Will health care price transparency help reduce costs?

Getting your appendix out can cost between $2,000 and $180,000. Hip replacements run from $10,000 to more than $100,000. Hospitals, we have also learned, frequently mark up the price of cotton swabs and routine X-rays by 300 or 400 percent, with most patients oblivious to the reason their health care bills are so large.

As a response to the hidden variability in health care prices, an increasing number of states have passed price transparency legislation. Federal legislators have even introduced several bills into Congress to make health care prices more transparent. Expect more such bills to follow.

But will health care price transparency help reduce costs? Seems it would. But health-care can be a strange and unique sect of economics. Could price transparency backfire and cause spending to increase?

In the traditional consumer marketplace, price transparency is a powerful force in incentivizing producers to raise the quality and lower the price of their goods. When a consumer decides to purchase a flatscreen television, for example, she will be hesitant to buy an expensive model when a less expensive alternative exists that is just as good. As a consequence of such consumer scrutiny, the average price for a 32 inch LCD TV dropped from $1,566 in 2005 to under $400 today, at the same time as the quality of those products increased dramatically.

The same kind of consumer pressure rarely exerts a similar influence on the cost and quality of health-care goods. For starters, most patients have little inclination, or motivation, to shop for health-care bargains. Insurance companies pick up most of the tab for patients’ health-care. A patient who pays a $150 co-pay for an MRI (like I do with my insurance) won’t care whether the clinic she goes to charges the insurance company $400 or $800 for that MRI. The MRI is still going to cost the patient $150. Even patients responsible for 20 percent of the tab (a phenomenon called co-insurance) face a maximum bill of only $160 in this circumstance. That is not an inconsequential amount of money, but it is still not enough money to prompt most patients to shop around for less expensive alternatives, especially when most consumers don’t realize that the price of such for services often varies significantly, with little discernible difference in quality.

To make matters worse, patients often don’t shop for health care in the kind of rationally defensible way that economic theory expects them to. According to neoclassical economics, when making purchasing decisions consumers independently weigh the costs of services from the quality of those same services. If toaster A is more expensive than toaster B, the consumer won’t buy A unless it is better than B in some way — unless it is more durable or has better features — and unless these improved features are worth the extra money.

Sometimes, however, cost and quality are not perceived by consumers as being independent attributes. Instead, people assume the cost of a good or service tells them something about its quality. For instance, blind taste tests have shown that consumers rate the flavor of a $100 bottle of wine as being superior to that of a $10 bottle of wine, even when researchers have given people the exact same wines to drink. Other studies show that expensive pain pills reduce pain better than the same pills listed at a lower price. Price, then, leads to a placebo effect.

Such a placebo effect is no major concern in the context of wine tasting and pain pills (even if it suggests that consumers could save themselves some money if they didn’t hold this strange belief that higher cost means higher quality). But suppose your doctor asks you to get a spinal MRI to evaluate the cause of your back pain, and you decide to shop around for prices before getting the test. Would greater price transparency cause you to choose an MRI provider more rationally? Or would you instead mistakenly assume that higher price means higher quality? There is reason to worry that price transparency won’t lead consumers to make savvy decisions. It is too difficult for people to know which health-care provider offers the highest quality care.

If patients are not going to make savvy use of price information to choose higher quality, lower cost health-care, some health-care providers, like doctors and hospitals, will probably respond to price transparency by raising their prices.

Imagine you direct an MRI center in Massachusetts, and the state government requires you and your competitors to post prices for your services. You consequently find out that the MRI center around the corner from you charges $300 more than you do for their spinal MRIs, and that this increased price hasn’t hurt their business. Imagine, also, that you are convinced that your competitors don’t offer higher quality MRI scans than you do — your MRI machines are just as new and shiny as theirs; your radiologists and technicians are just as well trained. In that case, if patients are not going to be price-sensitive, you are going to raise your prices to match your competitor’s. Otherwise you are just leaving money on the table.

Consider what happened in Denmark, according to an article published in the New England Journal of Medicine in 2011:

In response to concerns that the highly concentrated suppliers of Ready-Mix Concrete were charging widely varying prices to different buyers, Danish antitrust authorities began publishing information on actual invoice prices on a quarterly basis, beginning in October 1993. The result was an increase in average prices of 15-20 percent within a year, as the lower prices in the market rose and the higher prices edged up.

Or consider what happened in New Hampshire after the state began releasing price information on things like MRIs, as part of its health care price transparency efforts. In the twelve months following that bill, prices hadn’t budged at all. This probably happened because there was not enough local competition for the price information to change patient behavior.

Price transparency may also cause prices to rise by reducing health-care providers’ willingness to bargain with insurance companies. Currently, the price any given hospital charges for, say, a hip replacement will vary depending on which insurance company is paying for the service. A given hospital might have negotiated a higher fee from Aetna than from Blue Cross. Now suppose that legislation required hospitals to make all these negotiated rates public. Do you think Aetna is going to stand by and pay more money for a hip replacement than Blue Cross? Of course not. It’s going to demand the same deal. If price transparency made such negotiations public, then no hospital in its right mind would offer a discount to one insurance company unless it was willing to offer that discount to everyone. Price transparency could be a huge impediment to price negotiations.

I witnessed this phenomenon second-hand in the early 90s, when my wife was the director of managed care at Temple University (her job was to negotiate with managed care companies on Temple’s behalf). During that time, two managed care companies in Philadelphia merged, and quickly discovered that they had negotiated different rates from Temple for different services. The merged company came back to Temple and demanded that the new price of care match whichever of the two companies had previously negotiated the lower rate for any given service.

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Ultimately, the problem is complex and nuanced, but we should keep this in mind. Efforts to increase price transparency through state and federal law need to be carefully crafted and closely followed. Such laws should include research funding that would enable experts to evaluate how the law influences patient and provider behavior.

Also, whenever possible, price transparency should be accompanied by quality transparency. We need to provide consumers with information not only about the cost of their services but also about the quality of those services, so that they can trade off between the two when necessary. I recognize that this is a huge challenge. Measuring health care quality is no simple task. But if we are going to push for greater price transparency, we should also increase our efforts to determine the quality of health care offered by competing providers. Without such efforts, consumers will not know when, or whether, higher prices are justified.

Whatever we do, we need to stop naïvely assuming that price transparency will function in health care the same way it does in other parts of the economy. What works for toasters won’t necessarily work for MRIs.

Peter Ubel is a physician and behavioral scientist who blogs at his self-titled site, Peter Ubel and can be reached on Twitter @PeterUbel.  He is the author of Critical Decisions: How You and Your Doctor Can Make the Right Medical Choices Together.

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  • C.L.J. Murphy

    In his book Free to Choose, economist Milton Friedman described four ways to spend money.

    1. You spend your own money on yourself.

    2. You spend your own money on someone else.

    3. You spend someone else’s money on yourself.

    4. You spend someone else’s money on someone else.

    Obviously prices will matter most to someone in position #1.

    When you’re spending someone else’s money on yourself (#3) or spending someone else’s money on someone else (#4), not so much.

    A good prescription for lowering health care prices might be a combination of price transparency plus more high deductible/catastrophic insurance plans, and take insurance companies and the government out of the loop for most routine transactions.

    Can you imagine what grocery prices would be like if we all had “someone else” picking up the tab for us?

    • http://www.twitter.com/alicearobertson Alice Robertson

      Quote: Can you imagine what grocery prices would be like if we had “someone else” picking up the tab for us?”

      I really like Friedman (and Reason magazine which I noticed you quote from. I appreciate that because even one who reads a lot can’t keep up on it all). But I sorta think we do have this analogy going on right now. Of course, the Secretary of Agriculture says food stamps are a stimulus. Long ago once the government started to pay for baby formula the price tripled. Government went to court and was told the free market can do as they please. I wonder though what judges would say today now that we have such a welfare cultural mindset.

      • C.L.J. Murphy

        If you were to take away the subsidies for baby formula, I daresay the price would go back down. When people aren’t spending their own money for something, they don’t care how much it costs. The baby formula manufacturers are smart enough to recognise and take advantage of this. That’s a fault of government intervention and subisdy, not of the free market.

        • http://www.twitter.com/alicearobertson Alice Robertson

          I really enjoy your comments. Hmm…thinking…ultimately you are right…and, yet, the free market did take advantage of the situation and use a program meant to help moms as a stepping stool to make money (therefore hurting the segment of moms who pay for it…like moi!:) I still don’t get it…considering over 90% of mom’s can breastfeed I don’t understand our tax dollars paying for formula…but that’s only because I am cruel and cold hearted, or I don’t understand poverty (say what? Have you seen the liberal guidelines for WIC?). One supporter of the program said the government had to give out formula because impoverished moms may have drugs in their milk. There ya’ go….a bleeding heart liberal stance! Ha!

          I did read your thoughts on welfare and I think they are good thoughts….but…..I am into accountability. I help out in the innercity (a lone ranger type because some of the programs like Food Not Bombs were just a big too heavy on the MJ…and I don’t mean as an additive to the soup:) I plan on watching the video as soon as I can get dinner out of the way.

    • darbsnave

      I am not sure Milton Friedman captured all the possibilities. For instance, patients often take their doctor’s advice. So, there should be a:

      5. Someone else spends another’s money on you.

      This reflects what Arrow (1963) called information asymmetry between doctor and patient. It can put the doctor as a key actor in both the demand and supply curves.

  • Sgent

    I think its also reasonable to remember that most of the numbers quoted are not applicable to every day transactions. Insurance companies, as representatives and with similar incentives as consumers, already have an extreme incentive to negotiate for their customers. In addition, they have buying power, the ability to analyse quality indicators, and pricing information across the industry that no consumer will ever have.

    Blue Cross has 100′s of people (nationwide) employed in ferreting out details of hospital and doctor reimbursement. A consumer at best has a list price on a website — a number that is absolutely meaningless unless they are paying cash. A very well informed consumer (say one with a medical billing background) can possibly get some more information through Ingenix, CMS, or Medicaid, but that’s the sum total of information available.

  • http://onhealthtech.blogspot.com Margalit Gur-Arie

    I sort of understand why CMS is publishing chargemaster numbers and calling it transparency, and I can even understand why journalists in search of sensational headlines do the same. What I don’t understand is why researchers who know exactly how the system works, are analyzing chargemaster data, and why respected journals are publishing purely inflammatory stuff like that. It would have taken very little effort to look at the payment line on those claims, instead of the purely decorative charge line. Of course, there would have been very little to report if they did that, so maybe that’s one reason.

  • buzzkillerjsmith

    HC economist Kenneth Arrow’s theory solved this problem in the 1960s. HC is not a free market for several reasons, but for the purposes of this discussion there are two major factors.

    1. HC consumers must make their decisions under considerable uncertainty. How do pts know what is best, either in term of quality or cost? (Note: Many of the current measures of so-called quality are in fact bullshit, but that is a different discussion.) They don’t a lot of the time, so they must trust. A lot of the time people are incapacitated when important decisions need to be made. Note that this is one of the fundamental reasons for medical ethics.

    I would submit that the entities that now control much of medical care have no such ethics. In particular, I would submit that this is true for hospitals and insurance companies.

    2. Market power. The number of persons who may practice medicine is limited and rightly so. Quacks pose a great danger. If supply is limited, then the limited suppliers can charge a lot more than what they would be able to charge in a free market. Hence the idea that doctors should not maximize profits, another component of medical ethics.

    I would submit that the entities that now control much of medical care have no such ethics.

    Add that to the opacity of prices and the fact that sick people often do not bear the full cost of their care at the time of service and you can see that the “consumer” has virtually no chance of getting the best deal. Price opacity is one component but the two factors above are likely more important.

  • Anthony D

    Well, let’s see now. It makes medical care 2x, 3x, or 4x more expensive. It leaves 30,000,000 still without insurance or medical coverage. You figure it out.

  • Anthony D

    Here is were Obama care fails to lower costs. Today uninsured walk into emergency rooms and get care. Care they don’t pay for. So that cost ends up spread to what hospitals charge insurance companies or paying patients. If you ever had surgery and got detailed bill you see this. I was charged $8.00 for 1 ban-aid. $80 for back of salt water etc. When I called insurance company they said yes we agreed to these rates.

    In theory then if Obama care forces more to have insurance then cost of hospitals gets spread among more paying patients. Which in theory means hospitals should lower what they charge insurance. No more $8 ban-aid etc. Yet will hospitals actually pass on lower rates to insurance contracts and thus create lower premiums? I doubt it they will just make more money. As usual with our gov they think in theory on paper will become reality. Which is why they are wrong so much they don’t live in the real world. They are all rich people.

  • Kirk Osterland

    So long as a universal “basic” healthcare system is in place with a single responsible payer,then I don’t care how much money our society wants to devote to pay for it – 10,20,30,50 % of GDP ! That is society’s choice.If it wants to allow huge profits and salaries for clinic and hospital executives who have little or no impact nor concern for patient care – so be it.If it (society) wants to allow for gross inefficiencies and obscene prices for underevaluated medical proceedures and technologies – so be it.Healthcare does not fit the mold for a “business”.Yet access to proper “basic” care is of paramount importance to any person or family in real need – ask anyone with a chronic disease or a family member,esp. mother or child.
    I do not exclude by the way,the need for greater personal responsibility for family healthcare needs.If we could capture the money being spent by Pharmaceutical Companies on useless,even hurtful television adds and use it to support real HC needs it would help a lot to alleviate costs in the US that range from 3-5 times those of other Western countries,with,I might say,better outcome parameters.
    We have created a HC/business monster – can it be brought down ? ckirko

  • Medlr.com

    I agree. I think whether or not price transparency efforts save money depends completely on local competition for healthcare services.

    Take a LINAC that delivers radiation therapy for cancer. Assume we’re in a big city where there are lots of LINAC’s. The marginal cost of a treatment is small compared to the high price paid by consumers/payors. Anecdotally, most LINAC’s in the US run 8-10hrs per day versus 16-18hrs per day in Canada. So there’s a significant oversupply of LINAC’s in the US that are being kept alive artificially by high pricing. And that high pricing is at least somewhat the fault of poor price transparency efforts. Consumerism ought to be able to drive down the price of radiation treatment given supply/demand dynamics and the low marginal cost of each additional treatment to providers. The same could be said for other capital intensive, over-supplied/over-paid services like MRI and CT imaging (not trying to antagonize anyone here). If you as a doctor or a CFO are sitting on a huge amount of overhead, why wouldn’t you be tempted to discount your prices to take volume away from competitors?

    On the flip side, if you are the only gastroenterologist for 50 miles, why would you ever discount your colonoscopies? In fact, why not just charge a higher price so that people think your services are more valuable, particularly since consumers aren’t paying the full amount?

    The missing piece is competition. You need it for price transparency to help with costs. Take the airline industry. Before price deregulation, airlines competed on services (like our lone gastroenterologist example, above). After deregulation and then, gasp, Expedia, price transparency drove down prices.

    Bottom line: price transparency works only where there is healthy competition among docs and facilities