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Does Medicare Pay Below "Cost?" (Wonky!)


Over at Movin' Meat, Shadowfax has a useful reply to my post on Medicare's method of payment. In particular, he makes the important point that Medicare overpays many specialists and underpays many primary care providers. Agreed. In fact, one of the important and quiet wrinkles of health reform will be how it redresses that imbalance. If you want an affordable health-care system, you can't have your largest insurer tilting the playing field toward specialty care.

But he ends his post the wrong way. "Yes, Ezra," he says. "Medicare does work by dictat." But no! It doesn't! Hospitals and doctors are not forced to accept Medicare's rates by Medicare. (It is true, as Shadowfax says, that many hospitals choose to contract with Medicare and thus the doctors who practice at hospitals have to do so as well. But that's a rather different situation.). There may be a lot of reasons a doctor ends up working with Medicare, just as there are many reasons a supplier ends up working with Wal-Mart. You can argue that they're good reasons or bad reasons, and that policy should or should not change them. But the reasons are not that the law says they have to accept Medicare patients. And that's the argument I'm addressing here.

I also want to say a word on this idea that Medicare pays hospitals "below cost." You can see it clearly in the Blue Cross/Blue Shield slide that mbp3 contributed in comments. "This would seem to be at odds with your post," he/she wrote. The graph is very simple, as you can see. There's a dotted line marked "cost." Medicare is below it. Blue Cross Blue Shield is above it. But the argument here boils down to a very simple question: What is "cost?"

On March 17th, Glenn Hackbarth, the chairman of MedPAC, testified before the House Ways and Means Committee on this very issue. Hospitals, Hackbarth argued, are inefficient. Their costs are too high. And this was backed up in the data. "MedPAC analysis has identified a set of low-cost hospitals that consistently out-perform other hospitals on a series of quality measures, including mortality and readmissions," Hackbarth explained. "Among this set of hospitals, we found that Medicare payments on average roughly equaled the hospitals’ costs." In less "efficient" hospitals, Medicare's payments were below costs. You can see this in the following table:


Among the major differences between "efficient" and "non-efficient" hospitals was that the less-efficient hospitals were not under financial pressure: They made a lot more money from other sources. As such, they spent a lot more money on things like capital expansion. As example, compare the amount a young journalist spends to the amount a young investment banker spends. The banker requires more income to break even on that lifestyle. His "cost" is higher. But he doesn't need that lifestyle. He doesn't need that "cost." And if that banker is being paid on taxpayer dollars, I don't want him to have that lifestyle. I want him to have what he needs, rather than what he wants. Because I'm paying for it.

And so too with Medicare payments. Indeed, what MedPAC found was that hospitals under "financial pressure" -- hospitals that made less money, in other words -- managed to control their "cost" better. Medicare's payments sufficed for them. And their quality outcomes weren't any worse.

Put another way, the question is simple enough: Do you think hospitals are efficient? My read of the evidence is that they are not. "Cost" is too high. I think we need to cut costs. I think that the health-care system needs to spend less money than it currently spends. Another way of saying that is I want the system to begin paying below projected "cost." That, after all, is how you save money.

My read of the data is that there's sufficient room to do that without harming quality. The fact that the vast majority of hospitals continue to accept Medicare patients proves that, I think. Medicare's rates aren't where they'd like them to be. But it's still worthwhile for them to do business with Medicare. That suggests there's significant space between where hospitals are today and where they could be in a more efficient system.

That's not true for everyone, of course. As Hackbarth admits, Medicare underpays primary care providers, and it needs to redress that balance. And Medicare itself does a lot to increase costs across the system (in particular, it's fee-for-service payments give doctors incentive to increase volume). But in the aggregate, I think it's a feature, not a bug, that Medicare's payment rates are pushing hospitals to close that cost gap.

For people who want to dig deeper on this, Hackbarth's testimony is here.

By Ezra Klein  |  July 1, 2009; 6:54 PM ET
Categories:  Health Reform  
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Ezra, do you know what "rationalization" is? It really appears like you are grasping at straws to prove that Medicare rates are sustainable.

In the end, you're going to have hospitals staffed with the best, most expensive and anal accountants, paying nothing to mediocre doctors (speaking with thick, unintelligible accents). And you honestly believe you're going to get the same quality you get today?

Well hell, if we just lowered the standards of care today we could achieve all that without any government plan!

Posted by: whoisjohngaltcom | July 1, 2009 7:16 PM | Report abuse

The issue I have with the graph is that it labels the breakeven line as 'payment=cost'. Having worked with hospitals for years, I know that they have a near impossible time determining what the cost of a room is. For example, hospital xyz is built and 70% occupied....what is the cost of filling the next room? I guarantee you hospitals ignore what economists would call marginal costs and claim the cost of the first room is the same as the cost of the last room.

Ignoring that issue, though, and trying to address johngalt's point: we have private (129%), Medicare (92%) and Medicaid (87%). I am too lazy to do an exact weighted average but since Medicare/Medicaid control just under half of total health care spend, lets assume the current weighted average payment is around 110-112%. I think your position is: is there enough inefficiency in the system that paying Medicare rates will suffice and hospitals can survive on that? Perhaps. Perhaps not. But claiming that squeezing the status quo is impossible makes no sense either.

Health IT, appropriate closing of aging/poorly located facilities alone would squeeze out quite a bit of cost. And this would not adversely impact quality. If anything, it would improve it.

Posted by: scott1959 | July 1, 2009 7:33 PM | Report abuse

Clarification to my earlier post: in the second paragraph I reference "your position".....the you I am referring to is Ezra.

Posted by: scott1959 | July 1, 2009 7:34 PM | Report abuse

Seriously Ezra, you're twisting yourself into little circles here. Hackbarth said that even the best-performing hospitals are only nearing the break-even point. So even in the best case scenario you're paying maybe at cost.

I take Medicare patients, and especially Medicaid patients, as a service. We're not even talking about opportunity cost (ie giving up on higher paying private patients to see a lower paying patient), we're talking about LOSING money so that I can spend less my time with my family.

I understand that based on your qualifications as a guy with a computer you have a near perfect grasp of this situation, but please, please just listen to the doctors on this one. I'm agnostic on the public option (I think there are more important reforms but wouldn't mind seeing it passed), but I think we should stop pretending that the cost savings associated with it are magical. The governments gets a huge percentage of its patients by dictating its rates at a very low rate.

Posted by: CarlosXL | July 1, 2009 9:35 PM | Report abuse

When my husband broke his ankle three years ago, the EOB/bill was many pages long, totaled more than $20K and included things like an $80 ACE bandage (something available at Walgreens for about three bucks.)

Before my husband was discharged, his surgeon prescribed a prophylactic IV antibiotic treatment - since they put a metal plate in his ankle - they wanted to zap it of any possible infection.

The nurse, before starting the treatment, wanted to know if my husband was okay with this - if they went forward with what the doc ordered, he would be billed an additional day for the room.

Why the nurse asked him this question is a mystery. Her supervisor, who I had a long chat with, acknowledged that we were ALREADY paying for the room.

Perhaps I am overly cynical, but my feeling was that she was attempting to rid the room of this paying patient to open it up for another paying patient (it had been an icy March day, with at least 8 people in the ER with just broken ankles - and many more being treated for the various other things one sees in the ER.)

Nothing like double-billing for a room!

While my husband was overnight in the hospital for this broken ankle, every medical professional he saw ignored a gash in his cheek. Never cleaned it or bandaged it up.

I do not understand how hospitals develop their pricing structures. I think they don't really understand it either, leading to gross inefficiencies and less than ideal treatment.

Can miraculous things happen in hospitals? Yes, most definitely.

Are they efficient? No.

Another key question to explore, Ezra - the profits of health insurance companies. I'd really like to know what their profits have been in the last few years. And I'd REALLY like to know why the CEO of UHC got $124 million in compensation in 2005. Has he gotten a raise since then? What does the CEO of BCBS make?

These are aspects of health care costs that no one is mentioning, for whatever reason....

Posted by: anne3 | July 1, 2009 9:55 PM | Report abuse

1)There is Part A and B over and underpayments, important distinction. Shadofox talks about docs, you are referencing hospitals.

2) I would argue that rather than folks going to MCO's because they maintain higher price points, and thus "better" networks, there will be a collective drop in reimbursement across the board. Why do people persist in thinking private FFS business as usual will still continue under future payment re-jiggering?

3) "Docs will leave Mcare!" Yeah, and go where? How about this, health care reform will equal less pay for many. In this discussion, the premise is a radiologist making 400K in 2009 will make 400K+ in 2010, and forward--and will ply his or her wallet-craft elsewhere if reimbursement is unsatisfactory. Wanna bet. No one seems to question that some income levels are plainly out of sync with current optics. Yes, free market, and yes, hard working, times are gonna change.

Posted by: BradF1 | July 1, 2009 10:02 PM | Report abuse

BTW, the AMA is now open to a public option. This could be seen coming from a mile away, although people were getting themselves into a little AMA trashing fit.

Posted by: CarlosXL | July 1, 2009 10:34 PM | Report abuse

anne3 - You appear not to have considered that the nurse was asking because not everyone has solid gold insurance and their co-pay would be far greater. Even worse if the insurance company feels it was excessive and denies payment, leaving you to foot the bill.

Posted by: copperred | July 1, 2009 10:50 PM | Report abuse

Marginal cost and marginal demand set the price. If the model is to find the lowest cost provider, etc., that provides some standard of care, and pay everybody that amount, then we can expect supply to decline precipitously, as everybody but the LCP goes out of business.

Instead, prices have to be high enough that we get the supply we need. Competition still works fine, because lower cost producers have higher profits, therefore easier access to capital, therefore they can expand and drive out less competitive providers.

That seems pretty basic, and independent of how evil you think the Blues are.

Posted by: lfstevens | July 2, 2009 12:09 AM | Report abuse

Ezra makes a critically important point here. We cannot take the current cost structure for granted. After all, our primary problem is this conundrum: we pay 19% of GDP for healthcare and insure about 85% of our people to one degree or another, while other "western" nations pay about 10% of GDP for healthcare and insure 100% of their people, and the overall quality of care and life expectancy are the same (a little better in some places, a little worse in others).

When you buy a car in Europe and America the cost is pretty similar, accounting for exchange rates and taxes. When you buy a microwave, same deal. In fact, for the vast majority of consumer goods prices are very similar, once accounting for exchange rates and taxes.

But when you buy (utilize) a hospital room, or blood test, or knee surgery, it costs anywhere from 50% to 300% more in the US than in Europe. We're higher than single-payer countries and multi-payer countries alike. And don't say it's because we're insulated from costs, since Europeans are if anything more insulated from costs.

So why the hell does anyone think our cost structure reflects what healthcare really has to cost here? The ignorance and logical incompetence are astounding.

Posted by: jdhalv | July 2, 2009 12:38 AM | Report abuse

By the way, Ezra - not that you're keeping tabs - but I'm the same person who used to post under 'jd' on your old blog.

Posted by: jdhalv | July 2, 2009 12:40 AM | Report abuse

Let's not forget that Hospital costs are so high because of all those people without insurance, who rely on the emergency rooms, and whose bills often can not be collected. This unfunded part of the hospital's operational costs of effectively are subsidized by the paying customers. If everybody would have healthcare insurance, this would result in hospital bills showing a fairer picture of the true costs for every patient, and in an reduction of the amounts.

Posted by: Gray62 | July 2, 2009 4:48 AM | Report abuse


Almost all Hospitals are supposed to be non-profit. Which means they're supposed to do everything at cost by definition. All the others got into this sector knowing full-well they'd be competing against non-profits. Forgive me if I don't care that none of those guys are turning a profit.

I gladly listen to Doctors when they're talking about the medicine. But they have a horrible track record when it comes to fixing the health system. Remember tort reform was supposed to fix everything? Then it got passed. And it fixed nothing.

And Carlos, I feel for folks who played by the rules and still got screwed when the economy changed. I'm from Detroit. Most of the people I know are auto workers. They did exactly what they were supposed for literally decades. They had a contract. It said you put 20 years in at the plant and we'll give you a decent pension and health care for life. And they put in their 20 years. Then the economy changed. Now instead of enjoying their golden years they're fighting tooth and nail for crappy hour jobs, and praying they don't get sick before they hit 65.

It's clear the US Health Sector needs to change. It's just not sustainable. Which means a lot of American health workers are going to be screwed. They were counting on double-digit increases in health care costs to put their kids through college. And it just ain't gonna happen.

Recessions suck.

Posted by: NickBenjamin | July 2, 2009 6:15 AM | Report abuse

"So why the hell does anyone think our cost structure reflects what healthcare really has to cost here? The ignorance and logical incompetence are astounding."

See, the great thing about the free market is anyone should be able to answer that question by going down to the corner, hanging a shingle, and getting rich beyond their wildest dreams by simply undercutting everybody else whose service costs more than it supposedly "has to."

But maybe it *does* "has to" cost this much. Maybe doing the actual medicine part any cheaper just results in higher regulatory fines and higher legal costs. Maybe the "has to" problem is that government says providers "has to" deliver a very high, very uniform level of care to stay in business.

Maybe the standard of care is the thing that's unsustainable. After all, aside from some experimental procedures and aesthetics like the quality of the hospital food and in-room cable, isn't the technical standard of care for the poor the same as for the rich? I think they are, which begs the question: Are we all getting a rich standard of care or a poor one?

And I think the cost reflects that we "has to" get a pretty high standard of care. Or, in other words, cheaper care is illegal.

On one side of the coin, it's against the law to victimize the underinsured with substandard care. We value equality more than that. Sounds -- well, *fair*. But sometimes when you look at the exact same thing in a different light you see that it has other implications: On the other side of the same coin, there are 47 million people for whom it is illegal to purchase the level of care they could afford.

How -- well, *equal*.

Posted by: whoisjohngaltcom | July 2, 2009 8:38 AM | Report abuse

"Let's not forget that Hospital costs are so high because of all those people without insurance, who rely on the emergency rooms, and whose bills often can not be collected. This unfunded part of the hospital's operational costs of effectively are subsidized by the paying customers. If everybody would have healthcare insurance, this would result in hospital bills showing a fairer picture of the true costs for every patient, and in an reduction of the amounts."

There's a certain total amount of care being provided, and a total amount of money to pay for it all. "If everybody would have healthcare insurance," then these people would receive more care. But the losses due to cost shifting only go down if they end up paying even more into the system to cover it.

The losses, from cost-shifting non-paying insurees onto paying insurees are even greater than shifting the uninsured onto paying insurees, since insurees consume more care.

You have to get into some pretty questionable stuff, like "well, they'll be more productive when they're healtier", etc., to suggest that simply covering the uninsured will decrease losses. They have to pay more, too, or they just become a bigger liability.

Posted by: whoisjohngaltcom | July 2, 2009 9:07 AM | Report abuse


If you want a market system, you can't have the buyers so separated from cost. Check out this graph:

The problem is a mixed system, you can't have an indiscriminate buyer, like a teenager with a credit card, buying from a market system and expect for overall costs to go down. Even with pre-negotiated prices, the incentive for the buyer is to get as much as they can.

Posted by: staticvars | July 2, 2009 9:44 AM | Report abuse

i know i am oversimplifying but
let me see it i understand this debate

the government "unfairly dictates" reimbursement for services at less than cost

for-profit insurers "enthusiastically reimburses" for services at a rate that allows large margins above cost

wow! now i see why so many people go to the church of free market capitalism

wow! the wonders

Posted by: jamesoneill | July 2, 2009 10:01 AM | Report abuse

I think I'd add to Scott1959's point about the unknowability of cost the issue of patients seen at hospitals outside those patient's insurance network. Since the hospitals have no contract with that patients insurers, it's somewhat of a free for all (less so if Medicare is involved) in terms of what they can bill the patient or the patient's insurance. Unfortunately, it's become a bit of a financial release valve for the hospitals and, often, the patient ends up with the short end of the stick.

For example, you could have an infant admitted to a NICU at a non-par hospital (per EMTALA) and easily rack up a $1 million bill in a few weeks. This 'release valve' strategy has caused hospitals to cost shift their poorly negotiated contracts with insurers onto the non-par patients which, in addition to occasionally screwing them as they get a bill for a service vastly more than what Aetna might pay for the same service, also further distances the cost of that service with reality.

Posted by: ThomasEN | July 2, 2009 10:34 AM | Report abuse


Medicare reimbursement is a very complicated picture, and Shadowfax points out the main problem -- it pays better for some things, and worse for others, so how well an individual hospital or doctor does with Medicare depends on the mix of services each provides. One of the ways Medicare tries to obscure this fact isby focusing on inpatient margin for hospitals, thus completely ignoring what may be substantial losses on outpatient services. In general, Medicare "overpays" for some inpatient services and underpays for lots of outpatient and physician services. If, as a provider, you do a lot of outpatient/physician services, you are not doing well off of Medicare. The problem with this is that the direction of medical technology is unambiguously driving us from inpatient to outpatient to doctor's office. Medicare's payment policies not only ignore that secular trend -- they mitigate against it by incentivizing hospitals to keep as inpatient services that are just fine for the outpatient setting. This drives up costs in the long run.

Posted by: rdbacon66 | July 2, 2009 10:38 AM | Report abuse

I think this fact sheet is a useful look at MedPAC's analysis of this issue.

Key points

MedPAC concluded, “Increasing Medicare payments is not a long-term solution to the problem of rising private insurance premiums and rising health care costs. In the end, affordable health care will require incentives for health care providers to reduce their rates of cost growth.”

Hospitals with the greatest resources are less aggressive about containing costs and therefore have the highest Medicare ‘losses’ (the difference between Medicare rates and a hospital’s average costs). The most profitable and powerful hospitals spend more and increase their costs per unit of service. Hospitals with high profits, low financial pressure, large endowments or robust fundraising have the highest costs, and a higher cost base leads to lower Medicare margins. If Medicare were to increase payment rates, hospitals with market power would be unlikely to voluntarily cut prices charged to insurers and reduce revenue. Instead, hospitals might spend some or all of that revenue, pushing costs higher still.

MedPAC reports that Medicare aims to establish payment rates that cover costs that reasonably efficient providers would incur in furnishing high-quality care, thereby rewarding providers whose costs fall below the payment rates and giving an incentive to those with costs above the payment rates to become more efficient.

Although efficient hospitals have lower costs, they often deliver better medical care, MedPAC found in a separate study. In a review of 300 hospitals that performed well on a mix of quality measures and costs, the agency found these hospitals tended to have lower patient death rates than other hospitals.

Posted by: alexlawson | July 4, 2009 10:50 AM | Report abuse

@NickB - Given that so many providers are "non-profit", that implies that "profit" is not the problem in health care...

Posted by: lfstevens | July 4, 2009 7:10 PM | Report abuse

"MedPAC analysis has identified a set of low-cost hospitals that consistently out-perform other hospitals on a series of quality measures, including mortality and readmissions," Hackbarth explained. "Among this set of hospitals, we found that Medicare payments on average roughly equaled the hospitals’ costs."

The Liberal Magical Hospital Theory:
1. Hospitals save more lives by cutting costs to the point that even Medicare is profitable.

Occam's Razor theory:
1. Hospitals that specialize in the most highly reimbursed procedures lose less money, and
2. Hospitals which are losing less money can provide better care.

The smart money's on Occam, Ezra.

Posted by: whoisjohngaltcom | July 5, 2009 9:58 AM | Report abuse

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