Medicine and the market: New data show the price ain’t right

I recently read what I think is 2015’s best article regarding the business of health care. “

,” by Zack Cooper, PhD, and colleagues, uses claims data to analyze the variation in hospital prices across geographical areas. Its conclusions include the not very surprising statement that there exists significant price variation for identical services based on geographical area and the observation that markets that are dominated by a single hospital system have higher prices. 

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So why is this such a great article? Why do I think that every residency director should include this article in next month’s journal club and all of us small-town urologists should take 10 minutes to read it? Because this article will change the debate regarding the best way to regulate the cost of health care.

First, some background, and for this let me send you to a great New York Times article, “The Experts Were Wrong About the Best Places for Better and Cheaper Health Care.” It is well documented that Medicare health care costs vary significantly across geographical regions. The best research on this topic is done at The Dartmouth Atlas of Health Care, which has an incredible interactive website that allows you to look at Medicare health care costs by region, hospital, or topic. This data allows researchers to then identify hospitals and regions that provide excellent care (for Medicare patients) at low costs.

While this is excellent data and the researchers at Dartmouth deserve significant credit for compiling it, the data they use is inherently limited because, as noted in the Cooper article, Medicare covers only 16% of the population and only 20% of health care spending. Hence, while no one is questioning the validity of the data presented by the Dartmouth Atlas of Health Care, many groups have questioned its relevance given its limited applicability to the real world, where 60% of the population has private health insurance.

Next: What makes this article so interesting?

None of this information regarding Medicare cost variation is new, and all of its limitations are also well known. So what is so interesting about the Cooper article? Quoting the abstract, “We use insurance claims data for 27.6 percent of individuals with private employer-sponsored insurance in the US between 2007 and 2011 to examine the variation in health spending and in hospitals’ transaction prices.” (My italics added for emphasis). Up until now, the pricing data between hospitals and private insurers has been unknown, given that it has been considered commercially sensitive and the result of direct negotiations between hospitals and insurers. This is in stark contrast to Medicare costs, which are set by a public regulator through a complicated but public process.

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What did Cooper and his colleagues discover? To start, health care spending for privately insured patients varies by a factor of three across all regions, but this variation does not correlate with the variation in spending by Medicare across those same regions. As a result, while Grand Junction, CO has the third lowest spending per Medicare beneficiary (out of 306 regions reviewed), it ranks as 43rd highest for private insurance. The New York Times article I mentioned has a great interactive tool to see how your hometown does. (My hometown, Colorado Springs, does very well, being cheap for both Medicare [59^th lowest] and private insurance [87^th lowest] and is one of the few cities where a correlation exists between Medicare and private insurance costs.)

The finding that there exists a lack of correlation between Medicare and private insurance costs may explain why efforts by the government to duplicate cost savings across the health care system as a whole by using lessons learned from Medicare pricing hasn’t worked and won’t work. They are different systems. One is controlled by the government and the other by the market. Variation in Medicare costs can be explained by variations in volume of treatment, whereas variation in private insurance costs is due to the variation in transactions costs (ie, the negotiated cost of the procedure).

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The last interesting observation from this article is that hospitals in monopoly markets charge 15% more than markets with more than four hospitals. Adam Smith’s invisible hand strikes again. None of these conclusions should surprise any physician who runs his own business, as we all know that significant variations exist in the contracts that we sign between providers and insurance companies and that those of us who are lucky enough to practice in regions with multiple insurers or hospitals have an advantage over regions where a single health insurance company or single hospital dominates.

Next: "The article shows the importance of understanding the role the market itself plays in health care costs."

With that in mind, why do I think this article will change the debate on how to regulate health care delivery? The article shows the importance of understanding the role the market itself plays in health care costs. Insurance companies are merging. Why? I do not believe these mergers are happening to help insurance members but rather to allows the companies to reduce their own back-office costs and strengthen their bargaining power in regions they dominate.

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Many physician groups are merging (something I myself advocated in a previous blog) for the exact same reasons. In fact, some of the variation in costs in Grand Junction may be explained by the fact that some physicians in that area formed a larger group called Primary Care Partners, which allowed them to negotiate better payment rates from insurers than its members could have gotten alone (as explained by the New York Times article).

Overall, the Cooper article shows that efforts to reduce costs in the Medicare system will likely not translate into cost reduction in the private insurance system because the factors driving costs are not the same.

For completeness, the Cooper article is not perfect by any means. It only includes data from 27% of private insurance costs and does not include any non-employer-sponsored prices (such as that found on the Obamacare exchanges), so the ability to generalize even this data is limited.

Having said that, I hope this article awakens our friends in government that the solution to controlling the health care system’s costs is not more regulation aimed at turning all plans into Medicare but rather less regulation aimed at increasing pricing and outcomes transparency and allowing the market itself to dictate costs.

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