BUSINESS
05/24/2013 07:13 am ET Updated May 24, 2013

Hospital Charges Grow Like 'Compound Interest' In Opaque And Irrational U.S. Health Care System

Why would Orange Park Medical Center in Florida charge $117,445 to place a stent into a patient's artery, while the Mayo Clinic half an hour away in Jacksonville charges less than 45 percent of that amount?

The answer, in short, is because the U.S. health care system doesn't operate according to the standards of competition that govern other industries. Hospitals often rule local fiefdoms using their own idiosyncratic price-setting conventions, and the health insurance companies that pay the bills have little incentive to wage risky wars against prominent local institutions.

The prices in the above example are drawn from a database of charges at thousands of hospitals released this month by the Centers for Medicare and Medicaid Services. Variation of that level isn't out of the ordinary among U.S. hospitals, which maintain detailed price lists called "charge masters" for thousands of services.

American hospitals are locked in a vicious cycle that results in erratically inflating charges, which increasingly bear little relation to the cost of medical care or the amount actually paid. In practice, hospitals set prices as if they have no competition at all -- something that's reflected in the Centers for Medicare and Medicaid Services data. Hospitals tend to charge as much as they are able, knowing it's nearly impossible for patients to determine what local competitors charge or what health insurers pay. The fact that the system isn't affected by typical competition metrics is a major reason why Americans often pay higher health care prices than citizens of other developed nations.

These prices got so out of whack due to perverse financial incentives, poor competition among medical providers and health insurers, evolving management strategies, inattention and simple inertia stretching back more than half a century, said Farrell Turner, a health care consultant with Warren Averett in Anniston, Ala. Turner served as chief executive officer and chief financial officer for various hospitals during a more than 30-year career in the industry.

"By differences in management styles and the way that they have gone about raising their charges, what 40 or 50 years ago may have been a 4 percent difference now could be a 25 percent difference," Turner said. "It may almost be like compound interest."

Hospitals don't have uniform practices for setting prices -- even within the same facility or chain over time -- and that leads to huge discrepancies that worsen over the years. One year, a facility may raise prices a little, another year a lot. Or, the hospital may not change prices at all for a period of time, then return to the drawing board. This happens throughout the hospital industry with little consistency, Turner said.

One hospital may base its charges on a combination of services that make up the process of treating an ailment, while another may devise specific line-item prices for each element of a procedure, Turner said. Medicare and other payers fork over a lower fee for the overall treatment provided, but patients without insurance can see very different bills depending on how the hospital that provided their care accounts for charges.

This isn't how the rest of the economy works. In most industries, prices reflect the available supply of a product or service, public demand and a shared understanding of the costs of labor, supplies and overhead. Two nearby grocery stores may charge different prices for similar items, but the discrepancy tends to reflect unique, measurable disparities in their operations -- like their ability to demand greater volume discounts from suppliers or their relative market share. For the grocery stores, the costs of basic inputs like labor and real estate tend to be comparable.

In health care, by contrast, prices are subject to factors transparent to no one. Rather, listed fees are the consequence of various management styles and a given hospital's relationship with health insurance companies.

Hospital and health insurance industry experts emphasize that the list prices on the charge masters bear little resemblance to what health insurance companies, Medicare and Medicaid actually pay. Although this is true, it elides the fact that list prices continue to play a role in the rates some commercial health insurance companies pay, and can hit poor and uninsured patients the hardest.

Although these patients represent only a sliver of those treated in America's hospitals, they can be the most vulnerable to crushing medical bills that can lead to aggressive debt collection, financial ruin and bankruptcy.

Some hospitals base charges on their costs and overhead and try to keep them around what the local norms are, said Eddie Read, an El Campo, Texas-based consultant currently working as interim chief financial officer at El Campo Memorial Hospital.

"Everybody tries to get them very similar," Read said. "We don't have any interest in being thrown on the nightly news." Read retired as vice president of finance at Driscoll Children's Hospital in Corpus Christi, Texas, last year, after more than 30 years in the industry including stints as CEO and chief financial officer.

Hospitals with higher list prices disregard what competitors do, which can contribute to their charges growing more rapidly and out of line with costs, Read said. "They never look outside and see what the real world is. It's decades and decades. It's sad but it's true." Chief financial officers typically spend about 5 percent of their time working on the charge master, he said.

Further complicating this dynamic is the fact that hospital chains and individual facilities change their approaches over time, Turner said. One management team may prefer to keep charges low, while their successors may choose to raise charges in an effort to extract higher payment rates from health insurance companies, he said.

In some cases, a hospital will set a specific revenue target and elevate prices according to what procedures are most lucrative. "In order to get a 5 percent yield, you might increase some items by 1 percent, you might increase other items by 15 percent. You can either call that gaming the system or being smart," Turner said.

President Barack Obama's administration made the charges public in the hope that hospitals with the highest charges would lower them. Despite some early signs of concession by a few facilities in Florida and Alaska, the hospital industry is reluctant to embark on the massive, complex task of reevaluating how it does business.

"You don't have all the resources in the world to spend time going back and doing all this, so what is your return going to be?" Turner said. "You're not going to get anything out of it."

Likewise, health insurance companies don't have strong incentives to push back against high hospital charges because the smart ones ignore the charge masters, said Michael Seibold, managing partner of Seibold and Associates, a health care consulting firm in Tucson, Ariz.

Instead, Seibold said, health insurance companies that have enough negotiating leverage may agree to fee increases based on what they paid the previous year, not whatever the hospital says its list prices are. "It has literally nothing to do with charges," Seibold, who was a longtime executive at Blue Cross Blue Shield of Illinois, where he was president and chief operating officer from 1998 to 2001 before leaving the company, said.

In other cases, hospitals that have greater clout in a local market will insist health insurance companies base fees on a percentage discount on charges, which tends to lead to higher payouts, Seibold said. Health insurers' clients won't tolerate excluding prominent local hospitals from their networks no matter how high their charges may be. And health insurance companies often fail to scrutinize inflation in their payment rates over time, he said.

It's a story that began during the middle of the last century. In the 1950s and 1960s, hospitals charged prices based on their costs and their desire to earn a margin on their services. Health insurance companies in those days essentially paid hospitals whatever they charged. When Medicare came into existence in 1966, the program copied this model.

Things began to change in the 1980s, as national health spending continued to rapidly rise and health insurance companies and the government forced a shift away from hospitals effectively deciding for themselves how much they'd be paid.

Private health insurance companies began to negotiate rates with hospitals and create exclusive networks of providers, which sometimes are based on a discount off the hospital's listed charges. Around the same time, Medicare began paying flat fees for sets of procedures, rather than individual line items on the bills.

"Hospitals increased their charges dramatically during that period of time," said Seibold, the former insurance executive. "They will increase their charges because the only people who pay charges are health plans that are dumb enough to pay 'discount-on-charge' contracts and people who are either uninsured or private-pay," he said.

Still, when a health insurance company opens talks with a hospital about commencing a business relationship or needs to work out payment rates for new medical services, the charges come back into play, said Chip Kahn, president and CEO of the Federation of American Hospitals, a Washington-based trade group for investor-owned chains like HCA Holdings. "The charge master is involved at the beginning point in the negotiation," he said.

From 1999 through 2010, the gap between hospitals' estimates of their costs and what they listed as prices widened substantially, according to data analyzed by the Medicare Payment Advisory Commission, an expert panel that counsels Congress. Average charges were equal to 104 percent of costs in 1999 and rose to 218 percent of costs as of three years ago, the commission reported last June.

Maureen Sullivan, chief strategy officer for the Blue Cross and Blue Shield Association in Chicago, said a new trend may help buck the old system, no matter what hospitals do about charges. Government programs and commercial insurance companies have begun linking payment rates to the quality of care patients receive, she said.

"There has been a movement away from just looking at paying for discrete services to really understanding the patient's experience and to really understanding whether we're driving better value," Sullivan said. "The discussion on how much you're paying for services is not divorced anymore from the quality and value of the services that are provided."

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