Wednesday, March 17, 2010

Price controls do not work

If there is anything about economics that has been proven over and over, it is that price controls do not work. The unintended consequences are usually worse than the problem that led to the solution in the first place.

Massachusetts legislators, feeling the frustration of higher insurance premiums, are now considering a bill to limit doctor and hospital reimbursement payments to 110% of Medicare rates, or perhaps some other percentage of Medicare rates. The problem with this is that Medicare rates are not fully compensatory to doctors and hospitals and have contributed to the increase in private insurance company rates. This was one of the conclusions reached by the Attorney General in her extensive investigation of these matters.

An unreported fact in Massachusetts is that Tufts Health Plan, at the request of the Group Insurance Commission (the agency that manages the state employees' health plan), recently sent out a request for proposals for a new insurance contract for the tens of thousands government employees covered by the GIC. The main provision was that the doctors and hospitals would have to agree to rates set at 110% of Medicare.

The result: It was a bust. Hospitals and doctors did not express interest in the contract because they knew that they could not cover their costs with it -- even though they could have been included in a limited network and have an effective monopoly to serve this large group of customers.

If today legislators adopt price controls over hospital and doctors' rates, tomorrow they will have to deal with layoffs and closures in the Commonwealth's strongest economic sector. These organizations are not for-profit enterprises with shareholders who can absorb losses.

It is interesting to me that a state in which many people decry the idea of rate-setting would consider the idea of picking a certain price target by fiat for the medical sector. If we are going to move towards government supervision of reimbursement levels, please instead set up a regulatory body to determine the appropriate level of rates based on best medical practices and true underlying costs of hospitals. An evidentiary hearing in which all those factors are considered by qualified administrative law judges would do more to provide a sound basis for determining rates than the price control approaches being raised.


Anonymous said...

I gather the hearings did not go well. Price controls are the easiest solution of which to conceive, for people who don't understand a complex situation.
Really, though, the states are just trying to put a band-aid on an open fracture with a severed artery.

nonlocal MD

e-Patient Dave said...

For those of us who are econo-neophytes, can you offer the 15-second summary of "proven over and over"?

The Wikipedia page only cites the Arab oil embargo of 1973. But that cites a paper from the Cato Institute, hardly known for its objectivity.

Anonymous said...

Check virtually any economics text book: Price controls lead to shortage. Suppliers andproducers cut back on the goods and service they make because they can't cover their costs. It really is as simple as that.

e-Patient Dave said...

Sigh, sir, I don't HAVE any economics textbooks lying around. That's why I asked. :)

Your reply is sorta like physicists who say "Quantum mechanics is perfectly clear once you understand how it works." (Somebody said that to me once.) True but not useful. :)

If you happen to have an example that the lay bozo like me would recognize, it'll help. If not, no problem. Thanks.

Anonymous said...

Sorry, Dave.

Check "incomes policy" in Wikipedia -- --

"Price controls have also been used in modern times for such things as rent control in New York City and usury laws. Although they have been resorted to often, economists usually agree that price controls don't accomplish what they are intended to do and are generally to be avoided."

Rent control is one of the best examples. It resulted in a deterioration in the number and quality of the very housing stock that was supposed to be available for those of lower income. This was shown over and over in cities.

Interest rate regulation in Arkansas was another example. There was a state maximum set. During a period of inflation, with market rates above that level, people could not get mortgages for housing.

But really. Just think it through. If you can't charge your true cost of providing a good or service, why would you provide it? Or, you are forced to cut back on the scope and quality of what you do provide.

Anonymous said...


The analogy that occurred to me was Nixon and the oil price controls. Google that and you'll get a blast from the past! I did run into a Wikipedia article on price controls as a means to control inflation which is somewhat relevant though:


Barry Carol said...

It was an effort by employers to get around World War II era wage and price controls that led to the employer based health insurance system that we still have 65 years after the war ended and we can’t seem to get rid of it. Due to the tax preference for employer provided health insurance, patients are largely insulated from the cost of the medical services they consume and doctors, whose decisions drive the bulk of those costs, have no incentive to care about costs either.

As for hospital price setting, I’m certainly no fan of administered or dictated prices either. However, I think it would be helpful to payers, regulators, and the public if hospitals could be more forthright in disclosing their fully allocated costs with as much granularity as possible including their methodology for allocating indirect costs to each department. For example, how much does it cost your hospital to perform heart bypass surgery or a hip replacement? What are your costs for an MRI or a colonoscopy or a psychiatric consultation? It would also be interesting to know your marginal cost for providing each of these procedures as well as the escapable costs if you stopped offering them. When you are paid on a per diem basis, what are your costs for an inpatient bed day in a standard semi-private room?

I’ve heard arguments that Medicare pays enough overall for well run hospitals to cover their costs for treating Medicare patients. Many hospitals say that isn’t true. Some definitive data to back up that assertion would be helpful.

Anonymous said...


We have a detailed cost accounting system that does exactly what you say. And so, yes, we can show the positive or negative contribution margin on every single procedure here, for every payer.

The rub is, of course, how you choose to allocate joint and common costs. That is both an issue with both current operating costs and with the embedded cost of capital (depreciation and amortization). Each hospital probably does that in its own way.

When I was regulating the utilities, we prescribed which cost allocation method was to be used for all the companies, permitting a review of comparability. That is one thing that would be possible in an administrative rate-setting environment in the hospital world, too.

Anonymous said...

And payments to doctors is another matter altogether, Barry. One of the commenters on the Globe article cited here says:

"Capping payments at 110 percent would put most physicians and nurse practitioners out of business. Did you know that medicare pays about $30 for a fifteen minute office visit? So if one sees four follow-up patients an hour that's a whopping $120/hr. Try paying for the nurse, secretary, rent, and malpractice with that."

Keith said...

Keep fighting the fight Paul. I disagree with you on a lot of things, but this is not one and the importance is immense.
I would like to see (BEFORE it were put in place), to see an honest assessment of what this scheme would actually do to insurance rates across the board, available hospital beds, ER wait times, availibility of advanced technologies, and I think equally important unemployment (in local healthcare and overall, because the impact would also be on support services, construction, transportation, suppliers, etc etc).

Hildebrand, The Insurance Warden said...

Agreed that price controls are an atrocity. However, I doubt if a regulatory body would soften their impact by choosing appropriate levels. It would hardly take long, I aver, for it to fall under the sway of pull-peddlers, just as other government institutions and representatives have done.

Anonymous said...

Paul, While I share some of your concerns about price controls, I would find it refreshing if you'd give us some actionable, concrete ideas about how to deal with rising costs, and fast. Things may look good from Brookline Avenue (interesting to see that BIDMC is one of the highest paid hospitals in the state and BIDPO one of the best paid provider groups in the AG's report) but those of us who have to pay the premiums for care are drowning out here, and we're having trouble paying for other necessities of life with stagnant, and for many of us, falling incomes. Easy to criticize price controls, and to point out that health care is important to the economy but there's a lot of other potential economic activity that's being stifled by the rising cost of health care. What's your solution???????????????? And please don't tell me it's quality improvement. Quality improvement is immensely important but it won't cure what ails us in the cost area.

Anonymous said...

Actually, if you look at the testimony filed in recent days by the insurers, you will see that BIDPO and BIDPO are not necessarily among the best paid. That is where you see names named and numbers provided, not in the AG's report.

But to get to your point, there are lots of things documented over the months in this blog about efficiency improvements. Not all relate to quality and safety improvement, but I wholeheartedly disagree with any implication that those areas would not make a major difference. Our work in reducing ventilator associated pneumonia, for example, saved millions of dollars for Medicare and the state's insurers. Ditto for reduction in central line infections.

In a more subtle, but equally important vein, our new affiliation with Atrius Health has a commitment to send patients back to their clinics for follow-on procedures whenever possible, rather than retaining them in the higher cost tertiary setting. That kind of alliance, we hope, will provide a model of care that is more centered with primary care doctors. Having patients get the right care in the right setting has to be part of the solution in bending the cost curve.

Back to you. What are your proposals?

jonmcrawford said...

Couple comments:
1 - solution could be to reduce salaries, not the quality of the product (*gasp* did I say that out loud?)
2 - I've often wondered about how CMS can have actuaries calculate the UCR (Usual and Customary Rate) for fee schedules and back them up, when the industry loudly complains that they don't cover cost? Shouldn't it be trivial to prove that the UCR isn't usual nor customary, were that true?
3 - Is the problem that UCR covers the basic cost of the service, but does not allow for innovation/quality service/expansion that is part of attracting users to a quality hospital?

Interested in your thoughts

Anonymous said...

Others more familiar with CMS methodology would have to answer that.

Anonymous said...

Price control has no business in healthcare.. neither does nebulous billing by hospitals which lumps professional services (such as nursing and pharmacy) in their room rates. When hosptials produced true cost billing, then they can ask for fair rates..until then they can expect nothing but price caps..ITs time to let patients pick the level of ammenities:a meal plan..a room rate...but give them specific info on how much nursing and pharmacy care they needed based on their health condition and emotional state.

Michael said...

Mr Levy --

These price control that are being proposed, are setting prices for what the state will pay for services, via Mass Health or other state-paid plans, or are they setting what hospitals can charge for services period, whether covered by Mass Health, private insurance, or out-of-pocket payments?

Thank you,
Michael B

jonmcrawford said...

Sorry Paul, but I was looking for your thoughts as the CEO (not on #1, that was a throwaway comment that I know the response to). You are saying clearly that 110% of Medicare doesn't cover costs, but what DOES it cover? Would it allow you to break even, but only at the cost of no new facilities/equipment/etc? Does it cover the cost of the service itself, but not the administration of the service?

Without feedback like that, it seems like a he said/she said type of thing, where CMS says they're paying fair rates, industry says they're not, but nobody has any data to back up their opinion?

Anonymous said...

Uh-oh; it's hit the Health Care Blog - let the nuclear war begin.

ps the word verification was "spasms" - what do they know??!!


Anonymous said...


We'll need a finance person to answer specifically, but it is clear that the government payers do not pay fully allocated cost, i.e, associated capital facilities and administrative costs. In some cases, I believe they don't even pay the full current direct costs.

But let me see if I can get someone with a better handle on the details to answer.

Anonymous said...

Belated reply to Jon from our CFO:

If we were paid 110% of Medicare rates for Medicare patients, it would approximately cover the cost of their care. It wouldn't contribute to any of the other unfunded costs of the organization, such as charity care, Medicaid shortfalls, capital replacement, etc.

If we were paid 110% of current Medicare payments for non-Medicare (commercial) patients, it would be financially unsustainable because of a) the significant difference in utilization of services between the populations and b) the inequalities in Medicare inpatient and outpatient payments.

Medicare patients are heavy utilizers of inpatient services. About 56% of Medicare business is inpatient, and Medicare inpatient payments are not unreasonable. Medicare is a terrible outpatient payor, but Medicare patients are not huge utilizers of outpatient hospital services, so the outpatient loss is partially offset by an inpatient "gain", but still yielding a large loss (about 8-9%).

The commercial population is very different. Only about 37% of the services used by the commercial population is inpatient care. So, utilizing a Medicare fee schedule for a commercial population, even at 110%, wouldn't work because Medicare outpatient payments are so deficient.

Keith said...

At the hospital where I practice, they have built a lovely new lobby with a pretty waterfall. The CEO has seen his salary rise from 500,000 to nearly 2 mil over a 10 year period. Thy are in the process of redoing the ORs and have built a new ICU. All the upper administration have nice new Mercedes Benz's to drive around in.
They have also run extensive advertising that was rolled out during the winter olympics. They have instituted a full restaurant style menu and concierege service and a full steam campaign directed towards patient and employee "loyalty".

I echo the other writers that before you diss price controls, the hospital industry has to be truthful with how they alocate all these expenses that we in the trenches see as frivolous. If I spent in my practice the way my hospital does, then I too would be able to claim that Medicare reimbursement is insufficient to cover my expenses, but this would be disingenuous if I was providing myself with a new Mercedes and a rosewood and marble studded office.

The only way to stop the amenities race that you hospital guys are all enagaed in is to put a clamp on the payments and level the reimbursement so that hospitals will stop competing with flat screen TVs and concierge services and more on the basis of quality of care.

Anonymous said...

"All" is a bit of an overstatement...

Barry Carol said...

Paul – I wonder if there is some percentage of Medicare rates (150%, 200%) that you would deem unreasonable on its face beyond which neither commercial insurers nor the uninsured should be expected to pay, at least for services that cost more than, say, $250 to provide. Alternatively, what might the answer be if you look at it as a percentage of your own fully allocated cost for a given service, test or procedure?

If I remember correctly from my days in the 1970’s following electric utility companies, regulators used a term called the “zone of reasonableness” for determining allowed rates of return. I think hospitals should think in similar terms when negotiating with private insurers and, especially, when billing the uninsured.

Engineer on Medicare said...

From the Original Blog Post: "If we are going to move towards government supervision of reimbursement levels, please instead set up a regulatory body to determine the appropriate level of rates based on best medical practices and true underlying costs of hospitals. An evidentiary hearing in which all those factors are considered by qualified administrative law judges would do more to provide a sound basis for determining rates than the price control approaches being raised."

The last thing we need is judges deciding what rates should be, and thereby effectively dictating what congress must appropriate and other payers must pay.

There should be open competition on price and performance. A large payer, such as Medicare, could negotiate with multiple providers, and then decide what the limits of payment would be; and those payment levels would be published. If they settle for a certain price schedule for half of the health care capacity in Boston, and then simply refuse to pay more than that to the rest of the providers, the other can comply or lose market share while those with negotiated price schedules gain share. Major employers could insist on applying the same standard as a means of controlling their costs.

By applying that as a national strategy, with adjustments as appropriate for conditions in different regions of the country, they could drive down costs because providers would be driven to control costs in order to make a profit. If there was a broad public insurance option in that mix they would have even greater clout to manage costs.

Anonymous said...

Dear Engineer,

Sorry if I wasn't clear, but I wasn't talking here about a national plan, and I wasn't talking about an administrative panel determining Medicare rates. I was talking about state regulation of commercial insurance reimbursement rates in MA.


I'm not sure why it needs to be a percentage of Medicare, but your basic formulation is just right. Rate regulation in general allows recovery of prudently incurred operating expenses and then an allowance for return of capital invested and return on capital equal to the entity's cost of money. For nonprofits, the latter is rather easy to calculate, as it is simply their cost of borrowing (unlike for-profit entities which also have a component for an allowed return on equity.)

Anonymous said...

Fom Facebook:

Beverly: This has gotten so interesting you've got me reading the Boston Globe to see what's going on! There is also an editorial in today's WSJ that says bad things about Mass health care; public mandates increasing costs, and per capita costs 27% above nat'l ave. Maybe you need Md.'s system after all - but wait, that can't be done in 30 days......

jonmcrawford said...


Bravo on the response regarding the details behind what would actually be covered, that is much more enlightening as to the disparity between Medicare and commercial population utilization trends.

I have no answers on this issue (I know, you're shocked) but appreciate that the rates being proposed would not allow your organization (or any other similarly tasked hospital) to operate in a competitive fashion.

I will continue reading with interest...

e-Patient Dave said...


That WSJ piece is a majestic travesty, a monument to misusing statistics, as only a Wall Street publication could. (Yes, even beyond what a medical journal might.)

It's absurd to compare per capita costs between one population where no one's left out, and another where merchants (unrestrained insurance providers) can exclude anyone they want OR where the only ones you count are the ones who can afford coverage.

Even I saw this, before I'd studied healthcare at all: one of my very first blog posts, 12/8/07, was For prettier statistics, omit inconvenient people. Why this escapes "The WiSsaJ" is open to, ahem, speculation.

btw, Susannah Fox of the Pew Internet & American Life project has a new report coming out 3/24 on chronic disease. Pretty surprising.