High and Rising Health Care Costs. Part 3: The Role of Health Care Providers

The first article in this series discussed whether the cost of health care is a serious problem, presented evidence that demographic factors do not explain rising costs, and summarized the debate over whether free-market principles would contain costs (1). The second article focused on technology as a cost driver and discussed whether costs could be contained through expenditure controls or global budgets (2). This third article explores whether health expenditures are high because of the market power of health care providers and reviews the mechanisms that might control the prices and quantities of health care. Perspective 7: Provider Market Power Explains High and Rising Costs Market power is the degree of influence that an organization has over another organization (3). In economic terms, it is the ability of a seller to raise prices without losing business (4). Take the common example of health insurance plans buying hospital services: If the hospital (the seller) can negotiate a contract with the insurer that gives the hospital the reimbursement (price) it wants, the hospital has market power. If the insurer can prevent the hospital from raising its price by refusing to sign a contract with the hospital (causing the hospital to lose the patients enrolled in that insurance plan), the insurer has market power. Some observers believe that provider market power explains much of the outlier status of U.S. health expenditures compared with those of other nations (5-7). According to this view, when payers have market power, costs rise more slowly; when providers or suppliers wield market clout, costs increase more rapidly. When health insurance developed in Canada, the market power of the sole payers of health servicesprovincial governmentsenabled those payers to restrict prices paid to hospitals and physicians. In contrast, the U.S. health insurance industry was initially dominated by Blue Cross and Blue Shield, institutions that were controlled by hospitals and physicians. This uncontested provider market power allowed lucrative reimbursement formulas for hospitals and physicians. These formulas were replicated in Medicare as a result of the influence of Blue Cross, Blue Shield, the American Hospital Association, and the American Medical Association over the writing of Medicare regulations (5, 7). In addition, the pharmaceutical industry has deterred most governmental regulation of drug prices by using its influence over legislators (8). The result of the historical domination of providers and suppliers over payers has been a price structure far different from that of health care in most developed nations. Provider market power can be curbed in 2 ways: by the countervailing power of purchasers and payers (governmental and private) and by governmental regulation. Regulation of hospital and physician prices began to appear in the 1980s; the countervailing power of purchasers and payers grew in the late 1980s and early to mid-1990s, but then waned. However, the prices of health services preceding those developments were already high relative to prices in other nations, and this historical gap has persisted. The following sections explore whether high health care expenditures are primarily a result of high provider prices or large quantities of services, what cost-containment mechanisms are available to control prices and quantities of services, and how effective these mechanisms are. The price control and quantity control measures explained here are closely related to the expenditure control measures described in the second article in this series (2) (Table 1). Table 1. Minding the Ps and Qs of Health Care Costs Prices of Services One important difference between costs of care in the United States and those in other developed nations is the price per unit of carephysician fees, payments per hospital day, and pharmaceutical prices (10, 11). Even though the United States does not provide a greater quantity of physician visits per capita than other nations, physician income is 3 times higher in the United States than in the average nation that belongs to the Organisation for Economic Co-operation and Development. The ratio of average physician income to average employee compensation is 5.5 in the United States compared to 1.5 in the United Kingdom and Sweden (11). Physicians in the United States receive higher fees (prices) for similar services than do physicians in other nations (11, 12). Each acute inpatient hospital day in the United States costs more than double that in Canada and almost 3 times the median of that in nations in the Organisation for Economic Co-operation and Development (11). Inpatients in the United States also receive more intensive treatment (quantity) per bed-day than do inpatients in other nations. What appears to be a price differential is in fact a mix of price and quantity differences. To help tease out the influence of price and quantity, economists have calculated comparative prices of care for particular diseases and procedures. The average price of care for an acute myocardial infarction with angioplasty is 3 to 4 times greater in the United States than in 6 other developed nations. In 9 other nations, the prices of coronary artery bypass surgery were one fifth to one half that in the United States (10). Many pharmaceutical products improve quality and prevent costly complications of chronic illness. However, the costs of these products has been increasing at a rapid pacemore than 15% each year from 1998 to 2002 (13). Comparing a similar market basket of medications, Canadian and French prices are about 60% and German and United Kingdom prices are about 85% of those in the United States. Differences are wider for brand-name than for generic products. Nations whose governments control pharmaceutical prices have reduced prices compared with the United States (14). Price Controls Controlling prices has been an effective mechanism of cost containment, particularly in nations other than the United States. Two experiments with governmental price controls have taken place in the United States. In the 1970s, President Nixon responded to inflation in the economy by instituting general price controls. Hospitals were not allowed to raise prices, and hospital costs slowed markedly. When the program ended, hospital costs shot back up. In the 1970s, 4 states (Maryland, Massachusetts, New Jersey, and New York) legislated mandatory hospital rate setting, thereby limiting growth in hospital charges. The programs applied to all payers, so that hospitals could not shift costs from 1 payer to another. These states created savings of 10% to 15%, with hospital cost growth 3% less than that in states without such programs (5, 15). Over time, as political forces weakened the legislation, the power of the regulators gradually eroded and hospital prices again increased. In the 1990s, price controls on physician fees and hospital payments were administered by private insurers and by the government through Medicare. These controls were a major factor in slowing health expenditure growth. When the market power of insurance plans eroded because of hospital consolidation, hospital prices increased again (16, 17). Physicians, particularly in primary care, have not achieved economic clout because they have seldom consolidated into strong organizations; they therefore continue to feel the impact of reduced prices for their services. For physician services, the effect of price reductions are partially offset by increases in the quantity of services provided (18). For every 1% reduction in Medicare physician fees, the volume of physician services increases by 0.56% (19). If Medicare cuts the fee for coronary artery bypass surgery, thoracic surgeons recoup about 70% of their revenue loss by increasing the volume of surgeries for both Medicare and private patients (18). Quantity of Services Nations that have more physicians and hospital beds or deliver higher quantities of physician visits and hospital days per capita might be expected to have higher health expenditures. The United States has fewer physicians, hospital beds, and acute care hospital bed days per capita than the median country in the Organisation for Economic Co-operation and Development (11). But the United States has a higher ratio of specialist to primary care physicians (20), and it is specialists who perform high-cost innovative procedures (21). Why does the United States have a lower supply of providers but higher costs? There are at least 3 reasons. First, nations in which a greater proportion of physicians practice primary care medicine tend to have lower per capita health expenditures than does the United States, in which a greater proportion of physicians practice specialty care (20). Second, the price of hospital care is far higher in the United States than in other nations. Finally, even though the United States has fewer physician visits and hospital beds than do other nations, it has a greater supply of expensive new technologies and uses them more intensively (2). Another influence on the quantity of services is the method of physician payment, which is predominantly fee-for-service in the United States. Economists debate whether fee-for-service physicians generate more visits, diagnostic procedures, or surgeries to increase their incomes, known as supplier-induced demand (22). Regardless of whether one calls it supplier-induced demand or physician beliefs about how intensively to treat patients (23), the groundbreaking research of Wennberg and Cooper (24) and Fisher and colleagues (25, 26) uncovered large variations in the quantity of care delivered to Medicare patients between 1 geographic area and another (Figure). (See also part 2 of this series [2].) Figure. Average Medicare costs per enrollee by hospital referral region, 2001. Age-, sex-, and race-adjusted spending for fee-for-service Medicare in 1996 was $8414 per enrollee in Miami co