Explaining why America’s healthcare is so expensive

For the past four or five years or so, there has been intense interest and debate online about why healthcare in America is so expensive, and what can be done about it. Sites such as Vox and The Atlantic frequently publish articles trying to diagnose America’s healthcare cost problem. Scott has written many posts about rising healthcare costs, what he and others call ‘cost disease.’ Everyone has explanations, and there is no shortage of anger and blame to go around, but there’s nothing resembling a definitive answer about why healthcare in America is so expensive. I cannot lay claim to having such an answer, but I think I can provide some additional insight into explaining the problem and putting it in the correct context.

Consider these two recent stories of Americans being slapped with huge hospital bills:

Alan Grayson: My broken leg cost me an arm and a leg and Summer Bummer: A Young Camper’s $142,938 Snakebite. The story about the snakebite hospital bill went hugely viral, as further evidence of the intense interest and debate about healthcare in America today.

Regarding the first article, Alan writes:

The hospital bill was $69,240.

 

As a former economist, I can verify that in a free market, competition is supposed to drive prices down to the cost of production. What did my hip replacement cost the hospital? It had to pay for:

 

•The nurses, but there certainly were fewer nurses than patients, so at most we’re talking about three days of nurses’ pay.

 

•The mass-produced metal and plastic implants.

 

•The medicine, which was minimal (I don’t like opiates).

 

•My gown, eight meals, and electricity and water for my room.

 

•One hour in a surgical room, and three days in a hospital bed built in 1993. Amortize the bed cost of perhaps $100,000 over 24 years, and it works out to $11 a day.

 

The doctors billed me separately, and the hospital is a nonprofit that doesn’t pay taxes.

However, he fails to realize that:

This list of expenses is hardly exhaustive and excludes things such advertising, insurance, leases, and other expenses that involved in running a hospital and that are passed down to patients.

Second, he’s implying that hospitals, including non-profits, have profit margins in excess of hundreds of percent because patients are being billed astronomical sums, but the data shows that the majority of American non-profit hospitals have profit margins of just a few percent. HCA Hospitals, a publicly traded provider of healthcare services, has profit margins of around 8%. Yes, apparently charging $69,240 for a hip replacement isn’t as lucrative as it seems. So why is this. The answer also explains why healthcare is so expensive, because the quoted price is seldom what anyone actually pays in full. Almost no one pays the quoted price. Alan Greyson paid nothing. Neither did the parents of Oakley Yoder, who were billed $142,938 and paid nothing. In both cases, the price was negotiated down significantly and covered by the insurer, minus some possible copays and deductibles that are negligible by comparison.

Here’s a visualization of how the process works:

The bill is negotiated down 78% by the insurer, and the patient pays just 4% of the original bill. What an awesome deal. It also explains why hospital profit margins are not that high, because obviously the hospital is not getting all that $8,100.

In fact, someone who is uninsured can also negotiate, or not pay at all, and there is nothing the hospital can do besides try to collect the money through debt collection agencies, often settling for pennies on the dollar. Many states have homestead laws and various exemptions, which can make debt collection very difficult, if not impossible. Furthermore, hospitals must provide charity care, and in 2013, the cost of “uncompensated care” provided to uninsured individuals was $84.9 billion. In 2016, community hospitals provided more than $38.3 billion in uncompensated care to their patients. This is treatment for which no payment is received. Even Medicare and Medicaid leave hospitals short-changed. According to the American Hospital Association, “Medicare and Medicaid underpaid U.S. hospitals by $76.8 billion in 2017. Medicare underpayments totaled $53.9 billion and Medicaid underpayments $22.9 billion for 2017.” Such costs are passed to patients and private insurance companies in the hope someone with deep pockets will pay the bill as quoted without negotiating.

I’m sure many have seen tables that show how US hospitals charge more for certain procedures, compared to foreign countries. The good ol’ hip replacement (a favorite example given) costs 35% less France than in the US. However, the obvious difference is, there is less negotiating power. It’s not like an American can travel to France and then haggle down the price of his surgery by 50%. Rather, the prices are set by the government, and most private healthcare providers require that uninsured patents pay prior to treatment.

 

Third, Greyson erroneously blames a lack of competition, yet Apple dominates the premium smartphone market, but it’s not like smartphones have gotten too expensive relative to inflation. Same for Nike shoes or personal computers. For example, despite Windows having 92 percent of OS market share, the full version of Microsoft Windows 3.0 in 1990 cost $150, but a copy of Windows 10 only costs $120-200, so adjusted for inflation prices have actually fallen.

Hospitals are not intentionally ripping off patients when they charge these huge sums. Rather, they are trying to regroup costs, because the discounts and negotiations are so big. To put this in perspective, imagine going to a car dealership and haggling down the price by 80%, or in some instances, getting a $50,000 car for free. The dealer is going to go out of business unless someone pays the MSRP. Do you think you can go to an Apple store and demand a 50-80% discount on the latest iPhone? Of course not. Sure, Apple could discount it by a lot and still be profitable, although much less so, but it’s implicitly understood by consumers that the sticker price is what is paid and is non-negotiable. If Apple were forced to discount or provide charity iPhones, they would certainty have to raise prices to keep profits the same.

When one considers that patients pay so little-due to insurance, negotiating, defaulting, or charity care–American healthcare, despite the high sticker price that is almost never paid in full, is a good deal [imagine going to a store and trying to negotiate a 50-80% discount or free stuff...you would be laughed out]. Again, this is not a definitive diagnosis of America’s healthcare cost problem, but perhaps a piece of the puzzle.