The release of average charges for common procedures in more than 3,000 U. S. hospitals last week by the Centers for Medicare and Medicaid Services (CMS) elicited divergent reactions – not surprisingly.  On one hand, it was front-page news for most of the major newspapers: “Hospital Billing Varies Wildly, Government Billing Data Shows,” was the headline in the New York Times.  The article went on to speculate that these new data would likely “intensify a long debate over the methods that hospitals use to determine their charges.”

On the other hand the data were “old hat” to most health policy analysts.  Several colleagues mentioned to me that “this is old news” and “it isn’t meaningful at all because we all know that charges don’t mean anything.”

“No one pays charges” is the common refrain.  “Charges are merely an accounting fiction.”

Charges Do Matter — They Matter A Great Deal

Counter to the belief of both hospital industry representatives and many of my colleagues, hospital charge levels and rapidly escalating charges matter a great deal. While individual states and the Affordable Care Act (ACA) have instituted limits on the amounts low-income uninsured patients pay hospitals, insured patients that receive care at hospitals that are “Non-Par” or “out-of-network” are still victims of hospital’s exorbitant charging practices. When patients receive emergency services at an out-of-network hospital, the patient and/or insurance company (depending on insurer cost sharing for out-of-network care) pay full charges.

High and increasing hospital charges, combined with increasing proportions of cases admitted through the hospital Emergency Department (ED), are major factors behind the ever-declining negotiating leverage of private health insurers. This situation, coupled with the increased pricing power of the ever-more-concentrated provider industry, will be a major contributor to the almost certain rapid escalation in total U.S. health care costs in coming years.

First however, I would argue that charges are important because increasing charges are a symptom of the forces that lead to ever-increasing payment levels.  As Steven Brill showed in his recent Time magazine article on the madness of hospital pricing and payments, one doesn’t have to go very far from the charge data to get to a conclusion that actual payments are extraordinarily high and wildly variable.

Chart 1 below shows the increase in hospital “markups” of charges over costs for both hospitals nationally and in Maryland, as reported annually by the American Hospital Association (data are from the AHA annual statistical guide 1980-2011).

Chart 1 – Hospital Markups over Cost 1980 – 2011 (American Hospital Association annual statistics) Murray-Chart-1

As the chart shows, across the country, hospitals have marked up charges ever higher, from 20 percent above costs in 1980 to 220 percent in 2011. Although the data on actual payment levels (as opposed to the “sticker price” charges) are “trade secrets” of health insurers, other data on hospital payment levels (also available from the AHA Hospital Statistics 2012) show that hospitals have been able to increase the price they actually receive from privately insured patients from 120 percent of cost to around 135 percent of costs over the past decade.

Chart 1 also shows the much lower charge levels (which more or less equal payment levels) in Maryland, where the unique all-payer hospital rate setting system determines what hospitals get paid.  While rate regulatory systems as extreme as Maryland’s may not be everyone’s “cup of watered down hospital tea,” one benefit of rate setting (whether it be Maryland or Medicare) is more rational price levels that actually reflect relative resource use and bear some relationship to underlying costs.

So, at the very least, the CMS charge data reinforce the conclusion that hospital prices and payment levels nationally are not rational in the sense that they are not the prices that a truly competitive market would produce. This lack of competition, these ever-escalating payment levels, and misallocations of resources clearly add to our nation’s overall health care bill.

But of course this too is “old news.”

Inelastic Demand For ED Services And High Charges: A Poison Pill For Private Insurers And For Efforts To Contain Health Care Costs

More importantly, the already astronomical and rapidly escalating hospital charge levels also have a less obvious impact on the rise in overall health care costs.  High and increasing charges fundamentally undermine the negotiating leverage of private payers relative to hospitals, both big and small.  This dynamic, which has been playing out in negotiations between private insurers and hospitals for years, goes something like this:

As can be seen in Chart 1, in 1998, a patient who paid full charges generated an average profit margin of 98 percent of cost.  By 2011, the average patient who paid full charges generated a profit margin equal to 220 percent of cost.

When hospitals negotiate with health plans they have one of two options: 1) they can take a lower negotiated rate (around 135 percent of cost, which is the average payment level nationally as shown by the AHA statistics) and receive higher volumes of patients by virtue of being “in-network”; or 2) they can decline to be in-network and receive an average profit of 220 percent of costs on smaller patient volumes admitted through their EDs.  The higher the profit on ED patients that pay out-of-network rates, the stronger the incentive for the hospital to drive hard bargains with insurers over negotiated prices.

Recent analyses of private-sector pricing trends show stronger-than-average growth in hospital prices for Emergency Department services.  The Health Care Cost Institute (HCCI), which monitors spending trends by private insurers, found that from 2009 to 2011, unit prices for ED services increased by 16.3 percent, compared to 9.9 percent and 8.1 percent increases in prices for inpatient and ancillary services, respectively.  The profit-making opportunity to raise prices for services with highly inelastic demand curves is clearly not lost on the hospital industry.

Moreover, the percentage of ED patients who are admitted to hospitals is increasing at a rapid rate. According a recent study in the New England Journal of Medicine, the number of hospital admissions from the ED increased by 50.4 percent, from 11.5 million to 17.3 million. The proportion of all inpatient stays involving admission from the ED increased from 33.5 to 43.8 percent.

The dynamic described above is illustrated in Table 1 below.  The example is intended to show that insurers without dominant market share are in extremely weak negotiating positions even with relatively small hospitals or hospitals with small to modest market shares.

Table 1 illustrates the negotiating options confronting a given hospital when deciding to be a Participating (in-network) or Non-Participating (out-of-network) provider with a particular insurer.  As noted, the hospital can negotiate a contract and be assured of more volume (both ED volume and additional elective referral volume), albeit at a lower rate (about 135 percent of cost on average nationally). Conversely the hospital can opt for no contract, remain out-of-network and charge all of the insurer’s patients admitted through its ED full charges.  The revenue it will receive in either scenario is about equal (column F Scenario1 vs. Column E Scenario 2). Yet as a hospital increases its so-called “meaningless” charges from 320 percent to 400 percent of cost (i.e., charges that are “marked up” 220 percent are equal to 320 percent of cost), the negotiating leverage shifts even more in its direction, as is shown in column G.

Murray Exhibit
However, even under Scenario 1, with markups at 320 percent or higher, the hospital has relatively little incentive to negotiate with a health plan that cannot promise substantial volumes.  The bottom line conclusion, then, is that high markups and heavy and growing use of the ED as a source of admission act to substantially reduce insurer market power, even for providers with relatively small market share.  Those who negotiate on behalf commercial insurers are well aware of how the ability of hospitals to raise charges completely undermines their own negotiating leverage.

Medicare Advantage Plans Have Protection from Predatory Hospital ED Pricing

What could be done about this increasingly common circumstance?  The answer may come from observations of MedPAC staff from their recent investigation of provider prices faced by Medicare Advantage (MA) plans.

MedPAC’s research (see the transcript from MedPAC’s November 2, 2012 public meeting, pages 196-257, available here) shows that while MA plans must negotiate rates (just as non-Medicare commercial plans do), the MA plans, which are either stand-alone commercial entities or divisions of larger commercial insurance companies, pay provider rates that closely mirror Medicare Fee-for-Service (FFS) levels. The MedPAC staff theorize this may be because, by statute, non-network hospitals are limited in the prices they can charge MA plans for ED and other out-of-network care.  If the plan does not have a negotiated rate, by law, hospitals can only charge it the Medicare FFS rate (see §1866(a)(1)(O) of the Social Security Act). Because out-of-network prices are capped, hospitals are not able to threaten the MA plan with paying full charges for ED services if the plan rejects that hospital’s overall price demands.  This dynamic appears to significantly strengthen the MA plans’ negotiating position with a given hospital.

It is clear from the situation with MA plans that extending a limitation on the pricing of ED and out-of-network services to private insurers could significantly help shift the balance of negotiating power back to health care purchasers.  This could be achieved by passing a law, similar to the statutory protections given MA plans, that would establish a “Maximum Pricing Obligation” for ED and out-of-network care limited to some multiple of Medicare, say 125-150 percent.  In one fell swoop, such a rule would substantially alter the negotiating dynamic between private plans and providers.  The evidence from MedPAC regarding the pricing advantages of MA plans confirms this. In addition to an enhanced negotiating position, plans would also be freed up to pursue more aggressive selective contracting strategies with providers.

Such a change would help, not hurt, competition in the market for hospital services.

Need for Out-of-Network Protection is Growing

Moreover, the importance of this protection for MA plans, according to MedPAC staff testimony, appears to be increasing.  It is a well-documented fact that provider consolidation — which research shows leads to higher prices — is already extreme and once again on the rise (See Provider Market Power in the U.S. Health Care Industry: Assessing its Impact and Looking Ahead, Catalyst for Payment Reform, 2012.)

The MedPAC staff thus surmise that the trends of increased provider consolidation, larger markups, and greater proportions of patients admitted through hospital EDs are indicative of future reductions in the negotiating leverage of commercial insurers.  Conversely, this means there is, therefore, a growing need for the establishment of a similar protective rule applicable to private health plans.

Moreover, these dynamics have spillover effects to public expenditures on health care as well.  As has also been demonstrated by MedPAC, hospitals that are able to raise prices and payment levels and generate increased revenues tend to simply spend these new funds on new technologies, physician practices and business augmentation strategies (i.e., they simply and needlessly increase their operating costs).  Conversely, hospitals that face significant “financial pressure” from dominant insurers and fixed public-payer payment levels have substantially lower costs and yet maintain positive Medicare margins (see Chapter 3 pages 58-61).

As hospital costs rise, Medicare margins erode, which in turn places additional pressure on Congress and the Medicare program to increases Medicare payments. (A case in point is the FY 2014 proposed Medicare rule for updates to hospital payment rates released in April 2013, which provided for payment rates substantially higher than originally projected.)

Thus, it is clear that a failure to extend to all private insurers the protection MA plans enjoy from predatory hospital charging for ED and out-of-network services will have profound effects on the upward march of health care charges, prices, and our overall expenditures on care.


As Barak Richman from the Duke School of Law has discussed, health care providers with market power enjoy substantially more pricing freedom than monopolists in other industries because of the presence of U.S. style health insurance, which largely insulates consumers from the full implications of monopoly pricing.  This dynamic results in much greater potential for revenue generation and much greater distribution of wealth than would result from monopoly power in markets where consumers face the prices and price increases directly. (See Concentration in Health Care Markets: Chronic Problems and Better Solutions.)

Thus, the prospects for cost control are greatly diminished as long as providers are allowed to exercise their monopoly power, particularly where they face a highly inelastic demand curve – namely for emergency department services.  The ability to hold a gun to the head of private insurers in this fashion is a by-product of provider consolidation, the enhanced pricing flexibility of health care monopolies, and the increasing proportions of admissions through hospital EDs.  It is time for individual states and/or the federal government to take bold action to counter these ominous developments. It is time for a national debate on extending anti-price gouging safeguards to private insurers.  It is time for the establishment of a Maximum Pricing Obligation protection for those who are forced to pay full charges for ED and out-of-network care.