(This post is my opinion only and in no way constitutes the views of my employer or clients. It’s also written with an assumption the goal of a healthcare system is to provide quality care at the lowest price possible without disincentivizing providers. If you don’t start there, the rest doesn’t matter.)
Price elasticity of demand
Let’s go back to Economics 101. One of the foundational concepts of that class is price elasticity of demand. The purpose of this metric is to measure how much demand changes for a product based on a corresponding change in its price. If a change in price causes a large change in demand, the good or service is said to be “price elastic.” If there is little change the good or service is “price inelastic.”
Great, you’re thinking. How does this relate to healthcare? Let’s apply that concept. A person is buying toothpaste. The local drugstore has brand-name toothpaste for $3, then one day for no reason, they decide to rise the price to $30! Some people might still buy it, a number might opt for a cheaper store brand, and some will simply forgo brushing their teeth altogether. Now that same person is driving home from the store and suddenly starts experiencing chest pains. He drives to the local emergency room. He isn’t given a price for the care he is about to receive, nor would he likely care. A reasonable person under normal circumstances will pay whatever it takes to save their life.
Economics is all about power and incentives. Who has the power is these two scenarios? In the toothpaste scenario, the customer has most of the power. He has two good options besides buying the expensive store brand. He can look for a less expensive option or opt-out of personal hygiene completely with very little lost (except maybe some friends). In the second scenario, the local hospital is holding all the cards. This last year, there have been numerous articles explaining the fantasy world that is hospital pricing. This one is probably the best.
But, do you really want to know why providers charges so much? It’s really simple. Because they can. That’s it.
Hospitals are expensive because they sell an inelastic service, and there’s very little incentive to behave otherwise. In fact, if there are complications after surgery and patients return, they actually make more money instead of less. The inflated gross charge and related contractual write-off on the EOB you get the mail is a carefully negotiated figure based on the balance of power between payor and provider. For all the Affordable Care Acts flaws and the terrible rollout of the federal exchange, it actually does a few interesting things to address these issues.
Insurance exchanges and the individual mandate
The federal and state exchanges are designed to assist citizens in enrolling in some sort of insurance plan. The idea behind health insurance is not only to address risk, but also consolidate pricing power on behalf of patients. An entity representing thousands of patients has much greater power than any single person. It’s in the government’s interest that all citizens participate in some sort of insurance program. However, insurance companies, rightly, want the ability to control who can and cannot enroll in their plans. The only way any insurance company would give up that right is for the government to enact a corresponding disincentive for healthy people to delay enrollment until they’re sick. That’s where the individual mandate came from. It’s a trade-off. The insurance companies gave up the right to deny coverage, but gained a tax that incentivizes citizens to buy their product. There’s been a lot of talk about this one and we’ll see how it plays out. The bottom line is more people are participating in consolidated risk pools means less pricing power for providers at the negotiating table. This serves to lower costs.
CMS’s new program to test the bundling of payments is probably one of the most under-reported but interesting parts of the ACA. Under the current system, almost every provider in the US bills per procedure. This creates backwards incentives where hospitals can actually make more money when surgeries go bad. Bundled payments are an attempt to incentivize quality and efficiency rather than the opposite. By enrolling, the provider opts to receive a lump payment that covers an entire case rather than billing the individual components. If things go well, the provider could actually make more money. However, if there is poor quality of care, subsequent readmissions would eat straight into profits. This is where the uncomfortable conversations start between doctors and administrators that can lead to change.
If you are still reading this, you have my pity. I almost put myself to sleep writing it. The details of this law are arcane, and frankly no one really knows if it’s going to work. There are too many variables in play . However, there are some concepts in the law that in my estimation are worth an experiment. We’ll just have to wait and see.
Yin Aphinyanaphongs - Dec 30, 2013
Indeed, we are already seeing the jockeying for customers through price, at least in New York State, though companies do obfuscate the pricing by being less transparent about other costs. [http://www.nytimes.com/2013/12/09/us/on-health-exchanges-premiums-may-be-low-but-other-costs-can-be-high.html?_r=0] For othopaedics, our hospital is one of the first to do bundled payments, and our current research is piloting how predictive models may improve care and enhance the bottom line. I think that a whole hospital service based on predictive modeling may maximize profits while minimizing costs. I agree that for once the incentives are seemingly in the right direction.
Jared - Dec 31, 2013
Hey, thanks for the comment! Read the NY Times article. One thing they didn’t mention is that while the deductibles on bronze plans are high, customers are still getting the contractual write-off. These are often 50-75% of the gross charge whereas self pay patients get billed for the full amount. I’m really interested in the bundled payment experiment. It has great potential, in theory.
Martin - Feb 18, 2015
Keep it simple stupid- seems we ought to benchmark costs of services and then pin them to local indexes- insurance companies do this already to some extent