Issue No. 46: Where the Cost Savings Are: Hospitals

Six percentage points. That is the gap between the proportion of GDP the U.S. spends on health care and what other rich countries spend, according to a thorough study published last year in JAMA by three researchers affiliated with the Harvard T.H. Chan School of Public Health. What’s the source of the disparity?

Based on what you hear from media and politicians, a reasonable conclusion would be prescription pharmaceuticals. Even the Trump Administration, despite its professed preference for free-market competition over to nationalized medicine, wants to limit U.S. drug prices to an index of the pricesthat foreign governments set.

In fact, however, the Six Percent Gap has almost nothing to do with medicines. According to statistics from the OECD, the organization of developed nations, the U.S. spends 2.1% of GDP on pharmaceuticals; the average of the 10 other countries studied by the Harvard researchers is 1.5%. So that’s just six-tenths of a percentage point. A big chunk of the rest of the gap can be found in hospitals. The U.S. spends 5.8% of GDP on hospital care; the average of the 10 rich countries is 4%. That’s 1.8 percentage points. The rest of gap is filled with outpatient, physician, long-term care, and other costs.

Three Studies on Unhinged Hospital Costs

Not only are hospitals the main source of the disparity between health care spending in the U.S. and everywhere else, but also hospital costs, unlike pharmaceutical costs, appear to be coming unhinged. Consider:
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• After undertaking a detailed analysis of major not-for-profit hospital chains, the news service Axios reported May 21, that “the number of hospital admissions, surgeries and other medical procedures has continued to stay flat in many parts of the country. But that hasn't prevented hospitals from retaining large sums of money and hiring more people…. America's rural hospitals are dying. But large not-for-profit hospital systems in cities and suburbs are doing extremely well as premiums rise and as patients struggle to afford their medical bills.” Axios reported that net margins for these hospitals were a stunning 16.4%.

 

• An extensive study released two weeks earlier by the Rand Corporationfound that hospitals are charging private health care plans an average of 241% of what Medicare would be charged for the same services. “Spending on hospital services accounts for 44 percent of total personal health care spending for the privately insured, and hospital price increases are key drivers of recent growth in spending per capita among the privately insured,” said the Rand report.

 

• And a study in Health Affairs in February found between 2007 and 2014, “hospital prices grew 42 percent, while physician prices grew 18 percent. Similarly, for hospital-based outpatient care, hospital prices grew 25%, while physician prices grew 6 percent.” Concluded an article in Modern Healthcare that examined the study: “Hospital prices are the main driver of U.S. healthcare spending inflation, and that trend should direct any policy changes going forward.” 

These recent revelations once again raise a question that politicians and the media would rather ignore: Why is the spotlight on the cost of medicines when the cost of hospital care is far greater and, by some measures, out of control?

Some Facts About Hospital Spending

For the year 2017, the latest available statistics from the Centers for Medicare and Medicaid (CMS), hospital expenditures in the United States totaled $1.143 trillion. That’s about $3,500 per American. By comparison, prescription drug spending in 2017 was $333 billion, or about $1,000 per person. More facts about the scale of hospital costs:
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• Hospitals account for 32% of total health care spending; The greatest percentage of healthcare costs in the US.

 

• Hospital spending in 2017 was almost exactly twice what the U.S. spends on defense.

 

• In that year, hospital spending rose 4.6% more than any other segment of the healthcare system.

 

• The U.S. spends a proportion of its GDP on hospitals that is 45% greater than what other rich nations spend (5.8% vs. 4%).

Hospitals Change, But Efficiency Lags
 
The nature of hospitals is changing, and, while you would think that the change will lead to more efficiencies and lower costs, the opposite is happening. More and more, hospitals are becoming centers of out-patient, short-term care. For example, the total number of hospital admissions in the U.S. dropped from 38.9 million in 1980 to 35.1 million in 2015 (the latest statistics from theCenters for Disease Control) even though the U.S. population rose over this period by more than 100 million. The average length of a hospital stay during these 45 years fell from 10 days to six days, and the number of beds has dropped by half since 1975. Between 2000 and 2015 alone, the rate of hospital stays for those over age 65 dropped by 25%. Roughly half of appendectomy patients are going home the day of the operation; in the 1960s, the surgery required a stay of nearly a week.

Americans do not need intense, longer-term hospital services as much as they did in the past, and a major reason is that medicines are keeping them healthy enough to avoid surgeries and long stays. Just one examples: 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.) This period coincides with the development of important medicines to reduce cholesterol and high blood pressure and to combat other precursors of ASCVD.

Hospitals, however, remain inefficient places for administering health care. Astudy by CMS found that over the period 1990-2013, the average annual growth rate of multi-factor productivity was only 0.1% to 0.6% (depending on methodology). “Multi-factor productivity” (MFP) is the change in outputs that results from a change in labor and capital inputs. Along with population increases, it is the main factor in GDP growth. For private non-farm businesses in the U.S., the rate was 1.1%.
 
Even as hospital beds and stays have fallen, hospital employment has risen – from 4,662,000 in April 2009 to 5,229,000 ten years later – an increase of 12%, according to the Bureau of Labor Statistics. As The Economist magazine reported Aug. 12 issue: “America spends vastly more on administration [than Europe]: 8% of health spending versus 2.5% in Britain. As of 2013, Duke University hospital had 400 more billing clerks (1,300) than hospital beds (900).”
 
While hospital stays are decreasing, the cost of procedures done in the hospital is rising. 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%.”

Government More Problem Than Solution
 
What is the problem? An excellent report in December titled, “Reforming America’s Healthcare System Through Choice and Competition,” by the departments of HHS, Treasury and Labor, points to government itself as responsible for much of the problem, citing “misallocation of resources and widespread inefficiency in the healthcare system, particularly in public programs.” Says the report:

Since the government share of healthcare spending is so large, government rules impose inefficiencies on private firms dependent on public funding, even if they also serve privately funded patients. Simply put, government has played a large role in limiting the value Americans obtain for their healthcare spending. The United States is spending a large and increasing share of its national income on healthcare, and much of this spending does not lead to citizens living longer, healthier lives.
 
The HHS-Treasury-DoL report also pointed out that both hospitals and physician services have become more and more concentrated, with fewer players in big markets. The proportion of primary-care physicians working in a hospital or health care system rose between 2010 and 2016 from 28% to 44. Zack Cooper, a co-author of the study published in Health Affairs and an associate professor of health policy at Yale University, was quoted in Modern Healthcare as saying:
 
What is most worrying to me is that there has been fairly profound consolidation among hospitals and when they gain market power they have the ability to raise prices. They have the ability to gain more favorable contractual terms, which allows them to raise prices and resist the new, more sensible payment reforms.

A study published in Health Affairs in 2014 found “that an increase in the market share of hospitals with the tightest vertically integrated relationship with physicians--ownership of physician practices--was associated with higher hospital prices and spending.”

For the 10 years ending in February 2018, a study found, an average of 14 community oncology practices a month have been closed, acquired, or merged into hospitals. And a study last year found that between 2004 and 2014, the proportion of chemotherapy infusions conducted in hospitals for commercially insured patients rose from 6% to 43% -- and the cost of such treatment in a hospital as opposed to a doctor’s office for a day was more than twice as high on average.

Example of What’s Wrong: 340B
 
Government policy is encouraging concentration. Consider the 340B program, established more than a quarter-century 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 and 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, and it is encouraging these hospitals to swallow up other health practices, which then get to take advantage of 340B. Meanwhile, 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 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.

Weak Attempts to Address Costs
 
So far, government attempts to address the hospital-cost issue have been weak. In an attempt to increase competition, HHS is now requiring hospitals to disclose their prices. But the information that hospitals are providing is largely indecipherable. Take a look at this “Chargemaster” Excel spreadsheet provided by a hospital chosen at random, Methodist LeBonheur Healthcare of Memphis. What do you suppose “FNA BX W/CT GDN 1ST LES” means? It costs $1,604. In addition, these prices are meaningless to the 91% of Americans with health insurance. They want to know what they have to pay.

If, however, you want to get an idea of the total cost – to insurers and individuals – of major procedures, there are resources. The average cost of a hospital stay for pneumonia, for example, is $10,000; for the fracture of a lower limb, $17,000; for a heart valve disorder, $42,000. A liver transplant averages $813,000; kidney transplant, $415,000. An MRI averages $1,119 in the U.S. and $503 in Switzerland; an appendix removal is $15,930 in the U.S. and $2,003 in Spain; and a C-Section is $16,106 in the U.S. and $7,901 in Australia.

Why aren’t these figures more daunting to individuals and politicians? A big reason is the structure of insurance policies, both government and private. While hospital spending is more than three times pharmaceutical spending overall in the United States, individual Americans pay out of their own pockets$47 billion a year for pharmaceuticals compared with $34 billion for hospital services – or 38% more.
 
Let’s put the issue as simply as possible. In one sector of health care – hospitals – costs are rising at more than 4% annually, mainly because prices are rising. In another sector of health care – pharmaceuticals – costs are flat, and prices are flat. Hospitals represent about one-third of total health care costs; prescription pharmaceuticals, about one-tenth. If the aim is to constrain costs, where would any sensible public policy effort concentrate?