How Price Transparency Could End Up Increasing Health-Care Costs

Getting your appendix out can cost between $2,000 and $180,000. Hip replacements run from $10,000 to more than $100,000. Hospitals, we have also learned, frequently mark up the price of cotton swabs and routine X-rays by 300 or 400 percent, with most patients oblivious to the reason their health care bills are so large.

As a response to the hidden variability in health care prices, an increasing number of states have passed price transparency legislation. Federal legislators have even introduced several bills into Congress to make health care prices more transparent. Expect more such bills to follow.

But will health care price transparency help reduce costs? Seems it would. But health-care can be a strange and unique sect of economics. Could price transparency backfire and cause spending to increase?

In the traditional consumer marketplace, price transparency is a powerful force in incentivizing producers to raise the quality and lower the price of their goods. When a consumer decides to purchase a flatscreen television, for example, she will be hesitant to buy an expensive model when a less expensive alternative exists that is just as good. As a consequence of such consumer scrutiny, the average price for a 32 inch LCD TV dropped from $1,566 in 2005 to under $400 today, at the same time as the quality of those products increased dramatically.

The same kind of consumer pressure rarely exerts a similar influence on the cost and quality of health-care goods. For starters, most patients have little inclination, or motivation, to shop for health-care bargains. Insurance companies pick up most of the tab for patients' health-care. A patient who pays a $150 co-pay for an MRI (like I do with my insurance) won't care whether the clinic she goes to charges the insurance company $400 or $800 for that MRI. The MRI is still going to cost the patient $150. Even patients responsible for 20 percent of the tab (a phenomenon called co-insurance) face a maximum bill of only $160 in this circumstance. That is not an inconsequential amount of money, but it is still not enough money to prompt most patients to shop around for less expensive alternatives, especially when most consumers don't realize that the price of such for services often varies significantly, with little discernible difference in quality.

To make matters worse, patients often don't shop for health care in the kind of rationally defensible way that economic theory expects them to. According to neoclassical economics, when making purchasing decisions consumers independently weigh the costs of services from the quality of those same services. If toaster A is more expensive than toaster B, the consumer won't buy A unless it is better than B in some way -- unless it is more durable or has better features -- and unless these improved features are worth the extra money.

Sometimes, however, cost and quality are not perceived by consumers as being independent attributes. Instead, people assume the cost of a good or service tells them something about its quality. For instance, blind taste tests have shown that consumers rate the flavor of a $100 bottle of wine as being superior to that of a $10 bottle of wine, even when researchers have given people the exact same wines to drink. Other studies show that expensive pain pills reduce pain better than the same pills listed at a lower price. Price, then, leads to a placebo effect.

Such a placebo effect is no major concern in the context of wine tasting and pain pills (even if it suggests that consumers could save themselves some money if they didn't hold this strange belief that higher cost means higher quality). But suppose your doctor asks you to get a spinal MRI to evaluate the cause of your back pain, and you decide to shop around for prices before getting the test. Would greater price transparency cause you to choose an MRI provider more rationally? Or would you instead mistakenly assume that higher price means higher quality? There is reason to worry that price transparency won't lead consumers to make savvy decisions. It is too difficult for people to know which health-care provider offers the highest quality care.

If patients are not going to make savvy use of price information to choose higher quality, lower cost health-care, some health-care providers, like doctors and hospitals, will probably respond to price transparency by raising their prices.

Imagine you direct an MRI center in Massachusetts, and the state government requires you and your competitors to post prices for your services. You consequently find out that the MRI center around the corner from you charges $300 more than you do for their spinal MRIs, and that this increased price hasn't hurt their business. Imagine, also, that you are convinced that your competitors don't offer higher quality MRI scans than you do -- your MRI machines are just as new and shiny as theirs; your radiologists and technicians are just as well trained. In that case, if patients are not going to be price-sensitive, you are going to raise your prices to match your competitor's. Otherwise you are just leaving money on the table.

Consider what happened in Denmark, according to an article published in the New England Journal of Medicine in 2011:

In response to concerns that the highly concentrated suppliers of Ready-Mix Concrete were charging widely varying prices to different buyers, Danish antitrust authorities began publishing information on actual invoice prices on a quarterly basis, beginning in October 1993. The result was an increase in average prices of 15-20 percent within a year, as the lower prices in the market rose and the higher prices edged up.

Or consider what happened in New Hampshire after the state began releasing price information on things like MRIs, as part of its health care price transparency efforts. In the twelve months following that bill, prices hadn't budged at all. This probably happened because there was not enough local competition for the price information to change patient behavior.

Price transparency may also cause prices to rise by reducing health-care providers' willingness to bargain with insurance companies. Currently, the price any given hospital charges for, say, a hip replacement will vary depending on which insurance company is paying for the service. A given hospital might have negotiated a higher fee from Aetna than from Blue Cross. Now suppose that legislation required hospitals to make all these negotiated rates public. Do you think Aetna is going to stand by and pay more money for a hip replacement than Blue Cross? Of course not. It's going to demand the same deal. If price transparency made such negotiations public, then no hospital in its right mind would offer a discount to one insurance company unless it was willing to offer that discount to everyone. Price transparency could be a huge impediment to price negotiations.

I witnessed this phenomenon second-hand in the early 90s, when my wife was the director of managed care at Temple University (her job was to negotiate with managed care companies on Temple's behalf). During that time, two managed care companies in Philadelphia merged, and quickly discovered that they had negotiated different rates from Temple for different services. The merged company came back to Temple and demanded that the new price of care match whichever of the two companies had previously negotiated the lower rate for any given service.

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Ultimately, the problem is complex and nuanced, but we should keep this in mind. Efforts to increase price transparency through state and federal law need to be carefully crafted and closely followed. Such laws should include research funding that would enable experts to evaluate how the law influences patient and provider behavior.

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Also, whenever possible, price transparency should be accompanied by quality transparency. We need to provide consumers with information not only about the cost of their services but also about the quality of those services, so that they can trade off between the two when necessary. I recognize that this is a huge challenge. Measuring health care quality is no simple task. But if we are going to push for greater price transparency, we should also increase our efforts to determine the quality of health care offered by competing providers. Without such efforts, consumers will not know when, or whether, higher prices are justified.

Whatever we do, we need to stop naïvely assuming that price transparency will function in health care the same way it does in other parts of the economy. What works for toasters won't necessarily work for MRIs.