All Things to All People?
If you want to infuriate yourself over your morning coffee, read a couple of pages of Steven Brill’s article Bitter Pill: Why Medical Bills Are Killing Us in Time Magazine on the outrageous costs of healthcare in the United States. (h/t to Margaret Steinfels). The article follows the story of seven well and truly screwed Americans who are among the tens of millions who were un or under insured when they faced some kind of medical crisis (real or suspected). It is the story of twenty dollar aspirins and million dollar hospital stays, contrasted to the relatively small amounts that many of these things would have cost when compared to what Medicare pays for them.
During the course of Steinfels’s discussion of the article, the question came up of whether Obamacare directly addresses this terribly skewed medical pricing situation. The short answer is no. Obamacare is designed to address the problem of the un and under insured. But I will argue that it is nonetheless a significant move in the right direction of controlling health care costs in America.
Before I talk about what Obamacare will and will not do, let’s review the pricing for medical services. Like any business, a hospital has a cost to itself for anything that it sells or does. It also has a master list of what it charges to perform its services. This list is, naturally enough, called a “charge master”. The ratio of costs to charges is called the cost to charge ratio. All but the very smallest (like 6 bed) hospitals mark up their charges by several hundred to a thousand percent. The reason that hospitals mark up their charges so high can be ascertained in how medical pricing works.
In general, Medicare (which makes up most of a hospital’s business) pays about 98 percent of the costs of Medicare services. (The hospital is required to report its true cost structure to Medicare once a year in order to get Medicare funds). Medicare pays less than 100 percent of costs in order to pressure hospitals to become more efficient and to lower its costs year over year. Despite the whining from hospital administrators, this actually works, but what it doesn’t do is produce much if any of a profit margin.
In addition, Medicaid pays maybe 60 percent of costs per statute. Charity work, which all hospitals including the for-profit ones do, pays nothing. Then there is the amorphous mass of bills that are uncollectible. These primarily come from people like those in Brill’s article; people who although workers, are uninsured or under insured and who don’t have a couple hundred thousand dollars lying around for a sudden medical emergency.
As you can see, all of these categories together leave the hospital with a deficit. In sum total they don’t cover costs. So how does a hospital cover costs and make a profit? It makes it off the back of commercial insurance, which pays, say 135 to 140 percent of costs on average, subsidizing the rest and providing what Brill discovered are pretty fat profits for many institutions, including the not-for-profit ones.
But why do hospitals make their charge masters so high. It’s because that commercial insurance, while paying quite a bit more than costs, is in the business of providing discounts to hospital charges. The 140 percent of costs that your insurance company may be paying is expressed as a percentage of charges and as silly as this sounds, the higher the hospital charges the deeper the apparent discount. When an insurance company negotiates a 140 percent of costs deal, it might be getting a 70 percent discount to charges and 70 percent discounts seem like a wonderful thing, especially if your competitor is only getting a 68 percent discount.
Now if you are not insured commercially, by Medicare or Medicaid and if you are not one of the rare people eligible for charity care, you will be billed for 100 percent of charges and Steven Brill may write an article about how you had to liquidate everything that you own to pay for the heart attack that Medicare would have covered for a fraction of the price. Why do hospitals charge the uninsured 100 percent of billed costs?
Because it is profitable. Yes, one can negotiate with a hospital (usually), but even if the hospital “gives in” and reduced the charges by 50 percent, one may still be paying a higher percentage of cost than an insurance company that itself is paying 140 percent of costs on average.
Regarding Obamacare, when the “single payer Medicare for everyone” crowd lost the Obamacare vote, Obamacare moved away from a mandate to control costs at a chargemaster level. The country decided to have a universal insurance plan using private insurers (rather like they do in those socialist workers paradises of Switzerland and Holland). What was then needed was to provide the largest number of people with health benefits while keeping costs stable. Once cost controls were put aside politically, the hospitals dropped out of the political equation and the task became getting the largest amount possible of standard commercial discounts for the greatest number of consumers while keeping prices stable and the insurance companies whole.
What were the risks of Obamacare for the insurance companies? First and foremost, to provide universal coverage the government had to eliminate the individual underwriting of members. Whereas one is now deemed worthy of insurance based on gender and (pre-existing) medical conditions, which causes companies to select against anyone who poses any sort of health risk, everyone is now welcome under Obamacare. Individuals will now be aggregated into giant state sized “communities” and an average premium will be calculated for everyone in the pool. This is acceptable to insurance companies provided that each company gets an identical share of the risk in the pool. But what if all the sick people for whatever reason decide to only buy my insurance? Obamacare deals with this through a “risk adjustment”: every member gets a “risk score” which is then aggregated at the company level. Risk scores between companies are compared and the ones with lower risk scores have to subsidize the ones with higher risk scores so that everyone has the same score, which is to say the same proportion of risk.
The second thing that insurance companies worry about is pent up demand. We will be seeing something like 35 million previously un and under insured members entering the market. A lot of them need services that they have been holding off on for years. Won’t these people cause costs to skyrocket? (Brill thinks yes.) To prevent this, Obamacare sets up a “reinsurance” fund especially for high claims costs (which are defined as claims totaling more than $60 thousand.) The $60 thousand is called an “attachment point” and if a claim exceeds it, the insurance company draws on the fund.
The third thing the insurance companies worry about is a sort of wild card. Since insurance companies would be insuring a large population for which they have no claims experience, what if they are wildly off in their pricing? This is uncharted territory for them. This can work two ways. There is the potential to be wildly “correct” and therefore wildly profitable or wildly incorrect with huge losses. For this Obamacare establishes “risk corridors” where profits and losses are constrained within a band that caps both. People with profits above the band have to subsidize those with losses below the band. This creates an average profit rate for the whole industry (which is targeted at what the average profit rate is now.)
These three things (risk adjustment, reinsurance, risk corridors) are referred to in the legislation as the “3Rs” and are designed to work with a few other things to keep prices stable.
The uninsured and under insured then get access to the same kind of insurance that other commercial customers get. Yes, commercial insurance, at least in the short term, will still be paying an average of 140 percent of costs. But when everyone has insurance, we can then address the cost problem in the way that the free market has been addressing it all along. If the last sentence made you laugh, keep in mind that Medicare and commercial insurance have been successful in controlling costs. The wild card has been all the uninsured in the system and that will be mostly eliminated. The need for the commercial subsidy will begin to disappear.