United States Government Accountability Office

GAO Testimony 

Before the Subcommittee on Health, 

Committee on Ways and Means, House of 

Representatives

FEDERAL EMPLOYEES 

HEALTH BENEFITS 

PROGRAM 

Differences in Health Care 

Prices Across Metropolitan 

Areas Linked to 

Competition and Other 

Factors 

Statement of A. Bruce Steinwald 

Director, Health Care 

For Release on Delivery

Expected at 11:30 a.m. CST 

Friday, December 2, 2005

 

GAO-06-281T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

December 2, 2005

FEDERAL EMPLOYEES HEALTH 

BENEFITS PROGRAM 

Differences in Health Care Prices Across 

Metropolitan Areas Linked to Competition 

and Other Factors 

Highlights of GAO-06-281T, a testimony 

before the Subcommittee on Health, 

Committee on Ways and Means, House of 

Representatives 

Differences in utilization of health 

care services across the country

have been well documented, but 

less has been reported on

geographic variation in price. As 

health care spending is the product 

of utilization and price, information 

on health care prices and factors 

contributing to price differences

provides an additional perspective 

on drivers of health care spending. 

In an August 2005 report, GAO

examined claims data on enrollees

of preferred provider organizations

(PPO) participating in the Federal 

Employees Health Benefits

Program (FEHBP) and found 

substantial price variation across 

metropolitan areas, after adjusting 

prices to account for area

differences in the cost of providing 

services and in the types of 

services provided. 

This statement is based on GAO’s

August 2005 report entitled Federal 

Employees Health Benefits

Program: Competition and Other 

Factors Linked to Wide Variation 

in Health Care Prices (GAO-05-

856). It focuses on (1) factors that 

underlie area differences in price 

and (2) the contribution of price to 

geographic differences in spending

on health care. 

GAO found that market characteristics were closely associated with price 

differences across metropolitan areas for the FEHBP PPOs we reviewed. 

Areas with the least competitive markets—that is, areas with a higher 

percentage of hospital beds concentrated in the two largest hospitals or 

hospital networks—had prices of hospital stays and physician services that 

were higher than areas with the most competitive markets. The percentage 

of primary care physicians’ reimbursement that was paid on a capitation 

basis in health maintenance organizations (HMO)—a proxy for a payer’s 

power to bargain with providers on price—was also associated with 

geographic price variation. We found that in areas where either market 

share was concentrated among few providers or HMO bargaining power was 

weak (as measured by lower levels of HMO capitation), hospital and 

physician prices paid by the PPOs in our study were higher than average. 

When we controlled for other factors that might be associated with 

geographic price variation, hospital competition and payer bargaining power

remained associated with lower prices, but the effect was reduced, and 

much variation remained unexplained. 

Price contributed to geographic differences in spending per enrollee, but less 

than utilization. For both hospital and physician services, price contributed 

to about one-third and utilization to about two-thirds of the variation in 

spending between metropolitan areas in the highest and lowest spending 

quartiles. Price was positively associated with spending, as was utilization, 

for both hospital and physician services. Therefore, areas with either high 

prices or high utilization tended to also have high spending. In the case of 

physician services, price and utilization were modestly but negatively 

associated, such that areas with high physician prices tended to have 

somewhat lower utilization of physician services and areas with low 

physician prices tended to have somewhat higher utilization of physician 

services. 

www.gao.gov/cgi-bin/getrpt?GAO-06-281T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact A. Bruce 

Steinwald at (202) 512-7101 or 

steinwalda@gao.gov. 
Madam Chairman and Members of the Committee: 

I am pleased to be here to discuss the findings from our August 2005 

report entitled Federal Employees Health Benefits Program: Competition 

and Other Factors Linked to Wide Variation in Health Care Prices.

1

 In 

this report, we examined differences in prices paid for hospital stays and

physician services across selected metropolitan areas in 2001,

2

 the most 

recent year for which data were available when the study began. 

Differences in utilization of health care services across the country have 

been well documented, but less has been reported on geographic variation

in price. As health care spending is the product of utilization and price, 

more information on health care prices and factors contributing to price 

differences provides an additional perspective on drivers of health care 

spending. 

Our study examined claims data on behalf of more than 2 million enrollees 

of preferred provider organizations (PPO) participating in the Federal 

Employees Health Benefits Program (FEHBP). The prices these PPOs 

negotiated with physicians and hospitals were the same for the enrollees

in FEHBP as for PPO enrollees insured through other employers. Our 

study found that prices for FEHBP PPO hospital stays varied by more than 

250 percent and prices for physician services varied by about 100 percent

across metropolitan areas. We adjusted prices to account for area 

differences in the cost of providing services and in the types of services 

provided using Medicare’s methods of adjusting hospital and physician 

payments for these area differences, with some modifications. 

A detailed account of our findings and methodology is included in our 

August 2005 report. My remarks today will focus on (1) factors that 

underlie area differences in price and (2) the contribution of price to 

geographic differences in spending on health care. These remarks are 

based on the information contained in the report. The work done for the 

report was performed from September 2002 through July 2005 in 

accordance with generally accepted government auditing standards. 

 1

GAO-05-856 (Washington, D.C.: Aug. 15, 2005). 

2

We excluded some of the 331 metropolitan areas in the 50 states and the District of 

Columbia for lack of adequate claims information or sufficient number of hospital stays to 

support our analyses. We had a sufficient volume of hospital stays and physician services

to analyze hospital prices in 232 metropolitan areas and physician prices in 319 

metropolitan areas. 

Page 1 GAO-06-281T
In summary, market characteristics were closely associated with price 

differences across metropolitan areas. Areas with the least competitive 

markets—that is, areas with a higher percentage of hospital beds 

concentrated in the two largest hospitals or hospital networks—had prices 

of hospital stays and physician services that were higher than areas with 

the most competitive markets. The percentage of primary care physicians’ 

reimbursement that was paid on a capitation basis in health maintenance 

organizations (HMO)—a proxy for a payer’s power to bargain with 

providers on price3

 —was also associated with geographic price variation.

4

We found that in areas where either market share was concentrated 

among few providers or HMO bargaining power was weak (as measured 

by lower levels of HMO capitation), hospital and physician prices paid by

the PPOs in our study were higher than average. When we controlled for 

other factors that might be associated with geographic price variation, 

hospital competition and payer bargaining power remained associated 

with lower prices, but the effect was reduced, and much variation 

remained unexplained.

Price contributed to geographic differences in spending per enrollee, but 

less than utilization. For both hospital and physician services, price 

contributed to about one-third and utilization to about two-thirds of the 

variation in spending between metropolitan areas in the highest and 

lowest spending quartiles. Price was positively associated with spending, 

as was utilization, for both hospital and physician services. Therefore, 

areas with either high prices or high utilization tended to also have high 

spending. 

In public programs, such as Medicare, prices are administratively set, 

whereas in the private sector, prices are generally negotiated between 

providers and health insurers, or payers. Payers may negotiate discounted 

rates with providers, for example, in exchange for an anticipated share of 

patient volume. Some payers, especially HMOs, may negotiate capitation

arrangements with providers, under which the fixed payment per patient

puts providers at risk of losing financially if the costs of treating a patient 

Background 

 3

We use the term providers to refer to hospitals, physicians, and other providers of health 

care services unless otherwise specified. 

4

Capitation is a payment method used by managed care organizations where physicians are 

paid a fixed, predetermined payment for caring for an enrollee for a specified period of 

time, regardless of the number or type of services ultimately provided 

Page 2 GAO-06-281T
exceed the payment. In contrast to this arrangement, which fixes the 

provider’s payment regardless of the number of services provided, the 

traditional fee-for-service arrangement affords providers the opportunity 

to increase payments by increasing the volume of services provided. 

Payers that can negotiate a capitated rather than fee-for-service payment 

arrangement with providers likely have more negotiating power relative to

providers, which in turn can affect prices. In our study, we measured 

payer negotiating power in a metropolitan area as the percentage of 

compensation that was capitated for primary care physicians. 

The extent of competition among providers in an area may also affect 

prices. In general, economic theory holds that areas with more 

competition among providers are likely to have lower prices. 

Consolidation of providers, such as hospital mergers, reduces the number 

of competitors in the market, giving the consolidated competitors a larger 

market share. Recent trends of provider consolidation suggest that some 

markets are becoming less competitive. 

We found that in metropolitan areas where market share was concentrated 

among few providers or HMO bargaining power was weak (as measured 

by lower levels of HMO capitation), hospital and physician prices paid by

the PPOs (in FEHBP) were higher than average. Many of the metropolitan 

areas in our study had few providers in competition; about one in four 

areas had only one or two hospitals or hospital networks serving the entire 

market. In these areas, prices for hospital stays and physician services—

after adjusting for differences in these areas’ cost of doing business and 

mix of services—were substantially higher than prices in the most 

competitive metropolitan areas. For example, in Rapid City, South Dakota, 

one of the least competitive markets in our study, hospital and physician 

prices were higher than average by 25 percent and 10 percent,

respectively. In contrast, the hospital and physician prices in Pittsburgh, 

one of the most competitive markets in our study, were lower than 

average by 14 percent and 16 percent, respectively.5

Competition, Payer 

Bargaining Power,

Associated with Area 

Price Differences 

FEHBP PPO hospital and physician prices were also higher, on average, in

metropolitan areas with low levels of HMO capitation, suggesting little 

power on the part of payers to negotiate with providers on price. Across 

 5

Rapid City, South Dakota was in the quartile with the least competition, and Pittsburgh, 

Pennsylvania was in the quartile with the most competition. 

Page 3 GAO-06-281T
all metropolitan areas in our study, the average percentage of primary care 

physicians’ compensation that was capitated was about 8 percent. More 

than a third of the areas in our study had almost no HMO capitation; in 

these areas, less than 1 percent, on average, of the payments to primary 

care physicians were paid on a capitated basis. In the quartile of 

metropolitan areas with the highest levels of HMO capitation, the average

proportion of primary care physicians’ compensation that was capitated 

was 23 percent. 

Our study showed that prices contributed substantially to geographic 

differences in spending for hospital and physician care, but to a lesser 

extent than utilization. When we compared price differences and 

utilization differences in the metropolitan areas with the highest and 

lowest quartile of spending per enrollee, we found that the price of 

hospital stays contributed to about one-third of area differences in 

spending on hospital care while utilization—that is, the number of hospital 

stays—contributed to the remaining two-thirds. We found a similar 

relationship between the price of physician services and an area’s 

spending on physician care—namely, one-third of spending differences 

was attributable to price differences and two-thirds was attributable to 

service use differences. We also found positive associations between price 

and spending and between utilization and spending. That is, areas with 

higher prices or higher utilization also tended to have higher spending. In

the case of physician services, price and utilization were modestly but 

negatively associated, such that areas with high physician prices tended to

have somewhat lower utilization of physician services and areas with low 

physician prices tended to have somewhat higher utilization of physician 

services. 

In conclusion, our study results underscore the importance of examining 

an area’s market structure—including interactions between payers and 

providers—to fully understand private sector spending differences from 

one area to another. We found that, in addition to utilization of services, 

prices played a significant role in an area’s total health care spending. 

Therefore, it is important for participants and policy makers in geographic 

markets to understand the effect of prices as well as utilization on health 

care spending to make informed decisions about the actions needed to

moderate spending in their local area. 

Price Contributed to 

Geographic 

Differences in 

Spending, but Less 

than Utilization 

Concluding 

Observations 

Page 4 GAO-06-281T
Madame Chairman, this concludes my prepared statement. I will be happy 

to answer any questions you or the other Subcommittee Members may 

have. 

For further information regarding this testimony, please contact A. Bruce 

Steinwald at (202) 512-7101 or steinwalda@gao.gov. Christine Brudevold, 

Assistant Director; Hannah Fein; and Michael Kendix contributed to this 

statement. 

Page 5 GAO-06-281T

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