Economists tell us that setting the price of a good or service depends on market forces that balance supply and demand in order to optimize output with minimal waste. This dynamic is one of the marvels of competitive markets, where, with almost magical agility, prices constantly readjust toward an ideal value as consumers gravitate toward purchasing decisions based on desire and ability to pay.
Unfortunately, when it comes to pricing healthcare, these fundamental economic principles just don't work. There are lots of rational reasons for this market breakdown: third-party payments mask the true price of a service; consumer decision-making is stifled because of poor information; and there are too few substitutable goods to ensure competition. Worst of all, prices are, for the most part, hidden or unavailable. Instead of having an efficient mechanism that safeguards value and quality, price setting in the U.S. health system too often defers to the actions of dominant stakeholders who charge whatever a lopsided marketplace will bear.
Hospital officials complain that Medicare pays too little for care, so in order to make up the difference, they charge private payers like insurance companies and self-pay individuals the Medicare rate plus an inflation factor. To be fair, few patients pay hospital list prices; insurance companies negotiate discounts and hospitals often voluntarily lower prices for the uninsured. But all pricing begins with the hospital's "chargemaster," a comprehensive listing of items billable to a hospital patient or a patient's health insurance provider. The chargemaster sets prices at what the hospital would like to collect. These prices are the basis for calculating the discounts given to insurers and to people without insurance, and can run as high as 10 to 20 times what Medicare pays, although it commonly tracks at about three times the Medicare rate. Even though few may pay the list price, high chargemaster rates nevertheless set the base from which discounts are negotiated, and a higher base translates into higher prices, which, ultimately, leads to higher premiums. The uninsured, often the most vulnerable patients, cannot easily negotiate discounts and, even with hospital reductions, may face medical bills that can lead to bankruptcy and affect credit scores. The Affordable Care Act (ACA) hoped to address this through its coverage expansions, but high prices and deductibles continue to make access to healthcare unaffordable for many.
Hospitals are not the only health industry stakeholder to exert this pressure to gain market leverage and dictate higher prices. In part to provide a counterbalance to the consolidation within the hospital industry, the five biggest health insurers have been scouting for potential mergers. Anthem has made a public bid for insurer Cigna, Aetna has made a takeover proposal for Humana, and UnitedHealth Group has approached Aetna. If any of these merry-go-round deals are successful, fewer companies would dominate the insurance industry, thus putting into question whether sufficient competition remains in many markets to ensure consumer choice or mitigate price escalation.
The irony of all this is that the ACA encourages consolidation of health industry organizations where "integrated" or "accountable" combinations of physicians and hospitals work collectively to manage the health of patients throughout a continuum of care. If patients are healthier as a result and hospitals and physicians save money by curtailing expensive in-patient regimens and costly readmissions, these "accountable care organizations" are financially rewarded. The problem is that this scurry to consolidate physician groups and hospitals into larger systems of care may also prove anti-competitive and lead to market dominance and higher prices. Early data suggest that hospital prices and per-patient spending are higher in consolidated markets than in areas with fewer integrated systems.
The complexity of healthcare financing, with its myriad of economic levers, undermines the optimizing pricing mechanism found in well running markets. As a result, prices are variable, hidden and inequitable.
Perhaps it is time to revisit the notion of all-payer rate setting in American healthcare. In an all-payer system, all payers — government, private insurance, businesses and individuals — pay the same regional rate, or price, for any given medical service or procedure. Ten states experimented with hospital rate-setting systems over three decades ago and had some success in reducing the growth of spending. The rise of managed care in the 1990s alongside stakeholder and political interests derailed the effort. Today, Maryland remains the only state with some form of all-payer rate setting.
Moving to an all-payer scheme would reduce the tremendous price variation we see nationally and within the same geographic region. Standardized rate setting would eliminate the need to discount prices for various groups, reduce the access problems for enrollees in lower-paying government health programs (particularly Medicaid), decrease administrative paperwork, make the system vastly more transparent and encourage purchasers to compare hospitals based on performance, rather than price. Several developed nations successfully use an all-payer system to constrain spending.
Although opponents contend that an all-payer system is a back door to a "single-payer" system and therefore politically untenable, other experts have argued that the public has always been amenable to government involvement when it promises to reduce healthcare prices for consumers. To that end, a June 2015 public opinion poll reports that nearly three-quarters of the respondents viewed the cost of prescription drugs in the U.S. as unreasonably high, with half saying there is not enough government regulation to hold down prices. This may indicate a renewed public acceptance of government oversight.
Experts at Dartmouth, who have been studying the inefficiencies of geographic variation in health spending for over 30 years, have come up with a proposal for a short-term pilot program to stabilize prices: capping payments at 125 percent of Medicare rates. This "125 percent solution" would constitute a middle ground in the healthcare financing wars, recognizing that hospitals need to offset the costs of uncompensated care and, at the same time, constrain industry stakeholders who exploit the payment system with outrageously high prices. Standardizing rates for medical services would not address some of the other ills of the U.S. healthcare system, such as overutilization or quality lapses. However, it could begin to address the inadequacies of our imperfect market-based health system and to assess the utility of a more rational and just pricing mechanism.
Americans love to hate their government, but it may be time to reconsider the merits of an all-payer system.
Engelhard is the director of the Health Policy Program at the University of Virginia School of Medicine's Department of Public Health Sciences.