How Hospitals and Physicians Set Prices

By T. T. "Mitch" Mitchell

Are you one of those people who believes hospital prices are way too high? What about fees from physician offices? If so, you're not alone. Almost everyone has had to deal with a hospital or physician bill in some fashion, whether it's for themselves or for family members. Everyone talks about how the cost of healthcare has risen, and the first place everyone goes to gripe about it is hospitals, with physicians a close second.

I'm here to tell you, however, that you're blaming the wrong entity. Sure, some hospitals are gouging patients with what they charge, but that's not the majority. Healthcare providers have to conduct business in a fashion that no other industry has to deal with.

You go to a store because you want to go; you go to a hospital or physician because you don't feel well. You have to pay your bills up front when you buy products or services; most healthcare providers only charge you for your co-pays or deductibles up front, then have to wait at least 30 days, sometimes much longer, to get paid.

And the amounts they get paid aren't all that good; let's look at physicians first. Imagine you had to go to medical school for 8 years, then do an internship, all the while having to take out big loans. Finally, you're ready to be a physician, and your malpractice can run anywhere from $30,000 to $100,000 a year, depending upon specialty and what state you live in. Add to that the cost of renting an office somewhere, hiring staff (you must have some staff by law), paying for the costs of services such as billing services, cleaning services, pharmaceuticals in some cases, etc, it all adds up.

What about hospitals? Malpractice is much bigger because most physicians aren't actually paid staff, but you're liable for things they do within the facility. And you still have to cover all the specialties your facility has, such as lab, radiology, physical therapy, etc. Add to that having to pay all the staff, pay for all the supplies, cleaning services, pharmaceuticals, electricity, etc. And then add to that mandatory, money-losing areas such as emergency room services, and hospitals aren't making quite the money you believe they are.

Now, would it be fair if hospitals just charged you high fees without any regard for how it impacts patients? Not at all, and for the most part it doesn't happen. The rules are different for hospitals that are not for profit versus hospitals that are for profit, but things don't change that drastically. I'm going to tell you how it works, just so you know.

Healthcare providers set charge rates based on one of two principles. The first is based on cost; the second is based on reimbursements from specific insurance carriers, mainly Medicare. Let's talk about cost based charging first, because it's the most complicated.

Basically, what this means is that the medical provider has to figure out what their costs are in all the departments or areas they have to worry about, then they base their rates off that. For physicians, this might be easier to do, because they only have so many employees, rent is what it is, supplies are easier to keep under control, and of course malpractice insurance, and any other fees here and there. For hospitals, it's a lot more complicated, based on the fact that many departments really don't know how much money everything costs. Still, there are many facilities that do base their charges on costs, first determining what they are, then marking charges up anywhere from 200 - 400% usually. Of course, this is an average figure, because some areas will have items such as inexpensive pharmaceuticals marked up higher, and some very expensive items such as pacemakers much lower. Of course this is legal, but is it right? Sure it is; how much do you think your hardware store actually pays for screws and nails you buy from them?

Now let's look at the second one. Many facilities and physicians will base their prices on what they theoretically get paid by some of the insurance companies that pay them. One reason Medicare is a good one to use is because Medicare will post its general reimbursement dollars, whereas most other insurances don't. For physicians, Medicare will post a fee schedule; for hospitals, Medicare posts what's called an APC list, or Ambulatory Payment Classifications. Both are based on procedure codes, or the services that were provided.

Prices are based on these things, and, as before, charges are marked up anywhere from 150% to 500%. However, there are two things to know here. One, physicians who accept Medicare patients are only allowed to mark prices up a certain amount; those who don't accept Medicare as an insurance but see their patients are only allowed to charge a certain amount also. Two, just because charges are a certain amount doesn't mean that's actually what either hospitals or physicians get.

Ah yes, now it's time for the ugly side of healthcare finance. We'll use Medicare as a perfect example. Medicare might tell you they pay $45 for a chest x-ray, and that you, the patient, owes 20%, which means Medicare pays $36. However, Medicare doesn't come close to paying that. Based on yearly cost reports, Medicare's reimbursement usually comes somewhere between 35 and 45%. This means that out of that remaining $36, Medicare might be paying as little as $16.20, and the physician or hospital has to write off the rest. So, the healthcare provider is only getting around $25, no matter what's charged, if the physician is a Medicare provider (every public hospital MUST be a Medicare provider). It's like this across the board for all services provided to Medicare patients.

What about everyone else? Well, other than people without insurance, every insurance company that a healthcare provider participates with (this means the insurance company has contracted with the provider to accept their payment directly before billing the patient, if there's a balance that needs to be billed) negotiates a payment rate of some sort. Sometimes it's a fee schedule, which means a certain amount per procedure code. Sometimes it's based on a percentage of charges, which can be more beneficial to the healthcare provider. And sometimes it's based on what's known as UCR, which stands for usual, customary, and reasonable, based on an average of rates other similar providers in the area charge. Oh yeah, the insurance companies always know what everyone is charging for, which sometimes gives them a big advantage because providers aren't really supposed to know what each other is billing for (though they all have ways of finding out).

There are some payers (another term for insurance companies) that hospitals in many states are stuck having to accept that are killers financially. Those payers would be Medicaid, Compensation, and No Fault, as well as payers from other state and federal agencies such as prisons. In a state like New York, hospitals must belong to both the Medicare and Medicaid programs by law. But hospitals can't survive on these payments, so it becomes important for them to try to get as high a rate of payment from other sources to overcome it.

Unfortunately, this usually means the group that takes it on the chin the worst are the uninsured. In most cases, there are few discounts for them, and they're at the biggest risk of going to collections for non-payment of bills. However, every hospital has both payment plans and charity care processes, which can not only reduce how much self pay patients are asked to pay, but sometimes totally erases any financial obligation. It's based on income; that's pretty fair. All you have to do is ask, but facilities are supposed to have signs posted telling patients about this; most patient don't notice them, however.

Now you know how charges are created, and why they're priced the way they are. It may not make you feel any better, and it probably won't garner sympathy from many people. However, I'm betting that when you need the help, you'll feel a lot better knowing that someone is there willingly to take the chance to make you, or a family member, feel much better. And really, is there a limit on how much you'd pay for that life?

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T. T. "Mitch" Mitchell is president of T. T. Mitchell Consulting, Inc. If you would like to see more from this writer, check out his newsletter page.

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