Sorensen, Stanford Graduate School of Business, Stanford, California (asorensen@stanford.edu) 

Editor’s Note: This study is on our archives at RiskManagers.us. We are not sure if Mr. Sorensen is still at Stanford nor are we certain his email address is still active.