The Pricing of U.S. Hospital Services: Chaos Behind A Veil of Secrecy

Uwe E. Reinhardt


Health Affairs. 2006;25(1):57-69. 

In This Article

Abstract and Introduction

An economist's insights into what causes the variation in pricing, and what to do about it.

Although Americans and foreigners alike tend to think of the U.S. health care system as being a "market-driven" system, the prices actually paid for health care goods and services in that system have remained remarkably opaque. This paper describes how U.S. hospitals now price their services to the various third-party payers and self-paying patients, and how that system would have to be changed to accommodate the increasingly popular concept of "consumer-directed health care."

Asked by a wall street journal reporter to explain how U.S. hospitals price their services, William McGowan, chief financial officer of the University of California, Davis, Health System and thirty-year veteran of hospital financing, responded: "There is no method to this madness. As we went through the years, we had these cockamamie formulas. We multiplied our costs to set our charges."[1]

Exhibit 1 illustrates his point. Although the list prices reflected in Exhibit 1 vary by only a factor of slightly more than 4,they reportedly vary by as much as seventeenfold across all hospitals in California. However, these "charges" are much higher than the prices U.S. hospitals are actually paid. In 2004, for example, U.S. hospitals were actually paid only about 38 percent of their "charges" by patients or their insurers.[2] The actual prices they were paid appear to vary much less than "charges" do, although even that variation is remarkable large. For example, in 2001 the prices hospitals were actually paid by private health insurers serving the Federal Employees Health Benefits Program (FEHBP) varied by "only" 259 percent across the United States.[3]

Charges For A Chest X-Ray (Two Views, Basic) At Selected California Hospitals, 2004

Only a handful of Americans truly comprehend the complex payment system for U.S. hospitals—mostly those whose job it is to set, negotiate, and study hospital prices. Self-paying, uninsured patients certainly do not understand these practices. Quite aside from the incomprehensible variation of list prices across hospitals within a state, these patients might wonder why their neighborhood hospitals billed them more than twice the amount for a given procedure than what that same hospital billed their neighbor's insurance carrier for the same procedure.[4]

This paper has several purposes. First, I attempt to describe more fully the manner in which hospitals now price their services to the fiscal intermediaries who provide the bulk of the hospital's revenue, and also to self-paying individual patients. I should note at the outset, however, that any such description overlooks local variations to more general patterns. Next, I offer an economist's perspective on the widespread practice of "price discrimination" in the hospital industry—that is, the practice of charging different payers different prices for identical health care goods or services. I conclude by giving some thought to the problem of how prospective patients could be apprised of a hospital's prices under what has come to be known as "consumer-directed health care." Although the cost of a single inpatient episode typically will exceed the deductibles of consumer-directed plans and revert the matter to third-party payment, many consumer-directed policies require sizable coinsurance in addition to the deductible, which gives prospective patients a financial stake even in the prices charged for inpatient care.[5] Furthermore, a growing fraction of total hospital revenue now comes from outpatient services—36 percent of hospitals' total gross patient revenues in 2004.[6]