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Demystifying Hospital Pricing

I woke up this morning to a slew of text notifications asking “Did you see that executive order?” — referring to the latest directive signed by the Trump administration to improve pricing transparency in healthcare. Being the go-to healthcare guy, I get a lot of questions ranging from which hospital to go to or how to make medical bills go away (which I wish I know the answer to). But this question about pricing is one I receive almost once a day.

Yesterday, on June 24th, the President signed an executive order mandating hospitals and insurers “to publish prices that reflect what people pay for services.”

Earlier this year, the CMS, the largest government-sponsored payor in healthcare, required hospitals to publish charge prices — which meant little to the average consumers considering insurers rarely pay the full prices to begin with.

For non-healthcare folks, here is how pricing works every time you go to the hospital or the ER

The first step is to understand the healthcare triangle. Different from going to the grocery store, in most cases, you are not able to “buy” healthcare yourself. Instead, you pay into a pool of cash called insurance with the hope that if something catastrophic happens, your insurance will cover it.

Working on behalf of you, the insurer negotiates with hospitals to supposedly get you the best discounts off of the charge/full prices.

While overly simplified, the triangle below describes the three main stakeholders in a healthcare ecosystem (with suppliers and pharmaceutical companies excluded from the picture):

The second step is to understand why what you see is not what you pay. Charge price, reimbursement, Medicare price. What the heck are those?

The best way to think about hospital pricing is through the analogy of a Starbucks menu. Weird but bear with me. Consider the Frappuccino, there are three tiers of “product” you can get:

Venti (large)
Grande (medium)
Tall (small)

No endorsement here :P

The Venti — the charge price — the highest price the hospital uses as the starting point for negotiation — kept secret in a menu called the “charge master”.

The Grande — insurers negotiate with hospitals to pay a portion of the full price, often 30–40% .

The Tall — Medicare and Medicaid, as the largest government-sponsored payor, dictate how much they want to pay — often 10–20% for Medicare and less for Medicaid.

The difference: when going to Starbucks, the more you pay, the more Frappuccino you get. In healthcare, a knee replacement may cost your grandma’s Medicare ~$15K, but will cost your private insurance over $25.

So if you don’t have insurance, what do you pay? Unfortunately, without someone to negotiate on their behalf, uninsured patients often get billed the full price, which can be 3 times more expensive. In the case of the knee replacement, full charge can be about ~$80–150K. Discounts are sometimes available, but can’t be negotiated ahead of time.

So why then if I have insurance, I still have to pay so much out of pocket?

This is a complicated question depending on who you ask. But the basics of it has two prongs:

  1. Price inflation. As hospital and drug prices go up, insurers have to pay more for the same care you receive, which make them less profitable or even incur a loss. To counter this force, many insurers want the customers to have more skin in the game.
  2. Cost sharing. To do this, insurers increase deductibles (the amount you have to pay before the insurance starts paying) or implement a co-pay(you share the cost with them for each visit), in the hope that people will shop around for the best deal and chose wisely which hospital to visit.

The problem with this is that you can’t shop without knowing prices. But real prices are secrets hospitals and insurers do not share, even with internal staff. Because of this, healthcare consumers continued to do what they do best: go wherever is convenient at the time.

In 2019, the annual cost for an individual health plan is upwards of $4000 with a ~$7000 deductible (you pay before insurance pays). Which means, for a bad year, you will be looking at a $12000 out of pocket expense if something catastrophic happens. And even if nothing happens, that $4000 is still gone from your pay checks.

Are there solutions?

According to the latest data, 30 million Americans are without insurance, another 56 millions have insurance but are underinsured. This is a widespread issue that not only affects the lives of many, it has the power to swing political elections. Solutions are being thrown out by candidates and lawmakers everyday, but here are my thoughts:

  1. High deductible health plan: we tried this, pretty much a problem on its own. If you have it, you know it.
  2. Medicare For All: the current federal budget for healthcare stands at $1 trillion dollar. There are approximately 2.6 million people employed by the insurance industry. A single payor system will drive down prices but physicians likely to oppose the idea since a centralized negotiation power would reduce reimbursement by a significant amount.
  3. 100% Privatization of Healthcare: most people don’t know, but 29% of the Medicare budget (totals to $700B) is already being administered by private carriers, known as Medicare Advantage. This is one of the hottest segments in healthcare. Privatizing healthcare does increase competition, which improves patient experience. However, privatizing healthcare also prioritizes profits over social programs — likely play out unfavorably for those who live in the bottom 20% of the income scale. Prices, on the other hand, will probably stay the same.

Lastly, for the consumers, what do you do? The most innovative approach I have seen so far happens in Kansas City. A group of doctors converted to 100% cash, cutting out the middlemen, and passing the savings to the patients. Many are following suit across the country in a movement called Direct Primary Care.

Direct payment is not new, however, it is known only to those who are in the “inner circle”. But next time you’re at the pharmacy, it is worth asking for cash prices with coupons.

Your Z-Pack that costs $50 with insurance may magically become $5. But only if you ask.


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