Hospitals aren't bad guys; they're just business guys

September 9, 2013
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My friends working for hospitals think I have it in for them.

Since I started this blog three months ago, I’ve written more than once about the surprisingly high prices that hospitals charge, especially to privately insured patients, and how the hospitals themselves are now admitting they’ve been inefficient.

But it would be wrong for anyone to conclude that hospitals are the bad guys in the health care system. Hospital executives aren’t bad guys, they’re just business guys (and gals). By that I mean, they’re doing exactly what they’re supposed to be doing as the business leaders of their institutions.

“Hospital leaders are responding rationally to the incentives in their system,” Doug Leonard, president of the Indiana Hospital Association, told me. “They’re trying to negotiate from a position of strength.”

I agree with Doug. If I were a hospital executive—a thought that makes me and the local hospitals laugh—I would make pretty much the same decisions they have.

Consider the study last week that showed Indianapolis hospitals are charging privately insured patients 264 percent more than the federal Medicare program to deliver the same services to patients with the same level of illness. If I could command that kind of price premium for my hospital, would I charge it? Of course I would.

For these two reasons:

First, I could quickly develop a list of good things I could do with the money, such as continuing to pay attractive fees to doctors and nurses that serve unprofitable patients (like those on Medicaid) or who provide unprofitable services (such as mental health care). Or I could update the aging equipment in one of the hospital’s departments, or expand a hospital so the rooms could become private, thus cutting down on hospital-acquired infections.

Some might argue that hospitals are too profitable—their average operating cash flow last year was about 9 percent nationally. But 9 percent cash flow is modest compared to most other industries.

Second, even if I wanted to lower my prices, I could count on my nearby competitor not to lower his or her prices. In that scenario, my competitor would have the extra cash to pay better salaries, offer more services and update equipment and facilities. Soon, my lack of investment in my hospital would drive my patients to switch over to my competitor, further worsening my hospital’s financial condition.

My patients would leave because, until very recently, patients were almost completely shielded from the true cost of their health care. And even now, privately insured patients pay just a quarter of every dollar of care they receive.

So the best thing for my hospital would be to negotiate for the highest prices I could get from the private health insurers. In fact, to do otherwise, would be a breach of my duties.

And the same is true in any other industry. For an executive to charge a price any lower than the largest number of customers will bear is corporate malpractice.

So before insurers and employers get too angry at the hospitals, they should look in the mirror. And the same goes for all of us with employer-sponsored insurance too.

Most insurers and employers, so far, have been willing—not cheerfully, of course, but willing—to bear health care prices that are 264 percent higher than Medicare.

And why were they willing to bear it? Because employers knew that their workers wanted the widest possible choice of health care providers. So that’s what employers demanded.

And that’s what private insurers like Anthem Blue Cross and Blue Shield gave them. The widest possible choice for the lowest available prices.

Of course, Anthem was content to allow those lowest available prices to rise 7 percent to 8 percent each year, just so long as it was sure no other health insurer was getting a better deal. That way, Anthem maintained its huge market share in Indiana.

But the insistence by employers and their employees on the widest possible choice took away the biggest negotiating leverage Anthem had: to cut a hospital out of its network.

That’s how Wal-Mart keeps prices low—by threatening to pull a manufacturer’s product from its shelves if it doesn’t give the price Wal-Mart wants. But Anthem has not used its market dominance to pressure its suppliers on their prices. And least it hasn't been effective in doing so in the Indianapolis area. (For rural hospitals in Indiana, the situation has likely been much different.)

These dynamics are changing now. Anthem and MDWise Inc. have created health plans for Obamacare’s exchanges that each cut at least one Indianapolis-area hospital system. And it’s possible such “narrow networks” could migrate to the employer insurance market too.

Those narrow network products will pay hospitals lower rates than private insurance has done in the past—rates that will trend over time close to Medicare rates. So it looks like that 264 percent gap is likely to get smaller.

Also, health insurers—following the lead of the Medicare program—are trying to negotiate new kinds of contracts with hospitals, which hold their current prices steady, but give the hospitals a chance to earn extra money if it is able to document high quality care and good outcomes for patients.

The result has been that hospitals have gotten aggressive about cutting their costs. Some have even trimmed prices, such as IU Health cut to its imaging prices early this year. And others, pressured by Medicare’s policy of not paying for readmissions, have improved their quality.

“The volume-based system that we’ve been in, that rewards for technology and brings on an arms race, is coming to an end,” Leonard said. “Hospitals are rapidly driving costs down, anticipating that there’s no way that a year from now or two years from now or five years from now, they’ll be able to operate with the same cost structures they do today.”

In other words, now that the market is changing to demand lower prices and higher quality, hospital executives are continuing to be good business leaders, working to produce exactly what their customers want.

  • There's more to the story
    You article fails to provide the whole context to support your argument. Though the hospitals are charging more for private insurance, they're not turning around and paying employees more. They're cutting staff all over the place. And the benefits of their most qualified employees. The employees are feeling the changes in this environment the hardest. The hospitals have very high fixed costs (running a large facility is costly) and the changes to the system, including low reimbursements from Obamacare and Medicare, do not help lower their fixed costs. So now hospitals have less money to support their business, provide better service to patients, and innovate better healthcare. Now the hospitals are feeling the squeeze - and the employees are feeling it...except those at the top who have handed themselves incredible raises/bonuses. St. Vincent's CEO received a $600,000/year pay raise in 2012 for a leading a business that is struggling to stay afloat. So the title of your article is very subjective - if they're not bad guys, then why are they taking ridiculous salary and bonus increases while cutting employees and their benefits in the wake of lower income. Business 101: Revenue - Expenses = Profit...and they're elevating that expense portion and reducing their profit. Yes, they are bad men (and women).
    • Profit?
      Revenue-expenses=NON-PROFIT. If the hospitals want to be businessmen and women that's fine, but then they should yield up their non-profit status. How much of their cash comes from unearned income? I'd venture to say not much, but it allows the hospitals to avoid paying taxes, something the doctors and insurance companies can't do. Not exactly a level playing field, is it?
      • Hospitals
        Since hospitals pay no taxes and set their own outrageous prices, I consider them bad guys. Competition doesn't seem to hurt them, as few people will drive more than a few miles for a hospital's services. (It would be extremely inconvenient for their families.) If Obama wants to do some good, he will set prices hospitals can charge consumers. Oh, that's an extreme idea!
      • Better late..
        Agreed that hospital corporations should make appropriate profits to maintain facilities, support staff and introduce the latest EFFECTIVE treatments. The fact that Medicare seems to be the only organization that sees the picture wide angle, and make reasonable payments based upon successful outcomes, is a benefit which will accrue to everyone. It's hard to feel too sorry for large non-profits who make pretty respectable profits, just got religion on cost cutting, and have had the resources to buy and build many hospitals around the state, buy out and consolidate doctors offices and provider groups, and market their brands and products like the latest fad in beer or bourbon.
      • To Kurt
        You raise good points. With personnel costs making up 60 percent of the average hospital's budget, cost-cutting at hospitals will necessarily mean job cutting. The threat to innovation is real and is something I have written about before. As for executive salaries, big bonuses for executives at an organization (St. Vincent) that has concluded it has been administrator-heavy for years seems like a mixed message. But I have yet to an analysis of executive pay that suggests that cutting it could make a significant dent in a multibillion-dollar operating budget. Have you?
      • Big business
        Would like to see what else differentiates Indiana vs other midwestern locations to justify the higher reimbursement rates Indiana hospitals are commanding. Other states have restrictions on hospitals building facilities so close to one another, Indiana clearly does not. Does this result in higher hospital charges for us? While watching the evening news, there is an endless stream of 'our doctors are better' commercials. If they were all encroaching on each other's territories, and have so much excess capacity, would all this marketing be necessary?
      • Hospitals with government's help are badguys
        Hospitals lobby and "donate" to public officials for favorable laws and rules. We sadly saw the Indiana Supreme Court (loaded with "anything for business and elites" ) rule that contract law does not apply when a uninsured individual questions a unreasonable hospital bill. All hospital need to publish their rates. You get the cost before buying a car, house, and candy bar. You should be able to see the cost before an emergency room visit. A hospital selling it's sole with government approval should not be "just business"
        • To Steve and Dupree
          Hospitals incur, on average, charity care equal to only about 4.5 percent of their patient revenue, and not-for-profits are only slightly better at charity care than for-profits, even though they don't pay income taxes. So it's legitimate to at least question the NFP exemption for hospitals. My point in this post is that hospitals respond to the rules and incentives laid before them. We should expect nothing less. We should not expect self-sacrificing behavior from them, even with their NFP status. I just think that's an unrealistic expectation. If we as a society decide we want a different outcome than we're getting, we should change the rules for hospitals. And this is what is starting to happen.
        • Administrators Not Businessmen
          C'mon JK - Hospital executives are not truly businessmen. The don't operate in a market where the customer has information and decisionmaking power. Rather, they administer operations that depend on prices negotiated with insurance companies, which likely do not reflect actual costs. The condition has led to widely varying prices on procedures that have been in place for years. Please read the Time Magazine article from this past spring that highlighted some of the problems that these "businessmen" have failed to address.
        • Interesting
          The cost of care is what has driven our health insurance premiums through the roof. Essential the hospitals have to take on responsibility for their charges. It will be interesting to see, once the microscope is on all of their fees how they justify them. I also find it interesting that the health care community is not embracing the ACO model of care. Why not be rewarded for performance?
        • Doc's in the same barrel
          Now that the Hospitals are buying all of the doctor practices they now get the exemption on everything that happens through the offices as well. However without the exemptions the price of poker goes up and guess who will pay that price. It won't be the feds. it will be the self and private pays and guess who gets to pay that premium after tax. You got it! you and me!

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        1. You are correct that Obamacare requires health insurance policies to include richer benefits and protects patients who get sick. That's what I was getting at when I wrote above, "That’s because Obamacare required insurers to take all customers, regardless of their health status, and also established a floor on how skimpy the benefits paid for by health plans could be." I think it's vital to know exactly how much the essential health benefits are costing over previous policies. Unless we know the cost of the law, we can't do a cost-benefit analysis. Taxes were raised in order to offset a 31% rise in health insurance premiums, an increase that paid for richer benefits. Are those richer benefits worth that much or not? That's the question we need to answer. This study at least gets us started on doing so.

        2. *5 employees per floor. Either way its ridiculous.

        3. Jim, thanks for always ready my stuff and providing thoughtful comments. I am sure that someone more familiar with research design and methods could take issue with Kowalski's study. I thought it was of considerable value, however, because so far we have been crediting Obamacare for all the gains in coverage and all price increases, neither of which is entirely fair. This is at least a rigorous attempt to sort things out. Maybe a quixotic attempt, but it's one of the first ones I've seen try to do it in a sophisticated way.

        4. In addition to rewriting history, the paper (or at least your summary of it) ignores that Obamacare policies now must provide "essential health benefits". Maybe Mr Wall has always been insured in a group plan but even group plans had holes you could drive a truck through, like the Colts defensive line last night. Individual plans were even worse. So, when you come up with a study that factors that in, let me know, otherwise the numbers are garbage.

        5. You guys are absolutely right: Cummins should build a massive 80-story high rise, and give each employee 5 floors. Or, I suppose they could always rent out the top floors if they wanted, since downtown office space is bursting at the seams (