Determining the Level of Payments in Health Care

Uwe E. Reinhardt is an economics professor at Princeton. He has some financial interests in the health care field.

Perspectives from expert contributors.

In my previous post, I presented the following menu of payment systems for health care and discussed the various bases (the columns in the chart) upon which payment could be made. Now I’d like to discuss the rows in this chart – the methods by which the level of payments are determined.

Free-Market Determination: The first row represents what one might call the free-market method, with payment levels negotiated between individual health insurers or self-paying patients on the one hand, and individual providers of health care (doctors, hospitals, and so on) on the other. It is the system long used in the private insurance sector and for uninsured patients.

Tax-financed public insurance programs – Medicare, Medicaid and Tricare – could be folded into that approach by delegating the tasks of buying health care and claims processing to private insurers, as is now done with private Medicare Advantage plans and Medicaid managed care plans.

Many American policy analysts, policy makers and commentators believe this is the best and fairest way to determine how and how much the providers of health care should be paid. Perhaps it is.

As I have pointed out in a paper, “The Pricing of U.S. Hospital Services: Chaos Behind a Veil of Secrecy,” and in several earlier posts on this blog, however, this approach to setting prices for health care has had several consequences:

1. On average, the prices for health care goods and services negotiated by private health insurers in the United States tend to higher — about double or more — than prices for identical services and goods in other countries of the Organization of Economic Cooperation and Development.

2. It is in good part so because insurers do not seem to have sufficient market power, especially vis à vis hospitals, to resist very rapid price increases.

3. The varying degrees of market power among private insurers in the United States have led to pervasive price discrimination among payers, with prices for identical goods or services varying among payers by factors as high as 10 (see chart below).

No one has been able to demonstrate that these enormous variations have anything to do with commensurate variations in quality or that price discrimination in health care is efficient, let alone fair.

New Jersey Commission on Rationalizing Health Care ResourcesPayments to individual hospitals for the same procedure — here, appendectomies and coronary artery bypass grafts (CABG) — vary considerably.

Price-Setting in Quasi-Markets: To avoid these consequences of individual negotiations over prices, I had recommended in a recent post a so-called “all-payer” system for health care in the United States.

Under such a system, associations of health insurers within a region (e.g., states) would negotiate with corresponding associations of hospitals, doctors and of other providers of health care uniform fee schedules (whether fee for service or bundled payments) that then would apply to all payers and providers in that region.

Germany and Switzerland, where such systems are used, call these arrangements “quasi-markets.” Maryland has long operated an all-payer system for hospitals only, with fee levels being determined by a commission of stakeholders.

One advantage of such a system is that it would do away with price discrimination. Another is that it would vastly reduce the administrative cost of billing for health care.

Finally, the negotiations between the parties could be constrained, if so desired, with reference to some overall macro-economic metric – e.g., the expected growth of the payroll, where it is the base for financing health care, or the expected growth of gross domestic product per capita. This is how Germany and Switzerland have constrained the annual growth in health spending.

Unilateral Administrative Price-Setting: Unilateral price-setting by government is the third distinct method of determining the level of the prices paid for health care. It typically is used by tax-financed, government-run, single-payer health-insurance systems, such as those of Taiwan, South Korea, Japan, Canada and the Medicare and Medicaid programs in the United States.

Medicare price-setting in the United States has been characterized by its critics as “dumb price-fixing,” although it is not clear to me that the price-discriminatory practice in the private insurance markets represents more intelligent price-fixing.

Price-setting by Medicare has also been decried as a Soviet approach to pricing, and I fully agree that it is. It may be all the more surprising, therefore, that this system was imposed on the fees Medicare pays hospitals in 1983 by none other than President Ronald Reagan’s administration. The president at the time must have deemed it a good system.

In the meantime, it has been widely imitated by other health systems around the world.

President George H.W. Bush’s administration in 1992 imposed a similar system – the Medicare fee schedule based on the so-called Resource-Based Relative Value Scale on Medicare’s payments to physicians. Most private health insurers now use that scale to set or negotiate their own physician fee levels.

Unilateral, administrative price-setting shares with an all-payer system the advantage of simplicity in claims processing and, thus, lower administrative costs. Both methods furnish the ideal platform for common claims forms and electronic billing.

A major disadvantage of unilateral price-setting is clear from its name: providers may feel that they do not have sufficient say in determining the level of prices at which they are compensated for their services or products, even though they may be able to influence those fee levels by lobbying Congress.

A further disadvantage is that any administrative mechanism operated by government tends to be less flexible than would be negotiations among insurers and providers. It is not that people working in government agencies are inherently less capable than are their private-sector counterparts. It is so because governments must above all seem fair to all parties in its decisions and also fully transparent. Private parties do not labor under these constraints.

While I am on record as favoring the quasi-market approach to setting fee levels on health care, I recognize that honorable people can differ honorably in their evaluation of these approaches.

I am persuaded, however, that the opaque, price-discriminatory and administratively unwieldy – and hence very expensive – payment system of individual negotiations over fees has not served Americans well during in the last few decades.

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