High and Varying Prices for Privately Insured Patients Underscore Hospital Market Power

High and Varying Prices for Privately Insured Patients Underscore Hospital Market Power

HSC Research Brief No. 27
September 2013
Chapin White, Amelia M. Bond, James D. Reschovsky

In 13 selected U.S. metropolitan areas, hospitals charge privately insured patients prices well above Medicare payment levels, and those prices fluctuate dramatically both across and within markets, according to a Center for Studying Health System Change (HSC) analysis based on claims data for approximately 590,000 active and retired nonelderly autoworkers and their dependents. Across these 13 communities, average hospital prices for private insurance enrollees run about one-and-a-half times Medicare rates for inpatient services and roughly double Medicare's outpatient payments. Within individual markets, prices diverge sharply, with the highest-priced hospital typically receiving 60 percent more for inpatient care than the lowest-priced facility. The within-market price gap is even wider for outpatient hospital services, where the most expensive facility typically receives close to double the amount paid to the least expensive hospital. Unlike hospital prices, primary care physician prices generally hover close to Medicare levels and vary only modestly within markets. Specialist physician prices, however, tend to exceed Medicare benchmarks by a wider margin and show greater fluctuation both across and within markets.

Among the 13 markets, five are located in Michigan, which has an unusually concentrated private insurance landscape dominated by a single insurer commanding a 70-percent market share. Despite this dominant insurer presence, nearly every Michigan hospital commands prices above Medicare, with some receiving double what Medicare pays. In the eight non-Michigan markets, private insurers generally pay even higher hospital prices, with larger gaps between high- and low-priced facilities. The price variation for hospital and specialist physician services within communities highlights that some hospitals and physicians wield significant market power to extract elevated prices, even in markets where a single insurer dominates.

Peering Under the Veil

The prices that private health plans pay to medical providers are opaque not only to patients but also to the employers who purchase coverage. While the inherent complexity of medical care contributes to this lack of transparency, deliberate secrecy also plays a role. When private insurers negotiate payment rates with providers, both sides typically agree to keep the key terms confidential. Employers -- and their covered workers and dependents -- bear these costs but have no access to the contract details negotiated on their behalf.

From aggregate data, it is evident that elevated prices are central to the U.S. health spending problem, and it is equally apparent that private insurers generally pay more than Medicare or Medicaid. Yet, little is understood about why private prices are higher for some services than others, or why and how prices differ from provider to provider both across and within markets.

From qualitative research, it is clear that provider market power plays a decisive role in price negotiations and that certain hospitals and physician groups, known as "must-haves," can command prices substantially above those of nearby competitors. Earlier HSC research also produced quantitative evidence of wide price variation for hospital and physician services both within and across markets.

Additionally, the Centers for Medicare & Medicaid Services (CMS) released hospital-level and diagnosis-related group (DRG) data on charges for inpatient and outpatient services. While these charge data reveal wide variation in hospital billing practices, hospital charges do not reflect the negotiated amounts that private insurers actually pay.

Prices for Five Types of Services

This Research Brief addresses some of the limitations of prior studies and explores price variation in 13 markets in far greater detail than previously possible, using 2011 claims data for 590,225 nonelderly active and retired autoworkers and dependents represented by the International Union, UAW, and employed by Chrysler, Ford, and General Motors.

In this analysis, hospital and physician prices represent the "allowed amount" -- the actual total payment to the provider, encompassing insurer payments and patient cost-sharing. Prices are examined for five service categories, which collectively account for 71 percent of total spending in the autoworker plans: hospital inpatient (e.g., an inpatient stay for a heart attack); hospital outpatient (e.g., an MRI scan in an outpatient department); primary care physician services (e.g., a general internal medicine physician); medical specialist services (e.g., a cardiologist); and surgical specialist services (e.g., a thoracic surgeon).

Across the 13 markets, each hospital received two price indexes -- one for inpatient services and one for outpatient services. Each physician practice received up to three price indexes -- for primary care, medical specialist, and surgical specialist services. Medicare prices serve as the benchmark, with price indexes reflecting the ratio of autoworker plan payments relative to what Medicare would have paid for the same services. An index of 1.0 means the autoworker plans paid the same as Medicare; 1.2 indicates prices 20 percent above Medicare; and so on. Medicare prices incorporate adjustments for the complexity of services provided and are ostensibly set to cover the costs of a reasonably efficient provider.

High and Highly Variable Hospital Prices

In most of the 13 markets, a substantial gap separates the highest- and lowest-priced hospitals. Typically, the most expensive hospital receives 60 percent more for inpatient services than the least expensive one. The disparity is even more extreme in certain markets, such as Kansas City, Cleveland, and Toledo, where the highest-priced hospital receives well over twice as much as the lowest-priced facility for inpatient care.

Detroit illustrates the broad range of hospital prices within a single market. Over 100,000 nonelderly autoworkers and dependents are enrolled in one of the plans there, and 14 hospitals provided substantial inpatient care volume -- at least 50 admissions each. Among these 14 facilities, nine had price indexes tightly clustered around the market average of 1.5 (150 percent of Medicare). But five hospitals were paid at least 15 percent above the market average, with the highest reaching 2.2 -- or 220 percent of Medicare.

Price variation for hospital outpatient care was even more pronounced than for inpatient services. Typically, the highest-priced hospital in a market was paid close to double the lowest-priced facility for outpatient care. Cleveland showed the most extreme outpatient price variation, with the most expensive hospital paid three times as much as the least expensive. But wide outpatient price variation appeared across almost all of the markets studied.

Primary Care Prices Vary Little

Prices for primary care physician services diverge from hospital prices in two key respects: they tend to be much closer to Medicare -- and in some instances below it -- and they fluctuate less both within and across markets. In nearly all 13 markets, prices paid to primary care practices fall within a narrow band, typically between 85 percent and 135 percent of Medicare. Four markets -- Cleveland, St. Louis, Indianapolis, and Kansas City -- exhibit somewhat wider primary care price variation, with a handful of practices receiving prices well above Medicare.

More Variation in Specialists' Prices

Prices for medical and surgical specialty services show more variation than primary care and tend to run higher relative to Medicare. Specialty price indexes generally ranged from below 1.0 -- less than Medicare -- to 1.5 or even higher. Two markets -- Cleveland and St. Louis -- stand out because their highest-paid specialty practices receive prices 50 percent or more above the market median.

Specialist physicians typically deliver more complex services than primary care physicians. But complexity alone does not account for the divergent price patterns, because the Medicare benchmark already adjusts for differences in service complexity.

Making Sense of Price Variation Within Markets

Several factors can be eliminated as explanations for the wide within-market price variation, including the cost of doing business (labor costs within a market are roughly comparable), the complexity of services rendered (accounted for through Medicare benchmarking), and the type of coverage (all enrollees are in private plans with similar benefits).

What, then, drives the variation? The hospital industry has contended that higher-priced hospitals handle the most complex patients and bear greater costs related to teaching programs and capital investments. While this may explain some intra-market variation as sicker patients gravitate to tertiary centers, benchmarking to Medicare should mitigate this effect. In fact, many analysts believe Medicare's supplemental payments for medical education exceed the actual additional costs.

The more probable explanation is variation in negotiating leverage among providers and private insurers. Negotiating leverage hinges on the ability to walk away if no agreement can be reached. In terms of leverage, primary care practices rank lowest. Primary care physicians tend to practice solo or in small groups, are more numerous than specialists, and are more substitutable -- making them the least capable of dictating prices to health plans. In economics parlance, they are price-takers. An insurer does not need every primary care physician in a market -- it needs only enough to provide adequate access, and no single practice is essential to reaching that threshold. Consequently, very few primary care practices can command prices meaningfully above their competitors'.

The specialty physician market is generally more concentrated, with fewer practices per specialty than primary care physicians. Moreover, specialist practices tend to be larger. Research has shown that many specialty practices have grown in recent years partly to increase their negotiating clout. Many are large enough that insurers could not provide adequate local access to the specialty without them, giving these practices substantial leverage.

Hospitals occupy an even stronger negotiating position than specialist physicians. As typically large entities providing high volumes of patient care, individual hospitals or hospital systems wield leverage that physician practices rarely if ever match. At the top of the negotiating hierarchy are must-have hospitals -- those with some unique blend of reputation, location, and services. Private insurers know that employers will not continue offering their products if these must-have hospitals are excluded from the provider network. Even in metropolitan areas with many competing hospitals and systems, these must-have facilities can command unusually high prices. Furthermore, hospitals have increasingly merged into systems, potentially allowing affiliated hospitals within a market to negotiate collectively with insurers. And, many hospitals are hiring physicians and acquiring practices, then folding those physicians into their negotiations with insurers, which may bolster leverage for both the hospitals and the physicians.

Unused Insurer Leverage?

Provider leverage is only one side of the equation, and concentration on the insurer side also appears to influence price levels and variation. An insurer's leverage derives from its market share and its willingness and ability to direct patient volume to network providers. Blue Cross Blue Shield of Michigan (BCBSM) is a particularly dominant insurer across all Michigan markets, while some other markets, such as Cleveland, lack a comparably dominant carrier.

For an employer seeking affordable health coverage, competition among health plans is a double-edged sword. When multiple plans compete for an employer's business, they face pressure to keep administrative costs and profits low, which can reduce premiums. But when the health insurance market is fragmented, plans have less negotiating leverage with medical providers, which tends to push provider prices -- and therefore premiums -- upward.

Five of the 13 markets studied are in Michigan, and the remaining eight -- with one exception -- are in other Midwestern states without comparably concentrated insurance markets. Comparing Michigan markets with those in other states allows some limited observations about how a dominant insurer affects price levels and variation.

Within Michigan markets, prices vary less from hospital to hospital and from practice to practice than in markets outside Michigan, consistent with the idea that BCBSM is less susceptible than other insurers to price demands from must-have providers. Hospital prices also tend to be lower on average in Michigan markets, particularly for outpatient services. However, BCBSM does not appear to have used its market power to force physician prices below levels seen in other markets. For example, primary care physician prices in Michigan tend to exceed those in non-Michigan markets. This may reflect a deliberate effort by BCBSM to incentivize primary care and other physician practices to expand their capabilities for more patient-centered and effective care of complex patients, presumably with the expectation of reducing hospital and other costs over time. It may also be that BCBSM sees little gain and some political and legal risk in alienating providers by aggressively using its dominant position to drive prices down. As previous research suggests, dominant insurers do not need to push prices down aggressively -- they just need "to do better than the competition."

Potential Savings

Given the mounting evidence of substantial intramarket price variation, especially for hospitals, purchasing strategies designed to steer patients toward high-value providers clearly offer potential cost reductions. Approaches such as reference pricing, where the payer establishes a maximum allowed amount for a specific procedure in a given market, have generated savings and applied downward pressure on outlier provider prices in some markets. Other innovations in benefit design, when paired with information to enrollees about provider-specific cost differences, clearly have a role in such strategies.

To approximate the magnitude of potential savings from such purchasing strategies, actual plan spending was compared with hypothetical spending under a price ceiling set at the 50th percentile of each market's current price distribution. The 50th percentile (median) price represents the point at which half of services in that market were provided by higher-priced providers and half by lower-priced ones. A second set of hypothetical price ceilings used multiples of Medicare prices: 1.0 and 1.5.

The potential savings from capping prices at the 50th percentile amount to only about 5.5 percent of physician and hospital spending in the plans. For context, annual per capita spending growth for employer-sponsored health insurance has averaged between 7 and 8 percent. So, the savings from implementing an aggressive active-purchasing program might offset less than one year of spending growth. Nonetheless, even small percentage gains are significant given the enormous sums large employers spend on health care. Furthermore, active purchasing may begin giving large purchasers a more direct role in health care payment and delivery decisions. These strategies will face obstacles, including resistance from providers, insurers, and enrollees.

More substantial savings are possible if prices are capped below current norms. By far the biggest opportunity for savings appears in hospital outpatient settings, where a price ceiling equal to Medicare would reduce spending by 48 percent and a ceiling at 1.5 times Medicare would cut spending by 26 percent. But such a dramatic shift might require governmental rate-setting and force hospitals and specialist physician practices to cope with significantly curtailed revenue.

Looking Ahead

Even though overall U.S. health spending growth has decelerated in recent years, premiums for employer-sponsored health insurance have continued climbing at an unsustainable pace. And rising provider prices account for most, if not all, of the premium increases. If this trajectory continues, employers will face growing pressure to restrain spending growth -- whether by trimming benefits, shifting costs to employees, or deploying some form of active purchasing to moderate price increases. Insurers are consolidating and becoming more skilled at implementing active purchasing strategies. But at the same time, consolidation is accelerating on the provider side, recently including widespread hospital employment of physicians. As a result, health plans may encounter only stiffening resistance in their efforts to control high prices.

Sources and Further Reading

CMS: Medicare Provider Charge Data — Hospital-level charge data released by CMS for inpatient and outpatient services, referenced in this study as a comparison point for negotiated private insurer prices.

Health Affairs: Hospital Pricing Research — Peer-reviewed research on hospital market power, private insurer-provider price negotiations, and within-market price variation for hospital and physician services.

KFF: Employer Health Benefits Annual Survey — Annual data on employer-sponsored health insurance premiums, cost-sharing trends, and spending growth rates discussed in this analysis.

The Commonwealth Fund: Hospital Consolidation and Market Power — Research on how hospital mergers and health system consolidation affect negotiating leverage, pricing, and competition in private insurance markets.

NIH: Health Care Spending and Pricing Research — National Institutes of Health research on the drivers of U.S. healthcare spending, including the role of provider prices relative to utilization in explaining cost growth.