William CleverleyI read with great interest Stephen Brill’s exposé on healthcare costs in the March 4 issue of TIME magazine, “Bitter Pill: Why Medical Bills are Killing Us.” I have been deeply involved with healthcare financial issues for the past 40 years as a professor of healthcare finance at Ohio State University (1973 to 2001) and as the president of a firm that helps over 300 hospitals set CDM prices. We have received comments from many of our clients looking for a reaction to Mr. Brill’s indictment of hospital pricing, and my purpose in this communication is to react to the article. 

The article was well written and for the most part accurate in what was stated. Hospital CDM prices are very high and to be honest are not usually related to cost in any uniform and logical manner. A number of specific uninsured or underinsured hospital bills were used throughout the article to illustrate flaws in the healthcare/hospital system—e.g. high CEO salaries, profiteering by not-for-profit hospitals, medical technology, etc. Most of these issues have been cited for a long time and in a large number of both academic and nonacademic media. Although the article highlights those uninsured or underinsured patients who were faced with large hospital bills, no mention is made of the countless cases of patients without insurance who do not pay.

Cost shifting is the primary cause of high medical prices and was never really acknowledged in this article. Governmental payers, largely Medicare and Medicaid, do not pay the full cost of delivering care. Even the federal government recognizes that it pays less than cost.  MedPAC in its 2012 report showed that not-for-profit hospitals had a negative 6.5 percent margin for the period of 2006 to 2010. The burden of nonpayment by government and the uninsured must be shifted to patients with private insurance coverage. Many of the insurance firms operate as oligopolies in their markets and receive large discounts from provider prices. Prices are raised not to push this burden to the uninsured who pay less than 5 percent of their charges—or 15 percent of actual costs, but rather to recover from the commercial payers who may pay on a discounted charge basis. Medicare and Medicaid continue to pay a smaller percentage of their cost, and insurance firms demand larger discounts from billed charges, which further escalates the rate increase. In short, provider charges are increasing, but actual provider payments are increasing at a much smaller rate. 

Mr. Brill indicates that many hospitals operate as public utilities, a concept that I would endorse. In fact, we conduct a “Rate Defensibility Study” for our clients as part of the pricing engagement. We believe that, if a hospital is not making excessive levels of profitability and it does not have excessive costs, then by definition it must have a defensible revenue structure. This is the same type of process that a Public Utility Commission would pursue in approving rates. Please note, however, that a defensible revenue structure does not necessarily equate to low prices, because the hospital may be faced with a high percentage of Medicaid and indigent patients, which will require cost shifting. 

There are two tests for determining whether a hospital’s prices are defensible, involving two questions:

  • Is the hospital making too much money?
  • Does the hospital have excessive or unreasonable costs?

Mr. Brill tries to answer these questions but in an anecdotal fashion.  For example, he cites profit margins for many of the hospitals singled out in his article and indicates that they are high. Perhaps part of the problem may be the methodology used to define margins and profit. He references an IRS tax return for Stamford Hospital with a Sept. 30, 2011, year-end. I am assuming that this is the IRS 990 report. Mr. Brill stated that Stamford realized $63 million in operating profit on revenue of $495 million. The actual report shows $37.6 million of revenue over expenses for a profit margin of 7.6 percent, far lower than the 12.7 percent reported by Mr. Brill. To be sure, this is still a high margin relative to other U.S. not-for-profit hospitals, but it is not typical of most not-for-profit hospitals. 

Mr. Brill also made a generic statement about profit levels in not-for-profit hospitals. He states that a McKinsey study showed 2,900 not-for-profit hospitals with higher operating margins than 1,000 for-profit hospitals. Data derived from Medicare cost reports in 2011 contradict this finding. 

median operating margins

Second, Mr. Brill does not focus on the reasonableness of costs. Costs can be unreasonable for three primary reasons: 

  • The actual services provided may not be medically necessary
  • The level of resources used to provide services may be excessive, e.g. high staffing levels.
  • Payments for actual resources used can be too high, e.g. high salaries.

There is minimal discussion of medical services being provided that were not medically necessary. There is much more discussion about whether the costs were proper—e.g., whether the hospital paid too much for the resource used. It is in this area that Mr. Brill spends much time outlining what he believes to be excessive compensation. For example, the CEO of Stamford hospital received $1.86 million in 2011, which Mr. Brill clearly regards as excessive. Although we cannot comment on the merits of the CEO’s salary, it is useful to point out that total salaries at Stamford were $181 million and total expenses were $495 million. Slicing key executive salaries by 50 percent would most likely not have a material effect on total expenses. Executive salaries may be a lightning rod for attention, but they rarely have a significant effect on total expenses and therefore pricing. 

My overall reaction to Mr. Brill’s article is that it did not really provide any new information about why medical bills are killing us. In fact, I believe that it confuses the issue with anecdotal stories that make for interesting reading but little substantive analysis. 

William O. Cleverley, PhD, is president, Cleverley & Associates, Inc., Worthington, Ohio.

Publication Date: Wednesday, March 20, 2013