Sneaky Hospital Tactics to Force Higher Prices

Image credit: Rich Pedroncelli/Associated Press

There was a recent 60 Minutes episode with a segment that talked about why healthcare prices are so high, and I learned a couple new things.

The segment focused on Sutter Health, which is a large healthcare system in Northern California. Sutter Health was the bad guy in this episode, but the American Hospital Association dutifully provided a counter-argument to the story here.

For context, remember that the price negotiations between hospitals and insurers are not based on costs but rather bargaining power. The more bargaining power the hospital has over the insurer, the higher the prices they win.

Here is Sutter Health’s strategy to win more bargaining power, according to the 60 Minutes segment:

First, buy up other hospitals to become a monopoly in as many markets as possible. If you cannot be a complete monopoly somewhere, find a way to become a monopoly over a key service line, such as maternity care. Next, require two things in every contract you make with an insurer–a gag clause (so nobody can divulge the prices agreed upon) and an all-or-nothing clause (so the insurer has to have all the system’s hospitals and services in network or none of them).

The combination of all that leads to the hospital having much greater bargaining power.

How?

The insurers are kind of forced to have Sutter Health in their networks to avoid having important gaps in coverage (either a regional gap if the one hospital in that county isn’t in network, or a service-specific gap if Sutter Health is the only provider of that service in an area). They leverage that foot in the door with the all-or-nothing clause, so now basically every insurer is compelled to include every Sutter Health hospital, so Sutter Health can demand very high prices and get away with it. And, for Sutter Health’s protection against the bad PR they would get by charging such high prices, they have the gag clauses in place.

Pretty clever I’d say. Unfortunately for them, the government tends to notice when a hospital system becomes a monopoly in multiple ways, and they also notice when a hospital system is making a lot more money than others around it. So they get investigated, reporters dig up the juicy story, and the government slaps a few wrists with lawsuits and new regulations.

Is there a better, long-term solution to these tactics? I have a few thoughts on the matter. First, there’s nothing like monopoly rents to draw competition to a market, so allowing healthcare entrepreneurs to enter those monopolized markets/service lines would be a great start. And if Sutter Health’s competitor hospitals start doing some thorough cost accounting, they could know how much their different services cost and be able to start setting competitive “out-of-network prices.” When those competitors start winning market share, Sutter Health will have to respond with lower prices and more price transparency to become competitive again themselves.

So many market failures are solved by price transparency.

Back to Basics: What Is a Health Insurance Death Spiral?

Photo by Frank Cone on Pexels.com

This is one of those topics that comes up in healthcare reform discussions regularly, but we don’t often take the time to explain it. It’s not currently a trending topic, but it’s a perennial one, so it will come up again sooner or later.

Let’s start with an assumption: All people want health insurance.

But people’s willingness to pay for health insurance varies greatly. If it’s free, few would refuse. If it costs $200 per month, many more would refuse. If it costs $2,000 per month, most would refuse.

What determines whether someone thinks the premium is worth it?

A few things. The two biggest factors are (1) how much healthcare that person expects to need that year and (2) how much money they have. If a person expects to be hospitalized multiple times that year, a $2,000/month premium is probably going to be a lot less (even with the deductible and copays) than going without insurance. If a person is fairly wealthy and has the foresight to recognize that unpredictable healthcare expenses could be financially catastrophic, they would probably also be willing to pay the $2,000 deductible. But healthy people and poor people (and especially poor healthy people) are much less willing to spend much on premiums.

Ok, that was most of the background information, and here’s one more thing. If an insurance company is allowed to charge whatever they want for a premium, you know what they would do? They would collect a bunch of data on every insurance applicant and use some smart actuaries to calculate each applicant’s average expected annual healthcare spending, and then they would use that number (plus a percentage) for the person’s premium that year.

As you would expect, this would work fine for the young and healthy who will have low premiums. But for most others, it can be pretty expensive to the point that many would rather choose to forego insurance.

Now we can talk about how to cause a death spiral.

To solve that problem of premiums being too expensive for the people who probably need insurance the most and ending up uninsured, the government can make a simple policy that requires insurance companies to charge everyone the same premium. (For simplicity, I’m saying they will only have a single premium, although in reality they usually say something like, “You can only charge the sickest person 3x what you charge the healthiest person, and you can only use these few variables to decide who is sick and who is healthy.”)

What happens? The sick people get a great deal, and the healthy people end up subsidizing the sick people’s premiums.

This enables the sick people to get insurance, although now that the healthy people’s premiums are so expensive relative to what they’re getting out of it (many of them probably don’t even end up using their insurance most years), they say, “Forget that. Buying insurance isn’t worth it anymore.” And they drop out of the insurance pool in favor of going uninsured.

What happens then? All the healthiest people are no longer in the insurance pool, so the average expected healthcare spending per person will be much higher the next year. Therefore, the insurer is forced to raise premiums accordingly.

And, predictably, when those new higher premiums come out, again the healthiest in the insurance pool will say, “Last year it was just barely worth it for me, but this year with this crazy increased premium, it’s not worth it.” And they drop out of the insurance pool. This is about the time when the insurance companies get labeled as greedy, too.

The next year, premiums rise again, and more people forego insurance.

Do you see the pattern? That’s a death spiral. And, again, it’s caused by requiring insurance companies to restrict the degree to which they can charge different people different premiums.

There is a way to prevent this, though. If, at the same time as restricting premiums, the government also creates some sort of incentive for healthy people to stay in the insurance pool, it can prevent them from leaving.

That’s what the individual mandate was for. It was the government saying, “Hey, we need you healthy people to be in the insurance pool subsidizing the sicker people’s premiums, so we’re going to persuade you to do that by making you pay a fee (tax) if you don’t buy health insurance.”

It didn’t work very well. Many people didn’t know about it, and those who did figured they’d rather pay a relatively small tax than a relatively large insurance premium. That’s why premiums in the private market rose so quickly after the Affordable Care Act was passed. Not enough healthy people joined the insurance pool, and more dropped out each year. It wasn’t exactly a precipitous death spiral, but that is the direction it was trending.

Socialism Leads to Totalitarianism?

Friedrich A. Hayek
Image credit: Mises Institute

If you haven’t noticed already, I have a strong interest in political philosophy. Isn’t thinking about the different ways government could be designed exciting? This is primarily a health policy blog, but political philosophy topics are closely enough related to what happens in healthcare that I write about them here as well.

I recently read (listened to) The Road to Serfdom by Friedrich Hayek. The interesting thing is that he seemed to be using my framework for categorizing governments. So I’d like to restate his main points in the context of my framework.

The book was written during WWII and published in 1944. At that time, he was living in the U.K., and he was seeing a movement there toward central planning, so he wrote this book to explain to the people involved in that movement how central planning starts a country down a road that leads to totalitarianism. He used Germany’s then-recent political history as the main case study to show how that process goes.

Let’s say the U.K.’s government looked something like this at that time:

And the “planners,” as Hayek calls them, wanted to do this:

There were different motivations for this. One was that, at the time, technology was seen as necessarily pushing industries toward monopolies, so they felt that government ownership would limit the tyrannies of monopolies. Another motivation that developed is a change in how freedom was conceptualized. “Before man could be truly free,” they said, “the despotism of physical want has to be broken.”

Notice that these are not totalitarian desires; they are desires for efficiency and an increase in freedom and opportunity for the poor. So how does Hayek say they lead to big leftward shifts on the other three spectra?

He doesn’t exactly provide a super explicit stepwise process, but here are some of his major checkpoints along that road:

  • Planning a society will involve areas with great agreement, but there will also be areas with great disagreement. In those areas of disagreement, people lose the freedom to conserve their preferences.
  • If a state owns half the economy, it necessarily controls most of the other half indirectly due to the interactions between industries, such as through shared inputs to those industries (like labor and resources). This means there is no part of society where people are completely free of government direction.
  • After a democracy votes in a planning government, they find that the democratic process is ill equipped to handle the plan’s requirement for rapid and unified-purpose decision making, so different parts are working at odds with the overall plan or are slow to change to fit better. For this reason, the laws they pass increasingly delegate decision-making power to unelected experts. Eventually, their legislative power becomes limited to making decisions about the plan’s overall goals, although in this area as well they find themselves inadequate because frequent shifts in goals (due to differences in factions’ priorities and politician turnover with each election cycle) undermine progress toward any ideal. Thus, they begin to concentrate the power to direct the overall goals (and coordinate the efforts of those many boards of experts) into a single individual who is not fettered by democratic and legislative processes.
  • This new powerful leader is occasionally confirmed via the democratic process, but the leader has the power to ensure, one way or another, that the votes go in his direction so he can continue working toward the ideal society.
  • A planned economy becomes the rule of man because so many of the decisions about people’s lives become arbitrary (whose interests to prioritize over whose). For example, do you increase wages of the working poor who are struggling to get by or do you decrease unemployment?
  • A planning government only sets out to control and improve the economic aspect of people’s lives, but by controlling the economic aspect they are indirectly controlling nearly every other aspect, such as where people live (you can’t move somewhere else if the government hasn’t decided there will be jobs available in that area) and what you do for fun (which luxury items and entertainment options are available and how they are priced).
  • People are dissatisfied when they are made to go along with another’s set of priorities and values, so the government creates indoctrination tools that will reduce the number of people resisting their goal for an ideal society.
  • The whole apparatus of information, including schools and print and audio and visual media, will be used not only in supporting the ends but also the means to achieve the ideal society, and speaking out against it becomes not just an opinion but treachery.
  • The leaders who tend to arise in such a system are those who are the strongest and most motivated to get things done, which means they are the most likely to be willing to ignore negative impacts on other people in pursuit of their singular focus (the means justify the ends).

So this is where the U.K. could have ended up if the planners had gotten their way, and remember this would all come from the planners’ initial desires to have the government help out with inefficient industries and to reduce the despotism of poverty:

There are so many other points made in the book that flesh out these ideas more fully, but I will forbear. Suffice it to say that end point of the the road is not just totalitarianism, but serfdom, which is due to the increasingly impossible task of a government trying to control an entire economy and, in the process, distorting every single worker’s incentives away from efficiency and innovation and redirecting resources away from their most profitable uses.

Reading this was quite an interesting experience because, with every point Hayek made, I could visualize which spectrum he was talking about and interpret his explanations in terms of which direction (and how far) a country would slide along that spectrum.

And the question it left me with is this: If Democrats’ policies tend to push toward more wealth redistribution and more government control over industries (e.g., Medicare for All), does this mean electing Democrats puts us on the road to serfdom?

My thought is that it doesn’t. Pushing for Medicare for All is not the same as endorsing a planned economy. One could argue that it’s one step closer to getting us on that road, but we have seen “social democracies” in Scandinavia not progress toward totalitarianism, so maybe that slope isn’t as slippery as Hayek makes it out to be. Exactly which factors would also need to be at play for us to truly get onto the road to serfdom? I don’t know. Any thoughts or ideas are welcome.

Healthcare Experts Often Support Good Healthcare Reforms for the Wrong Reasons

This week’s post is a little later than usual, but next week will be back on track with a Tuesday post about Hayek’s book about socialism, The Road to Serfdom, and how it fits into my framework for categorizing governments.

Something I have noticed for many years now is that many good and important healthcare reforms are touted by experts for the wrong reasons. Supporting a good reform for the wrong reason may seem harmless, but without a clear understanding of the principles behind why the reform is important, the implementation may undermine much of the benefit of the reform, or it may not be evaluated based on the right expected impact (and, therefore, cause the reform to be incorrectly judged as a failure). Either one of these mistakes could ruin the reform.

Example 1 – Quality metrics reporting: This refers to making providers track and report a variety of quality metrics, which are then usually used to give quality-contingent bonuses. These quality metrics are also often reported publicly with hopes that it will add some accountability to providers and motivate the lower-quality ones to improve.

What many experts don’t realize is that quality-contingent bonuses are not going to make a big dent in our healthcare problems. They also don’t realize that the main purpose for quality metrics should be to help people make value-sensitive decisions, which means the tracked and reported metrics need to enable people to do this. Commonly used metrics these days, such as aggregate mortality numbers and overall patient satisfaction scores, aren’t super useful at achieving this goal.

Example 2 – High deductibles: Some experts say that if people have high deductibles, they’ve got some “skin in the game” and will therefore stop being such spendthrifts, which will decrease overutilization and total healthcare spending.

It’s true that a high deductible will reduce healthcare spending;, although, unfortunately, people tend to decrease unnecessary AND necessary care. That’s what the classic Rand Health Insurance Experiment demonstrated. But lowering spending is not the main purpose of high deductibles. The primary benefit of them is that they make people actually consider price when they are choosing where they will get care, which allows people to start preferentially choosing higher-value providers (i.e., make value-sensitive decisions). Of course, this only applies to services that cost less than the deductible.

Example 3 – Bundled payments: These are seen as a way to get providers to integrate more and, through that integration, “trim the fat” (what’s with all the flesh metaphors?). Usually the reduction in total episode costs comes from providers becoming less likely to discharge people to skilled nursing facilities.

Bundled payments do get providers to send fewer patients to nursing facilities and to find other superficial ways to decrease total episode costs, but the primary benefit is that they allow people to compare, apples to apples, the total cost of a care episode. Again, it’s all about removing barriers to value-sensitive decisions. This will lead to complete care process transformations as providers become motivated to improve value relative to competitors and are assured they will win greater profit as a result. So implementing bundled payments with a single provider in a region will likely result in only very modest benefits, which will come from those superficial low-hanging-fruit types of changes.

That’s enough examples for this week! Merry Christmas, and may everyone do good things for the right reasons.

The One Thing Healthcare Lacks that Makes It So Dysfunctional

People making value-sensitive decisions and thereby driving value-improving competition in the book industry! Photo by @thiszun on Pexels.com.

If I had to pin down one thing that healthcare lacks that makes it such a dysfunctional industry, this is what it would be: value-sensitive decisions. I throw the term around here and there, but it deserves a little more explanation.

You’ve heard of someone being price sensitive, right? It means price is an important consideration when they are choosing between multiple options.

How about quality sensitive? That means quality is an important consideration when choosing between multiple options.

Everybody is quality sensitive; they don’t want to acquire something that doesn’t fulfill their need.

And people are usually price sensitive. The exception would be when the difference in price between their multiple options is such a tiny percentage of their wealth that it’s deemed insignificant. For example, a wealthy person buying a book on eBay would probably choose the $25.00 “Like New” book rather than the $24.99 “Acceptable” book. The poor college student, on the other hand, may very well get the cheaper one!

Remember, Value = Quality / Price. Therefore, when someone is both quality sensitive and price sensitive, it’s called being value sensitive.

In a normal industry, value-sensitive people buy the option that they deem to have the best mix of quality and price, which is slightly different for every person depending on what aspects of quality are most important to them and how much money they are willing to spend on the thing. These value-sensitive decisions are the engine of competition.

You see, when value-sensitive decisions are taking place in an industry, every company in that industry is trying to deliver the best mix of quality and price because they know that if they succeed at doing that, consumers will choose their product over their competitors’ products, which will enable the company that accomplishes that to reap the biggest share of the profit pie.

Of course, there are different consumer segments with different wants and different amounts of money to spend, but companies are trying to achieve that perfect mix of quality and price for each consumer segment that they’re targeting.

This is the core aspect of a properly functioning market. Without value-sensitive decisions, everything gets distorted. Companies will still fight for the greatest share of the profit pie, but the focus of competition is no longer on overall quality and total price to achieve that. Instead, competition shifts to focus on the aspects of a product that consumers are basing their choices on.

So, bringing this back to healthcare, if a patient has no idea about the relative quality of Hospital A versus Hospital B, they use quality surrogates, such as convenience of parking or how beautiful the lobby is. And if they will only pay a flat copay regardless of the total cost of their hospitalization, they stop caring about relative total price completely.

Think of a scenario where a patient has a flat copay for any in-network hospital. If they have to pay $10 to park at Hospital A, but parking is free at Hospital B, the cost of parking has now become the salient feature upon which they will be basing their assessment of price. And assuming they think both hospitals are of equivalent quality, that parking fee just made Hospital A’s value lower compared to Hospital B, so the patient will choose to go to Hospital B.

Basing a multi-thousand dollar purchase decision that could literally be life or death on a $10 parking fee seems pretty ridiculous, doesn’t it? But this is what our healthcare purchase decisions are relegated to when we do not have the information and incentives necessary to make proper value-sensitive decisions.

Given the sorry state of value-sensitive decisions in our healthcare system, I would argue that it is delivering exactly the overall low value that we should expect. And this is why I focus so much on explaining how we can eliminate our healthcare system’s barriers to value-sensitive decisions.