In 2007, health companies in the Fortune 1,000 earned $71 billion. Of the 52 industries represented on Fortune’s list, pharmaceuticals and medical equipment ranked third and fourth, respectively, in terms of profits as a share of revenue. From 2000 to 2007, the annual profits of America’s top 15 health-insurance companies increased from $3.5 billion to $15 billion.
In competitive markets, high profits serve an important social purpose: encouraging capital to flow to the production of a service not adequately supplied. But as long as our government shovels ever-greater resources into health care with one hand, while with the other restricting competition that would ensure those resources are used efficiently, sustained high profits will be the rule.
Health care is an exceptionally heavily regulated industry. Health-insurance companies are regulated by states, which limits interstate competition. And many of the materials, machines, and even software programs used by health-care facilities must be licensed by state or federal authorities, or approved for use by Medicare; these requirements form large barriers to entry for both new facilities and new vendors that could equip and supply them.
Many health-care regulations are justified as safety precautions. But many also result from attempts to redress the distortions that our system of financing health care has created. And whatever their purpose, almost all of these regulations can be shaped over time by the powerful institutions that dominate the health-care landscape, and that are often looking to protect themselves from competition.
Take the ongoing battle between large integrated hospitals and specialty clinics (for cardiac surgery, orthopedics, maternity, etc.). The economic threat posed by these facilities is well illustrated by a recent battle in Loma Linda, California. When a group of doctors proposed a 28-bed private specialty facility, the local hospitals protested to the city council that it was unnecessary, and launched a publicity campaign to try to block it; the council backed the facility anyway. So the nonprofit Loma Linda University Medical Center simply bought the new facility for $80 million in 2008. Traditional hospitals got Congress to include an 18-month moratorium on new specialty hospitals in the 2003 Medicare law, and a second six-month ban in 2005.
The hospitals’ argument has some merit: less complicated surgical cases (the kind specialty clinics typically take on) tend to be more profitable than complex surgeries and nonsurgical admissions. Without those profitable cases, hospitals can’t subsidize the cases on which they lose money. But why are simple surgeries more profitable? Because of the nonmarket methods by which Medicare sets prices.
The net effect of the endless layers of health-care regulation is to stifle competition in the classic economic sense. What we have instead is a noncompetitive system where services and reimbursement are negotiated above consumers’ heads by large private and government institutions. And the primary goal of any large noncompetitive institution is not cost control or product innovation or customer service: it’s maintenance of the status quo.
In 1751, Benjamin Franklin and Dr. Thomas Bond founded Pennsylvania Hospital, the first in America, “to care for the sick-poor and insane who were wandering the streets of Philadelphia.” Since then, hospitals have come to dominate the American medical landscape. Yet in recent decades, the rationale for concentrating so much care under one roof has diminished steadily. Many hospitals still exist in their current form largely because they are protected by regulation and favored by government payment policies, which effectively maintain the existing industrial structure, rather than encouraging innovation.
Between 1970 and 2006, annual Medicare payments to hospitals grew by roughly 3,800 percent, from $5 billion to $192 billion. Total annual hospital-care costs for all patients grew from $28 billion to almost $650 billion during that same period. Since 1975, hospitals’ enormous revenue growth has occurred despite a 35 percent decline in the number of hospital beds, no meaningful increase in total admissions, and an almost 50 percent decline in the average length of stay. High-tech equipment has been dispersed to medical practices, recovery periods after major procedures have shrunk, and pharmaceutical therapies have grown in importance, yet over the past 40 years, hospitals have managed to retain the same share (roughly one-third) of our nation’s health-care bill.
Hospitals have sought to use the laws and regulations originally designed to serve patients to preserve their business model. Their argument is the same one that’s been made before by regulated railroads, electric utilities, airlines, Ma Bell, and banks: new competitors, they say, are using their cost advantages to skim off the best customers; without those customers, the incumbents will no longer be able to subsidize essential services that no one can profitably provide to the public.
Hospitals are indeed required to provide emergency care to any walk-in patient, and this obligation is a meaningful public service. But how do we know whether the charitable benefit from this requirement justifies the social cost of expensive hospital care and poor quality? We don’t know. Our system of health-care law and regulation has so distorted the functioning of the market that it’s impossible to measure the social costs and benefits of maintaining hospitals’ prominence. And again, the distortions caused by a reluctance to pay directly for health care—in this case, emergency medicine for the poor—are in large part to blame.
Consider the oft-quoted “statistic” that emergency-room care is the most expensive form of treatment. Has anyone who believes this ever actually been to an emergency room? My sister is an emergency-medicine physician; unlike most other specialists, ER docs usually work on scheduled shifts and are paid fixed salaries that place them in the lower ranks of physician compensation. The doctors and other workers are hardly underemployed: typically, ERs are unbelievably crowded. They have access to the facilities and equipment of the entire hospital, but require very few dedicated resources of their own. They benefit from the group buying power of the entire institution. No expensive art decorates the walls, and the waiting rooms resemble train-station waiting areas. So what exactly makes an ER more expensive than other forms of treatment?
Perhaps it’s the accounting. Since charity care, which is often performed in the ER, is one justification for hospitals’ protected place in law and regulation, it’s in hospitals’ interest to shift costs from overhead and other parts of the hospital to the ER, so that the costs of charity care—the public service that hospitals are providing—will appear to be high. Hospitals certainly lose money on their ERs; after all, many of their customers pay nothing. But to argue that ERs are costly compared with other treatment options, hospitals need to claim expenses well beyond the marginal (or incremental) cost of serving ER patients.
In a recent IRS survey of almost 500 nonprofit hospitals, nearly 60 percent reported providing charity care equal to less than 5 percent of their total revenue, and about 20 percent reported providing less than 2 percent. Analyzing data from the American Hospital Directory, The Wall Street Journal found that the 50 largest nonprofit hospitals or hospital systems made a combined “net income” (that is, profit) of $4.27 billion in 2006, nearly eight times their profits five years earlier.
How do we know whether the value of hospitals’ charitable services compensates for the roughly 100,000 deaths from hospital-borne disease, their poor standards of customer service, and their extraordinary diseconomies of both scale and scope? Might we be better off reforming hospitals, and allowing many of them to be eliminated by competition from specialty clinics? As a society, couldn’t we just pay directly for the services required by the poor? We don’t know how many hospitals would even survive if they were not so favored under the law; anyone who has lost a loved one to a preventable hospital death will wonder how many should.
What amazed me most during five weeks in the ICU with my dad was the survival of paper and pen for medical instructions and histories. In that time, Dad was twice taken for surgical procedures intended for other patients (fortunately interrupted both times by our intervention). My dry cleaner uses a more elaborate system to track shirts than this hospital used to track treatment.
Not every hospital relies on paper-based orders and charts, but most still do. Why has adoption of clinical information technology been so slow? Companies invest in IT to reduce their costs, reduce mistakes (itself a form of cost-saving), and improve customer service. Better information technology would have improved my father’s experience in the ICU—and possibly his chances of survival.
But my father was not the customer; Medicare was. And although Medicare has experimented with new reimbursement approaches to drive better results, no centralized reimbursement system can be supple enough to address the many variables affecting the patient experience. Certainly, Medicare wasn’t paying for the quality of service during my dad’s hospital stay. And it wasn’t really paying for the quality of his care, either; indeed, because my dad got sepsis in the hospital, and had to spend weeks there before his death, the hospital was able to charge a lot more for his care than if it had successfully treated his pneumonia and sent him home in days.
Of course, one area of health-related IT has received substantial investment—billing. So much for the argument, often made, that privacy concerns or a lack of agreed-upon standards has prevented the development of clinical IT or electronic medical records; presumably, if lack of privacy or standards had hampered the digitization of health records, it also would have prevented the digitization of the accompanying bills. To meet the needs of the government bureaucracy and insurance companies, most providers now bill on standardized electronic forms. In case you wonder who a care provider’s real customer is, try reading one of these bills.
For that matter, try discussing prices with hospitals and other providers. Eight years ago, my wife needed an MRI, but we did not have health insurance. I called up several area hospitals, clinics, and doctors’ offices—all within about a one-mile radius—to find the best price. I was surprised to discover that prices quoted, for an identical service, varied widely, and that the lowest price was $1,200. But what was truly astonishing was that several providers refused to quote any price. Only if I came in and actually ordered the MRI could we discuss price.
Several years later, when we were preparing for the birth of our second child, I requested the total cost of the delivery and related procedures from our hospital. The answer: the hospital discussed price only with uninsured patients. What about my co-pay? They would discuss my potential co-pay only if I were applying for financial assistance.
Keeping prices opaque is one way medical institutions seek to avoid competition and thereby keep prices up. And they get away with it in part because so few consumers pay directly for their own care—insurers, Medicare, and Medicaid are basically the whole game. But without transparency on prices—and the related data on measurable outcomes—efforts to give the consumer more control over health care have failed, and always will.
Here’s a wonderful example of price opacity. Advocates for the uninsured complain that hospitals charge uninsured patients, on average, 2.5 times the amount charged to insured patients. Hospitals defend themselves by contending that they earn from uninsured patients only 25 percent of the amount they do from insured ones. Both statements appear to be true!
How is this possible? Well, hospitals bill according to their price lists, but provide large discounts to major insurers. Individual consumers, of course, don’t benefit from these discounts, so they receive their bills at full list price (typically about 2.5 times the bill to an insured patient). Uninsured patients, however, pay according to how much of the bill the hospital believes they can afford (which, on average, amounts to 25 percent of the amount paid by an insured patient). Nonetheless, whatever discount a hospital gives to an uninsured patient is entirely at its discretion—and is typically negotiated only after the fact. Some uninsured patients have been driven into bankruptcy by hospital collections. American industry may offer no better example of pernicious “price discrimination,” nor one that entails greater financial vulnerability for American families.
It’s astonishingly difficult for consumers to find any health-care information that would enable them to make informed choices—based not just on price, but on quality of care or the rate of preventable medical errors. Here’s one place where legal requirements might help. But only a few states require institutions to make this sort of information public in a usable form for consumers. So while every city has numerous guidebooks with reviews of schools, restaurants, and spas, the public is frequently deprived of the necessary data to choose hospitals and other providers.