Over the past year, the media has been captivated by substantial variation in pricing or the cost to employers and patients of particular healthcare services.a


Cries of market failure and exhortations for transparency in pricing ensued, based on a presumption that patients might self-direct to lower-cost care should they better understand pricing, thereby saving billions of dollars.

But would cost savings really result? To figure that out, it is critical to understand what healthcare prices really mean, how consumers respond to price differences, and whether that response might reduce costs in the long run.

The Meaning of Healthcare Prices

To interpret prices, consumers first need to understand how prices are determined. That means understanding that, within the pricing structure for any given provider, government payers pay less, private payers pay more (but use prices to negotiate discounted payments), and all patients are charged the same amount for the same service. Consumers also need to understand that providers try to set prices so that the discounted revenues they receive cover the anticipated costs of delivering services. Providers might negotiate different discounts on services for different purchasers, based on anticipated total volume. For example, based on anticipated use of all services, insurers might receive different discounts on MRI services. Finally, providers know that very few patients pay full prices, and most who might be charged the full amount have the option of minimizing their costs by making price comparisons among providers. For instance, although the strategy is not widely used, an uninsured patient who needs elective surgery might obtain estimates from a number of providers and choose the lowest-cost provider. 

An apt analogy is the way two grocery stores might price apples and steak. One store might price apples inexpensively to lure customers in for steak; another store might use the reverse strategy. The pricing is influenced by the relative availability and cost of apples and steak, the relative markets for each, and assessments of the impact that pricing might have on overall market share. These considerations hold sway because grocery stores, like healthcare settings, have relatively high fixed costs that are spread more thinly with higher sales volumes. Finally, in both markets, different customers might reasonably pay different prices: Pricing for an apple may vary based on consumer loyalty, volume of apples purchased, use of coupons, or even negotiating ability.

Like grocery prices, healthcare prices do not accurately reflect production costs, relative work effort, or value—and few buyers actually pay full price. However, unlike food items, most healthcare goods are not substitutable, and their use is not determined primarily by consumer preferences. Because health insurance distorts costs of health care considerably more than coupons or volume purchasing distort costs of food items, consumers may experience very different out-of-pocket costs based on the current status of their deductible or the type of insurance they have. For example, an MRI might cost a patient $1,500 at the beginning of the year, but $20 after the deductible has run out. Although differences in the costs that patients actually pay might influence consumer behavior, the lack of a relationship between prices of individual healthcare services and consumer costs makes it hard to imagine that greater price transparency would serve much purpose in consumer choice, unless prices serve as an indicator of quality.

How Consumers Respond to Price Differences

Although full prices are not typically experienced by patients, expenditures in the form of premiums, copayments, and coinsurance are. The RAND Health Insurance Experiment found that consumers do respond to differences in out-of-pocket costs.b Unfortunately, consumers are as likely to reduce out-of-pocket costs by avoiding needed care as by avoiding unnecessary care. Further, there is no indication that quality is associated with costs; indeed, lower healthcare costs have been associated with higher quality.c

The problem is compounded by consumers’ common tendency to consider only immediate costs—a tendency that clearly risks substantially higher costs at a later date. By delaying a screening colonoscopy that might have identified early and inexpensively treatable colon cancer, for example, a patient risks incurring massive, bankruptcy-inducing costs from treating undetected, advanced cancer, as well as worse outcomes. More important, even sophisticated healthcare consumers may not be able to differentiate between high- and low-quality care, irrespective of what they pay. It is therefore not clear that pricing transparency at the individual service level would guide patients toward more efficient use of services, much less higher value use of healthcare services.

A Better Way

A focus on pricing of individual services is not a simple way to reduce costs for several reasons. 

First, as has been established, healthcare prices do not accurately reflect costs of delivering care, patient costs, or quality. It is unclear what information patients can derive from a better knowledge of prices. Second, health care is largely purchased through third-party payers: Pricing transparency is unlikely to inform patients about the relative value of their benefits package—knowledge that would be much more valuable to them. Third, healthcare experiences tend to occur as bundles of care; understanding prices of individual services is not as helpful as understanding prices—and out-of-pocket costs—of an entire care episode or, better yet, overall annual consumer costs for health care for an identified service population.

These are difficult concepts for even financial managers to digest. To help patients better understand costs and their true impact on their finances, it may be helpful to include the overall costs of health care in the prices of consumer goods. Executives of large companies have used this strategy, for instance, when then-CEO Rick Wagoner of General Motors reported that healthcare expenditures accounted for more cost than steel did in GM vehicle price tags.d

One could imagine a variation on the nutrition facts label that reveals the healthcare costs embedded in an item, whether steak, apples, clothing, or cars. That might raise consumer awareness of overall healthcare costs, and more explicitly convey how consumers are actually experiencing those costs. A focus on prices of individual services and their variation is likely to garner media attention, but it may distract from what is truly important: how patients experience healthcare costs. It will be important to spend time carefully developing understandable information and financial incentives that nudge both patients and providers toward more efficient and higher value health care.


William B. Weeks, MD, MBA, is a professor, The Geisel School of Medicine, Hanover, N.H., and a member of HFMA’s New Hampshire-Vermont Chapter.


footnotes

a. See, for example, Tanner, L., "Appendix Removal: Huge Sticker Shock in Study," Associated Press, April 24, 2012; "New Data Show Price Differences for Health Procedures," USA Today, May 9, 2013.

b. Newhouse, J.P., Free for All? Lessons from the RAND Health Insurance Experiment, Cambridge, MA: Harvard University Press; 1996.

c. Fisher, E.S., Wennberg, D.E., Stukel, T.A., et al.,“The Implications of Regional Variations in Medicare Spending. Part 2: Health Outcomes and Satisfaction with Care,” Annals of Internal Medicine, Feb. 18, 2003; Weeks, W.B, Gottlieb, D.J., Nyweide, D.J., et al., “Higher Health Care Quality and Bigger Savings Found at Large Multispecialty Medical Groups,” Health Affairs, May 2010.

d. Will, G.F., “What Ails GM,” The Washington Post, May 1, 2005.

Publication Date: Sunday, September 01, 2013

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