Issue No. 39: Where Are Health Costs Rising Most? Hospitals. And Here is Why.

One of the great mysteries in recent years is why pharmaceutical companies are portrayed as the villains in the story of rising U.S. health care costs while hospitals are virtually ignored. A devastating article in the new issue ofNational Affairs, a respected journal that explores domestic policy, helps to set the record straight and to explain the conundrum.

Before we get the article itself, here are some recent facts about hospital costs.

• Total U.S. hospital spending in 2017 reached $1.1 trillion, compared with $333 billion for prescription drugs, according to a new study by the Centers for Medicare and Medicaid Services (CMS).
• For the year ending Dec. 31, 2017, hospital costs rose 4.6%, compared with a 0.4% rise in drug costs, again according to CMS. For the previous year, hospital costs rose 5.6%, or more than two and a half times the rate of inflation. Drug costs in 2016 rose 2.3%. Hospital spending increases are outstripping drug increases again in 2018.
• Overall, hospitals represent 33% of U.S. health costs; physician and clinical spending, 20%; drugs, 10%.
• Hospital costs have risen by at least 4% in 11 of the past 13 years, according to the latest Altarum Health Sector Trend Report.
• The U.S. spent 5.8% of Gross Domestic Product on hospitals in 2016 (latest data), by far the highest proportion in the OECD, the organization of rich nations. By contrast, Germany spends 3.2% of GDP on hospitals; the U.K., 4.1%; Canada, 3.1%.

Hospital Costs Soar, But Utilization Metrics Decline

What makes soaring hospital spending hard to understand is that key metrics on the utilization of hospitals have been declining. For example:

• “Between 2000 and 2015, the population rate of nonneonatal, nonmaternal inpatient stays dropped for all age groups; the largest percentage decrease (25 percent) was among patients aged 65 years and over,” wrote Ruirui Sun and colleagues in a report last year for the federal Healthcare Cost and Utilization Project (H-CUP).
• Hospital stays for specific diseases have plummeted. From 2001 to 2014, the rate of atherosclerotic cardiovascular disease (ASCVD) inpatient stays among adults decreased 41.5%. (ASCVD is defined here as coronary artery disease, acute myocardial infarction, or ischemic stroke.)
• The number of hospital beds in the U.S. has declined from 1,213,000 in 1990 to 902,000 in 2014 (latest figures from the Centers for Disease Control and Prevention, or CDC). That is a drop of 33% during a period when the U.S. population rose by 29%.

It is no surprise, then, that the cost of stays and procedures is rising. For example, between 2005 and 2014, the average cost per hospital stay, adjusted for inflation rose a total of 12.7%, according to a 2017 H-CUP report. “The cost of a maternal (childbirth) hospital stay rose 12.8% (again, adjusted for inflation); neonatal stay, 19.2%; surgical, 16.4%; injury, 17.1%.”

These increases have occurred even though stays are generally shorter than in the past. One study found that the average hospital stay for pneumonia fell from 5.6 days to 3.6 days over just a six-year period in the early 2000s. More and more appendectomy patients are going home the day of the operation; in the 1960s, the surgery required a stay of nearly a week.

Government Subsidies and Protectionism Make Hospitals Inefficient

So, less use of hospitals, more spending on hospitals. What gives?

In the National Affairs article, Chris Pope, a fellow at the Manhattan Institute, has an answer. He blames the problem on excessive government intervention creating what he calls “hospital protectionism.” He writes, “America's hospital industry is already one of the most politicized sectors of the nation's economy, and its shape and structure are the product of decades of deliberate legislative and regulatory actions.”

Pope begins with basic hospital economics. Hospitals have high fixed costs. One study found that “84% of expenses relate to buildings, medical equipment, and (often-unionized) labor — costs which, unlike medications or supplies, cannot easily be expanded or reduced in line with patient volumes.” The normal response would be for “expenditures [to] be spread over more patients, [so] prices can be greatly reduced.”

That is what has happened in Europe, and Pope offers some eye-opening examples:

The United States performs only slightly more MRI scans (118 per 1,000 residents) than France (105 per 1,000) but employs three times as many MRI machines (39 versus 13 per million residents). This helps explain the disparity in the average cost of an MRI: $1,121 in the United States but only $363 in France.

America's hospital sector has become plagued with such overcapacity. Whereas the European Union had an average hospital-bed occupancy rate of 77% in 2015, the rate in America's community hospitals was only 63%. Occupancy rates were less than 30% for American hospitals with between six and 24 beds, and 42% for those with 25 to 49 beds.

The United States simply has too many hospitals. While we have 4,840 community general hospitals, Pope writes, the initial 13 Eurozone members, which have a population greater than the U.S., have only 2,901. “This is not just a matter of population density,” he writes. Massachusetts, for example, has a population density nearly twice that of Denmark (not including Greenland), yet Massachusetts has 75 hospitals compared with 21 for Denmark. On average, hospitals in Europe have 235 beds; in the U.S., 150.

U.S. hospitals are characterized by lower volumes of surgery and other procedures. Pope notes that 65% of heart-bypass operations in California occurred at facilities with fewer than 200 procedures a year; compared with 7% at such smaller facilities in Canada. “Low volumes,” he writes, “also inhibit learning (by organizations as well as clinicians) and reduce the quality of care: The 30-day mortality rate following such procedures is 5.2% in low-volume hospitals and 2.1% at high-volume hospitals, with a ‘safe’ threshold achieved by facilities treating at least 415 cases per year.

Political Favors Are at the Root of the Problem

The mysteries mount. Why does the U.S. have so many smaller, less efficient hospitals? The answer seems to be politics.

Pope writes that the current situation is “the product of two decades of deliberate interventions to protect hospitals from falling revenues through a combination of subsidies and restrictions on competition.” What politicians seek to defend through their interventions with hospitals is the status quo. He writes:

Whereas hospitals seem strong to economists, they do nothing but plead their weakness to congressional staff: Without assistance, they claim with some plausibility, they will be forced to scale back essential services or close their doors. Members of Congress from both parties, all of whom have hospitals in their districts greatly cherished by their constituents, are highly sensitive to such concerns. In addition to the practical convenience it offers, a well-equipped local hospital gives residents a sense of security and helps anchor a community.

Hospitals also bring an enormous number of well-paying jobs (5.7 million in 2015) to places that otherwise may have few. This political power is catalyzed by lobbying spending ($103 million in 2017) that rivals the amount spent by the entire defense industry ($125 million).

The result is a host of special political favors. For example, Pope notes that Medicare established fixed-payment rates in 1983, but a GAO study 30 years later found that 91% of hospitals were eligible for upward adjustments or exempt from the rates entirely. Pope enumerates other subsidies that maintain the current bloated system. Fee schedules for Medicare services delivered in a hospital outpatient department, for example, are sometimes “more than three times as much for the same procedures when they are delivered by doctors directly employed by hospitals.”

The Stark Law, passed in 1992, “was enacted in 1992 to ban physicians from referring Medicare or Medicaid patients to specialty hospitals in which they have a financial stake, due to conflict-of-interest concerns,” Pope writes, but, in fact, the law’s effect is to keep lucrative operations at community hospitals when they could easily be shifted away.

The government “also provides $16 billion per year to hospitals with medical residency programs — a subsidy that is not needed to get hospitals to employ underpriced skilled labor, but which they nonetheless prize.” Then, there are state Certificate of Need laws that allow large hospital systems to “easily get approval for investments they seek to make, while smaller competitors and newcomers can find it hard to establish a foothold or to build the scale needed to challenge incumbents.”

One of the Worst Subsidies: the 340B Program

One of the worst politically tinged subsidies to hospitals is the 340B program. It was established 27 years ago as a way to help poor hospital patients. In order to participate in Medicaid, drug manufacturers have to provide outpatient medicines at prices discounted by 20% to 50% to hospitals that serve a disproportionate share of low-income Americans. The hospitals are then allowed to claim full reimbursement at undiscounted rates are supposed to use this excess for charitable care.

But, as we pointed out in Issue No. 30 of this newsletter, the program is not working as promised. It has become just another subsidy to support inefficient hospitals. The vagueness of the law allows hospitals to ignore the obligation to help poor patients and for hospitals that serve non-poor patients to get benefits as well.

In study published in the New England Journal of Medicine last year, Sunita Desai of the New York University School of Medicine and Michael McWilliams of the Harvard Medical School concluded, “Financial gains for hospitals have not been associated with clear evidence of expanded care or lower mortality among low-income patients.”

Meanwhile, the program has ballooned in size. Adam Fein of Pembroke Consulting, publisher of the Drug Channels blog, released data last summer showing that the 340B program has grown at an annual rate of 31% since 2013 (by comparison, manufacturers’ net drug sales grew by about 5% a year. In 2007, the program accounted for 1.6% of all U.S. drug sales in 2007; by 2016, the proportion had reached to 5%.

Discounted drug purchases under 340B, rose to $19.3 billion, up from $16.2 billion the year before. And, as Fein notes, as those purchases have risen, charity care by hospitals has declined, from 6.1% of total expenses in 2012 to 4.3% in 2016.

The 340B program has greatly expanded with little oversight. More than 25%of retail, mail and specialty pharmacies are now eligible for the discount. In 2016, according to findings by Drug Channels, more than 50% of total hospital purchases in the U.S. were through the 340B program.

In a paper in 2014, Rena Conti of the University of Chicago and Peter Bach of Memorial Sloan-Kettering pointed out how 340B has set in motion factors that raise overall health costs:

The 340B program creates a widening disparity between noneligible and eligible hospitals and affiliated oncology practices in the profits they are able to obtain from the care of well-insured patients with cancer. This disparity is likely underlying trends toward consolidation and affiliations between community-based oncology practices and 340B-eligible hospitals.

This disparity may also lead to shifting of care out of community-based oncology practices and into hospital-based infusion suites. These trends will tend to increase total spending. Cancer care delivered in a hospital-based outpatient infusion suite is typically more expensive than that delivered in a physician’s community-based office.

In another study, published in the New England Journal of Medicine by Sunita Desai of the New York University School of Medicine and Michael McWilliams of the Harvard Medical School, found that facilities owned by hospitals eligible for 340B had “230% more hematologist-oncologists than expected in the absence of the program” and that “program eligibility was associated with lower proportions of low-income patients in hematology-oncology.”

That study concluded, “Financial gains for hospitals have not been associated with clear evidence of expanded care or lower mortality among low-income patients.”

High Infusion Costs – And a Response

High infusion costs for specialty drugs at hospitals plague the health-care system. An analysis by Fein of data from the Medical Pharmacy Trend Reportfound, for example, that Remicade, an immunosuppressant drug, cost 120% more to administer in a hospital than in a doctor’s office; Neulasta, a bone-marrow stimulant, cost 100% more; and Alimta, a chemotherapy drug for lung cancer, cost 50% more.

As a result, health insurers are cracking down. In Michigan, Blue Cross Blue Shield and Priority Health “have created programs to eliminate from coverage most infusion services at hospitals or outpatient centers owned by hospital chains,” wrote Jay Greene last April in Crain’s Detroit Business. And a policy instituted last summer by Blue Cross Blue Shield of North Carolina states bluntly: “Hospital outpatient infusion, in the absence of the clinical indications above [mainly a history of adverse events], is considered not medically necessary.”

At the start of 2018, the Trump Administration took a step toward reforming 340B by reducing the Medicare repayment rate by about 30%, cutting the profit hospitals were making from the discounts that were forced on drugmakers. The politically powerful American Hospital Association sued, lost an appeal last July, then refiled the case in September and won a favorable ruling on Dec. 27 in U.S. District Court for the District of Columbia. The case is far from over.

Law Requiring Hospital Cost Disclosure Goes Into Effect

Meanwhile, a new law went into effect on Jan. 1 of this year requiring hospitals to post their prices online. The law is hardly a panacea. Yes, the average cost of a kidney transplant is $415,000, but the new price postings are confusing, and consumers don’t pay them anyway. In fact, one reason that hospitals do not feel pressure to constrain their prices is that patients pay so little out of pocket. As Pope explains:

Hospital services are disproportionately consumed by those with major illnesses who have already passed deductibles and caps on out-of-pocket costs. As a result, a study by Gautam Gowrisankaran, Aviv Nevo, and Robert Town found that patients pay an average of only 2% to 3% of hospital bills as co-insurance, and are more than 40 times less responsive to prices than those paying out of pocket. From the hospitals' perspective, the most lucrative well-insured patients may be sensitive to travel, quality, and amenities, but are usually insensitive to cost.

Pope offers the right antidote: competition and the elimination of most, but not all, subsidies. “The objective of public policy,” he concludes, should be “to allow competition wherever possible to eliminate inflated costs while establishing a reasonable floor in access to emergency care. Policymakers should seek to establish a ring-fenced subsidy for emergency and safety-net services, along with an expectation of full competition for elective care.”

That makes sense. But just as important as proposed solutions is simply the matter of focus. It’s time policy makers put their own political interests aside and started targeting by far the most important source of higher health-care costs: hospitals.