How to Change How Prices Are Set in Healthcare

Image credit: shutterstock.com
Image credit: shutterstock.com

In my previous post, I described the three ways prices can be set in healthcare: administrative pricing, bargaining power-based pricing, and competitive pricing. I also bemoaned the fact that the prices paid to providers by private insurers are determined more by relative market share than by anything else* . . . but this post explains how we can change all that.

I see two possible pathways from bargaining power-based pricing to competitive pricing, so here they are.

First Pathway

Let’s pretend a colonoscopy clinic is super innovative in how they do things, and they eventually are able to lower their costs by 20%. This is great for them because the prices they are paid by insurers has stayed the same (remember, those prices are determined primarily by relative market share, not costs), so now they have a really solid profit margin. And yet, the managers of this clinic still aren’t satisfied because they have excess capacity they want to fill.

One day, the managers come up with an idea. They say, “Up to this point, we’ve always maximally leveraged our bargaining power with insurers to win the highest prices we possibly can, but what if we do something radically different? What if we offer to lower our prices by 10% in exchange for the insurers putting us in a new, lower-copay tier? This would induce way more of their policy holders to choose us for their colonoscopies, so we’ll fill up our excess capacity. And, according to our calculations, our increased volume will more than make up for the lower prices. So everyone wins! Our profit increases, the insurer saves money with the lowered prices, and the patients are happy because their copays are less as well.”

Soon, some of the clinic’s competitors would figure out why their volume is starting to drop, so they would probably find a way to offer lower prices to get put into that lower-copay tier as well. Competitors who can’t or won’t lower prices will slowly lose market share until they, too, are forced to either lower price or improve quality enough to convince patients that going to them is worth the extra money.

Voila! Competitive pricing.

I have a friend who manages a large self-insured employer’s insurance plan, and I asked him what he would do if a clinic came to him offering lower prices in exchange for steering more employees to it. He said as long as the provider can show that quality won’t go down with the additional volume and that wait times for appointments won’t increase, he’d probably go for it.

Now, of course this wouldn’t work with every kind of healthcare service. I purposely chose a non-emergency service that already has pretty straightforward pricing. But as a priori quality and pricing information becomes more available, more services will be candidates for this pathway to competitive pricing.

One other point: Hospitals generally do a horrible job of cost accounting (they’re just such complex organizations!), so they usually have no idea if a proposed price reduction will still be profitable or not. Thus, they’ll be left behind in this game until they start to develop better cost accounting methods. If they have some foresight, they’ll start fixing that now.

Second Pathway

An insurer is despairing the fact that many of the providers in the region have combined into a single price-negotiating group, so now the insurer is stuck paying way higher prices than before. But then some health policy-savvy managers figure out a solution. They say, “Let’s implement reference pricing for a bunch of non-emergency, straightforward services. Let’s start with colonoscopies. This is how it works. We’ll tell our policy holders that we’ll put $1,200 toward a colonoscopy (the “reference price”). If a policy holder chooses a provider who charges more than that, they will pay everything over that price. A few clinics in the area offer prices that are lower than $1,200, so policy holders will still have a few options if they don’t want to pay a dime. But, (and here’s the best part) the price the providers in that huge price-negotiating group forced us to accept is $3,000, so they’re definitely going to lose a lot of volume, which will probably force them to lower their price.”

Soon other insurers jump on the reference pricing bandwagon and higher-priced providers who are losing tons of volume will be forced to price competitively.

In conclusion, shifting to competitive pricing is not immediately possible with most healthcare services. But the way to make more healthcare services amenable to competitive pricing is to improve a priori quality and pricing information: quality information needs to be standardized and more relevant to the factors patients should be considering when they’re choosing between providers, and the full price of an episode of care needs to be available beforehand so patients can compare them apples to apples. Only after these changes happen will we be able to rely more on competitive pricing, which, most importantly, will do more to stimulate value-improving innovations in our healthcare system than almost anything else.

* I also complained about how administrative prices don’t encourage (and actually stifle) innovation toward higher quality and lower prices. Check out the Uwe Reinhardt quote in this blog post and then think, “Uwe must have been reading Taylor’s blog.”

Why Aren’t Prices Transparent in Healthcare?

Image credit: presentermedia.com

I had a friend ask me that (the title of the post) a few days ago. He prefaced the question by saying he’s asked a few different people and knows already that there isn’t a simple answer to it. But those other people he asked misled him. The answer actually is quite simple. And why nobody is explaining this clearly, despite all the talk about price transparency in healthcare these days, is a symptom of a general lack of understanding of how industries actually function.

Prices are transparent in healthcare–the insurer knows exactly how much they’ll pay each healthcare provider for every service they cover. The problem isn’t transparency. The problem is that the party making the decision on where to seek care is not the same party that bears the financial consequence of that decision. Who chooses where to seek care? The patient. Who bears the financial consequence of that decision? The insurer. Therein lies the rub.

Think about two different scenarios. In the first, the patient will have both responsibilities. Patients would start to actually consider whether the extra $5,000 they would have to pay to go to Provider B for their cholecystectomy would be worth it as opposed to just going to Provider A. Is Provider B’s quality actually that much better to make it worth the extra $5,000? If not, patients will probably choose Provider A. And what happens when patients all start being unwilling to pay unjustifiably high prices? Provider B will either have to lower prices (goodbye crazy price variations!) or continue to deal with a large number of unused operating room hours. Patients win because they get better value, and high-value providers win because they get patients. In this situation, the decreased expenditures on healthcare are taken from the low-value providers. Who would argue against that? In this case, even the “I’m better than the average physician” belief that 100% of physicians have (statistically impossible as it may be) will help to decrease healthcare expenditures.

This pairing of both responsibilities in patients is actually happening, by the way. Why do you think insurers are trying out reference pricing, where they just commit to put a set dollar amount toward a given procedure and have the patient cover the difference if they choose a provider who charges more than that? And what about tiered plans, where patients choosing to go to the more expensive hospitals (the ones in the higher tiers of the insurance plans) have to pay a larger copay? And what about high-deductible plans for services below the deductible? These are all doing the exact same thing but in different ways: making the person who chooses where to get care the same person who bears the financial consequences of the decision. And providers with higher value are being rewarded with increased market share (volume).

In the second scenario, the insurer will have both of those responsibilities. It’ll still bear the financial consequences, of course, but now it’ll also be the one that tells patients exactly where to go for care. Patients wouldn’t like this, of course, but what would happen? Insurers would send every patient to the cheapest provider that meets minimum quality standards. Unlikely to ever happen? For run-of-the-mill procedures, probably it won’t ever happen. But for incredibly expensive one-time procedures, it already has. I heard a story about an insurer that did this with liver transplants (which, all told, is estimated to cost over $500,000 dollars). The insurer asked around to all the reputable local hospitals and got the cheapest bid for each patient. Then they sent each patient to the lowest-bidding hospital. The insurer saved a bundle. And the hospitals that could offer lower prices (possibly because they had lower costs somehow) were rewarded with volume. Ah, that whole reward value with volume thing again. It’s beautiful.

One final real-world example. ACOs. So far, one major way they’ve saved money is by sending patients to cheaper specialists. Let’s apply the principles we’ve just talked about to understand what’s going on. The referring provider is generally the party charged with making the decision of where the patient will go for a specialist visit. (The doctor says, “You need a specialist to look at this. Here’s the phone number for a good doctor, so go see her.” The patient says, “Okay, Doc, whatever you say. I’ll go see her.”). And when the referring provider is getting a bonus for keeping overall costs down, he now also bears the financial consequence of sending patients to expensive specialists because it’ll cost him his bonus. Now that you understand the principle of those two responsibilities needing to be invested in the same party, the world starts to make sense; you start to actually be able to predict whether something will work or not.

So now when you hear people complaining about our “horrendously evil system of third-party payment,” you’ll know that it’s not intrinsically a bad thing. It’s only bad when it results in a separation of those two responsibilities, the decision-of-where-to-seek-care responsibility and the financial responsibility.