Addressing Hospital Pricing Leverage through Regulation: State Rate Setting

Addressing Hospital Pricing Leverage through Regulation: State Rate Setting

NIHCR Policy Analysis No. 9 | May 2012 | By Anna Sommers, Chapin White, and Paul B. Ginsburg

Although the pace of U.S. health care spending growth had slowed in recent years, total health expenditures continued to outstrip growth in both the overall economy and workers' wages. Rising prices charged by medical providers -- hospital care in particular -- played a significant role in driving up premiums for the privately insured. Over the preceding decade, certain hospitals and health systems had accumulated substantial negotiating leverage with private insurers, becoming so-called 'must-have' providers that could demand payment increases well above their actual cost growth.

Historical Context of State Rate Setting

During the 1970s and 1980s, a number of states implemented rate-setting systems designed to constrain hospital prices. Most states eventually abandoned these regulatory frameworks, but Maryland and West Virginia continued to regulate hospital payment rates. Maryland's system, which applied to all payers including Medicare, had been in place for decades and was widely studied as a model for price regulation in health care.

Design Choices for Modern Rate Setting

State policymakers considering rate setting faced a series of consequential design decisions. Which payers would be covered -- only commercial insurers, or Medicare and Medicaid as well? Which services would fall under rate regulation -- inpatient stays only, or outpatient services too? How would payment rates be calculated, and what methodology would be used? Each of these choices carried tradeoffs between administrative complexity, political feasibility and the system's ability to actually constrain price growth.

Governance and Political Pressures

A critical factor in any rate-setting system was its governance structure. Hospitals, insurers, physician groups and patient advocates all had strong financial interests in how rates were set, making political pressure on regulators virtually inevitable. An effective rate-setting authority needed structural insulation from these pressures -- independent board members, transparent methodologies and clear statutory authority -- to maintain credibility and resist capture by the interests it was meant to regulate.

Accommodating Payment Reform

Any rate-setting system also had to consider how it would accommodate broader payment reforms aimed at improving efficiency and quality. Initiatives like episode-based bundled payments and pay-for-quality programs were gaining traction nationally. A rigid rate-setting structure that locked in fee-for-service payment levels could inadvertently discourage the adoption of these alternative payment models. Policymakers needed to design rate regulation that was flexible enough to support innovation while still providing a check on hospital pricing power.

The analysis concluded that while rate setting was not a simple policy solution, it represented one potentially effective tool for addressing the growing market power of hospital systems in negotiations with private insurers. The experiences of Maryland and West Virginia offered practical lessons for states willing to pursue this path.

Sources and Further Reading

This analysis was originally published as NIHCR Policy Analysis No. 9 through the National Institute for Health Care Reform, an affiliate of the Center for Studying Health System Change.