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

Price Discrimination by Hospitals

It might be argued that because hospitals initially bill all of their patients at their chargemaster prices, they do not engage in "price discrimination"—the practice of charging different customers different prices for identical goods or services. Invoices at chargemaster prices, however, are insincere, in the sense that they would yield truly enormous profits if those prices were actually paid. The reality is that hospitals accept different payments from different payers for identical services, and that can properly be called price discrimination.

Price discrimination is sometimes decried as unfair, and it may be so. It is, how-ever, commonly practiced by the hotel, airline, pharmaceutical,and telecommunications industries; by public utilities; and by universities, where different classes of students are granted widely varying discounts off full tuition, partly as a reward for intellectual acumen, or on the basis of the family's ability to pay. Price discrimination also is a perfectly natural phenomenon in any health system not subject to price regulation.

All of these industries have several things in common: They have high annual fixed costs relative to the incremental cost of producing additional services; they can segment their markets into distinct classes of customers, each with different degrees of price-sensitivity; and customers cannot resell their products among themselves, because it is either technically impossible (such as for physician or hospital treatments) or illegal (such as for pharmaceutical products).

The sellers of a good or service might practice price discrimination in the pursuit of two quite distinct objectives. First, sellers might simply seek to maximize the total amount of revenue that can be extracted from society for a given volume of output and, thus, their profits. By charging some groups more than others, profit-seeking sellers can extract from the buy side more revenue and profits for a given sales volume than they could with a single price. The distinguishing characteristic of such sellers is that they would never sell any output to any market segment at prices below incremental production costs, unless that had profitable public relations value or they were mandated to do so by law—such as under the Emergency Medical Treatment and Active Labor Act (EMTALA) of 1986.[29]

Alternatively, sellers—especially not-for-profit sellers—might price-discriminate merely to cover their fully allocated total costs (plus, perhaps, a modest profit margin) in a way that conforms to prevailing distributive, social ethics. Physicians have always defended their erstwhile sliding fee scales on those ethical grounds, although not all economists have been persuaded by that rationale.[30]

Richard Steinberg and Burton Weisbrod recently presented a model in which nonprofit institutions price-discriminate to achieve ethically desirable distributional goals.[31] An important, relevant insight from their model is that competition from either for-profit or nonprofit organizations in a market area severely limits the nonprofit's ability to pursue that policy. Under truly severe competition, the authors show, even nonprofit organizations will behave more and more like profit-maximizing enterprises, to survive in the long run. That is, of course, precisely the situation in which many nonprofit U.S.hospitals now find themselves. In that market context, price discrimination probably is profit-maximizing more often than practiced to pursue ethical goals.

What prevailing distributive ethic in U.S. society, for example, would dictate that uninsured patients be billed the highest prices for hospital care and then be hounded, often mercilessly, by bill collectors? What prevailing distributive ethic dictates that large insurance carriers with market muscle be granted steeper discounts off charges by hospitals than smaller insurance carriers with less bargaining power?

Probably the best defense hospitals can make for their current patterns of price discrimination is that both the federal and state governments can use their monopsony power to impose unfunded mandates in the form of shortfalls of payments from fully allocated costs. That practice, along with lingering excess capacity in most hospital market areas, can explain why for-profit and nonprofit hospitals alike now have little choice but to price their services to private payers essentially as profit-maximizing enterprises.