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

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.

Please enable JavaScript to view this content.

Editor's note: IBJ is now using a new comment system. Your Disqus account will no longer work on the IBJ site. Instead, you can leave a comment on stories by signing in to your IBJ account. If you have not registered, please sign up for a free account now. Past comments are not currently showing up on stories, but they will be added in the coming weeks. Please note our updated comment policy that will govern how comments are moderated.