Although there is strong public sentiment that health care costs in the United States are too high and are growing at an unsustainable rate, there is little agreement about how to address the problem. One of the major contributing factors to rising health care costs is unnecessary and wasteful spending, as evidenced by the significant variation in the amount that hospitals and physicians are paid by private insurers for essentially the same service. These payment variations reveal waste, which is an important driver of spending in health care markets across the US.

A Review Of The Evidence On Payment Variation

In a 2011 Health Affairs article, Uwe Reinhardt noted that the actual amounts paid by a large New Jersey health insurer for a colonoscopy varied from a minimum of about $200 in a physician’s office to a maximum of about $3,750 in a hospital setting. Even within specific settings (physicians’ offices, hospitals, and ambulatory surgery centers), there was significant variation in the prices paid for this one relatively simple and common procedure. This makes no sense and clearly adds significant and unnecessary costs to the US health care system.

In a 2010 study of payment rates in eight health care markets, Paul Ginsburg noted that the “average inpatient hospital payment rates of four large national insurers ranged from 147 percent of Medicare in Miami to 210 percent in San Francisco. In extreme cases, some hospitals received almost five times what Medicare pays for inpatient services and more than seven times what Medicare pays for outpatient care.”

The reasons for these payment variations differ from market to market, and in some markets the variation is much less than in others. However, Ginsburg argues that provider market power over private insurers is the primary reason for the variation.

Another explanation for these variations in payments is the cost shift theory, which implies that because public payers (Medicare and Medicaid) pay health care providers well below costs, the hospitals and hospital systems must charge private health plans well above costs to offset the losses from public payers.

However, Austin Frakt, in a 2011 Milbank Quarterly article, cautions that policy makers should view with a degree of skepticism most hospital and insurance industry claims of inevitable, large-scale cost shifting. He argues that consolidation of hospitals and hospital systems increases the market power of hospitals relative to insurers and could significantly affect private prices.

This variability and complexity in how health care services are reimbursed suggests that billions of dollars in payments to health care providers have little or no relationship to the underlying value or cost of those services, adds significant, unnecessary costs to the health care market, and makes price comparisons difficult for consumers.

A recent study by Zack Cooper and colleagues found that in the period 2007 to 2014, Medicare spending per beneficiary decreased by 1.2 percent in real terms while spending per private insurance enrollee in the group studied increased by 16.9 percent. They concluded that, in the short run, growth in providers’ prices is one of the factors driving growth in private health care spending when compared to Medicare’s regulated fee-for-service payments.

Private insurance payments in the US health care markets amounted to nearly one trillion dollars in 2015. If these payments were reduced by just 1 percent through regulation of prices, the savings could amount to $10 billion dollars a year. However, to achieve these savings, there needs to be a consensus regarding the reasonable value of every health care service no matter where or by whom they are provided and the amount to be paid for those services.

Addressing Payment Variation And Preserving Competition

I believe there is an approach to address these variations in insurer payments that uses existing Medicare cost-finding and payment rules but allows private insurers to continue to offer competitive health plans within the context of new regulations on pricing and payment. Medicare payments for provider services are currently determined through a formulaic approach and set by law at rates that are, on average, below hospitals’ costs of providing care. However, these rates have resulted in nationally accepted base payments for every service and are adjusted for a number of factors that are specific to each hospital. Even in the face of low Medicare reimbursement rates, though, very few hospitals have chosen not to participate in the Medicare program.

Let me be clear that I am not suggesting that all hospitals and other health care providers be paid Medicare rates for all the services they provide. Rather, I am proposing that the Medicare payment and cost-finding methodologies, which have been in place since the 1980s, could serve as the framework or index that would be applied to all payers and would become the basis for payments for all services. As a matter of fact, many commercial payers already use the Medicare model as a basis for payments to hospitals for inpatient and outpatient services, and many state Medicaid programs are moving in that direction. What is lacking is any uniformity in these approaches.

The approach I am suggesting would use the current Medicare methodology as a reference point to establish a base payment rate for every health care service or procedure provided. These prices would become the “index” or base price for all payers, including commercial payers and potentially Medicaid.

State regulatory authorities, or preferably, a national rate-setting commission, would need to be established and charged with the task of analyzing payment rates for defined services and for establishing limits on the amounts that private insurers could pay for specific services. These regulatory authorities would also need to establish reporting requirements and data collection methodologies that would apply to all payers so that payment information would be consistent and transparent.

The Maryland Rate Setting Commission has been regulating all-payer payments to hospitals since the 1970s and has achieved significant savings by reducing the growth of health care expenditures from what had been expected. Robert Murray, former executive director of the Maryland Health Services Cost Review Commission, judged the Maryland system to be “one of the most enduring and successful cost-containment programs in the United States.”

As an example of how my proposed national model could be implemented, assume that the base Medicare payment for an uncomplicated knee replacement in a hospital is $20,000. Under this model, commercial payers might be limited to pay no more than, say, 140 percent of the Medicare base payment for that procedure, or $28,000.

As noted above, Ginsburg found that the “average inpatient hospital payment rates of four large national insurers ranged from 147 percent of Medicare in Miami to 210 percent in San Francisco.” Digging deeper into these data, payments ranged from 84 percent of Medicare at the 25th percentile in Los Angeles to 252 percent at the 75th percentile in San Francisco. This being the case, there will no doubt be winners and losers should this model be implemented.

This is not unlike the situation that occurred when Medicare implemented the Prospective Payment System in the 1980s, using diagnosis-related groups as the basis for payment. The solution at that time was to gradually introduce the new payment model over four years to provide hospitals time to adjust their revenue expectations.

For example, under my proposal if a hospital is currently being paid 210 percent of Medicare rates for a knee replacement, or $42,000, its payments will be reduced over time to $38,500 in year one, $35,000 in year two, $31,500 in year three, and $28,000 in year four, inflation adjusted. In other words, the hospital’s current payments will be shifted to the new payment system through pre-defined steps over a four-year period. These payments could take into account hospital type, geographic variations in cost, and other factors, consistent with Medicare payment rules. A similar approach could be taken in regard to physician payments as well.

This would result in a more standardized pricing and payment system that could be indexed to inflation over time and could provide a more rational structure for an eventual evolution to an all-payer, value-based payment and global budget approach for hospitals. By reducing the variation in payments in the current fee-for-service model, there would be less carryover of overpayments into the value-based payment models of the future.

Looking Ahead

Variability and complexity in how health care services are reimbursed by commercial payers add significant costs to the health care market, make price comparisons more difficult for consumers, and inevitably are reflected in rising health insurance premiums.

As reported by Pro Publica in October 2018, the administrator of the Montana state employees’ health plan used Medicare payments as a reference point to limit payments to hospitals for services provided to its enrollees and saved $17 million on total expenditures of $200 million in the first year and a half. Although the hospitals resisted the plan at first, most have accepted the payments and appear to be doing fine.

Addressing variations in commercial payments as proposed above is administratively and politically feasible, would not require the elimination of private insurance companies or the government assumption of health care payments, would tie payments more closely to the actual value of the health care services provided, and could result in billions of dollars of cost savings for consumers of health care services.