Medicare’s Hospital Payment Rates Could Save Employers Billions

Executive Summary

The cost of hospital care has become increasingly unaffordable for the majority of Americans. The United States spends more on hospital care than any other nation, even though Americans consume less hospital care than their peers in other developed countries.

High hospital spending in the United States occurs largely because Americans pay higher prices per unit of service than patients in other countries. In fact, the United States spends more per capita on inpatient services than any developed nation, save Austria and Switzerland. Including outpatient services, the United States spends nearly $4,000 per person on hospital care annually; 22 percent higher than the next highest country (Germany, $3,225) and nearly 79 percent higher than the average among high-income countries, according to data from the 2022 World Index of Healthcare Innovation.

For decades, prices at American hospitals have increased at a faster pace than those of other goods and services. Since 2000, inpatient hospital prices increased 237 percent, while outpatient prices increased 227 percent. By comparison, prices for all goods and services in the United States economy combined increased only one-third as much, 76 percent over the same time period.

Payers and policymakers have begun to reach their limit and are pushing back against high hospital prices in numerous ways. One tactic that is gaining favor is reference pricing.

Reference pricing refers to an insurer paying a fixed amount for a good or service based on a benchmark rate, rather than negotiating separate rates with providers. Most often, reference pricing involves the insurer paying a certain percentage of what Medicare pays, whether it be the same price as Medicare (i.e., a 100 percent reference price) or some higher percentage.

In this paper, we sought to determine the “maximum” savings that could be achieved in Texas if private insurers paid hospitals the same prices as Medicare. First, we calculated the collective savings possible to the estimated 18 million Texans with private insurance. Then, we estimated savings specifically to the covered lives in the state government’s employee health benefits system.

We found that those 18 million Texans would spend about $6 billion less on inpatient care annually if all privately insured patients paid the same prices as Medicare. For state employee health plans, we estimated the annual savings to be more than $169 million. Due to important data limitations, our estimated savings for state employee health benefits represent a floor, rather than a ceiling, on possible savings to the state government and Texas taxpayers. This implies even more savings beyond our “maximum.”

Unsurprisingly, the hospital industry opposes policies that reduce costs through reference pricing. Hospital administrators often argue they need to charge higher rates to private insurance to offset the lower rates they receive from Medicare and Medicaid. But researchers find there is little correlation between the rates hospitals charge the privately insured and rates charged to those with public coverage.

Nevertheless, more private insurers are turning to reference pricing to rein in spiraling hospital costs as well as other health care goods and services. States like Montana are successfully implementing reference pricing for their state employees.

Though poorly designed reference price models can increase out-of-pocket costs to patients, carefully designed models can lead to lower hospital costs and insurance premiums for families while reducing government deficits.

Introduction

In 2022, 36.6 percent of American personal health care expenditures occurred in hospitals, more than in any other health care setting. Hospital spending has risen to the point that the average American family now spends more on hospital care than on its federal tax bill. The high cost of hospital care is unsustainable for working families, especially given the rising cost of other necessities like food and housing.

It is remarkable that the United States pays so much for hospital care per capita despite using hospitals far less than other high income countries. In 2020, the average inpatient hospital stay in the United States cost $14,900 and lasted an average of 4.9 days. In contrast, the OECD inpatient average stay cost $8,503 and lasted 7.6 days. These figures demonstrate that the driving force behind high hospital spending in the United States is price, not utilization.

Nevertheless, third-party payers and governments try to reduce hospital spending by controlling utilization. For instance, some insurance companies review planned procedures for medical necessity and require their customers to bear higher cost-sharing burdens in order to discourage overuse of hospital services. Still, hospital spending per capita continues to increase rapidly, increasing by 23.4 percent from 2018–2022, at an average annual rate of 4.7 percent.

The RAND price transparency study

Health policy researchers recognize that the unit cost of hospital services in the United States leads the world. Furthermore, the evidence collected by researchers shows that the privately insured pay far more for equivalent services than their peers in public programs such as Medicaid and Medicare.

Perhaps the most prominent study examining this phenomenon is the RAND employer-led price transparency study, beginning in 2019. RAND has since published four rounds of analysis, with the latest two rounds capturing prices among private insureds across every U.S. state.

These studies paint a sobering picture of what ordinary insured Americans face. The prices charged to those with private insurance in some states are more than triple that of the rates charged to Medicare beneficiaries.

Notably, hospital administrators have long argued that it charges higher prices to private insurance because reimbursement rates for Medicare and Medicaid are too low to be profitable for hospital systems, a process called cost shifting. However, evidence shows that prices charged to the privately insured do not vary according to the percentage of Medicare and Medicaid recipients a hospital treats. Simply put, hospitals charge high prices to those with private insurance because they can.

There are several reasons hospitals enjoy negotiating leverage over insurance companies. First and foremost, hospital systems have consolidated rapidly in many regional markets across the United States and have successfully prevented competitors from entering such markets. Additionally, hospitals have demanded that anti-competitive contract provisions be included in their agreements with insurers. These provisions give hospitals an advantage when negotiating reimbursement rates. Finally, opaque prices further expose the average patient to exploitative pricing.

Ultimately, Americans need more tools to push back against monopolistic pricing in hospital markets.

Potential savings for privately insured Texans

Insurance companies and governments now consider reference pricing as one tool to reduce hospital prices. Because Medicare’s pricing system is ubiquitous throughout the health care system, including its extensive price list of medical procedures known as current procedural terminology (CPT) codes, most reference pricing methodologies benchmark negotiated prices to a percentage of what Medicare would pay for the same service. It follows, then, that in order to achieve the maximum possible savings, payers would implement reference prices at rates equal to Medicare rates, assuming hospitals would never accept private insurance rates lower than what Medicare pays.

To determine the maximum savings of reference pricing for inpatient services in Texas, we set up a hypothetical scenario in which private insurers paid inpatient hospital rates equal to Medicare rates, or a relative price of 100 percent of Medicare rates.

We used data from the Healthcare Cost, Utilization, and Price Project (HCUP), including discharges and inpatient spending by type of insurance. To calculate the potential savings to the privately insured in Texas for inpatient services, we applied the RAND Corporation’s estimate of the average percentage price of all privately insured patients relative to Medicare prices, hereafter referred to as the “relative price.” In 2020, the relative price for private insurance was 223 percent of Medicare rates. Fortunately, the RAND analysis accounts for the differences in inpatient service use and intensity, geography, hospital uncompensated care rates, and other factors so that we can make a meaningful price comparison between private insurance and Medicare.

In 2020, data from HCUP shows $11.0 billion in inpatient spending billed to privately insured Texans statewide. Dividing this figure by the relative price of 223 percent yields total spending of about $4.9 billion — meaning Texans would save about $6.1 billion if the privately insured paid the same prices as Medicare beneficiaries.

Importantly, the major limitation in using RAND’s relative price estimate is uneven data reporting from self-funded employer health plans, as well as the absence of an All-Payer Claims Database (APCD) in Texas to provide additional claims data. (APCDs track all prices negotiated between health care payers and providers; the Texas APCD was established after RAND’s latest analysis.) As a result, the relative price used in our calculation may not be generalizable to all inpatient costs reimbursed by private insurance in the state.

Texas public employee savings

In the absence of a publicly available average relative price for Texas public employee health plans, we set out to calculate it across a range of inpatient services using hospital and health plan data made available in compliance with the federal government’s transparency in coverage regulations.

From a sample of hospitals across Texas, we found that the average relative price for plans offered by the Texas Employee Retirement System (ERS) and the Teachers Retirement System (TRS) averaged 150 percent of Medicare rates — significantly better than the state’s average prices in the commercial insurance sector.

After estimating the relative price for ERS and TRS health plans, we made a few key assumptions to calculate an estimate of savings on a 100 percent relative price for Texas public employee health benefits. First, we assumed ERS and TRS plan participants use inpatient services at the same rate as the overall privately insured population. Second, we assume ERS and TRS employees and their families have the same health status as the wider privately insured population.

Given these assumptions, our next step was to estimate inpatient spending by ERS and TRS members by finding the combined number of covered lives under ERS and TRS, and multiplying this percentage by the total inpatient spending by private health plans in the state.

The U.S. Census estimates that 17.7 million Texas residents were privately insured in 2020. In the same year, ERS and TRS reported a combined 930,000 covered lives, or 5.3 percent of the privately insured population in the state. Once again, we applied the $10.98 billion inpatient cost attributed to private plans in the same year, yielding $581.9 million in estimated inpatient spending by Texas public employees and their dependents. Dividing this figure by the relative price of 150 percent means $387.9 million would be spent if ERS and TRS paid Medicare rates — a savings of $194 million shared by public employee households and taxpayers.

Our calculations have a few key limitations. First, the 150 percent relative price difference may underestimate how high prices for Texas public employees are relative to Medicare beneficiaries. This is because ERS and TRS employees and dependents — which include healthier children — use inpatient services with a lower degree of service intensity than Medicare beneficiaries. Other studies, including RAND’s employer-led price transparency initiative, use claims data to adjust Medicare prices to account for differences in the mix of services used by the privately insured versus Medicare populations.

In other words, the difference in the total amount ERS and TRS employees pay for inpatient services relative to Medicare recipients is a function not only of prices but also the mix of services they use. Holding the total amount of inpatient spending constant, the lower intensity of services means prices for ERS and TRS employees must be higher per unit of service than our analysis would otherwise indicate.

The second limitation is a lack of data on where ERS and TRS employees and their families receive care. For example, ERS and TRS may employ tools to more effectively encourage members to use higher value or lower cost sites of care. Without this information, it is impossible to know if ERS and TRS members use the same hospital providers at the same rates as the wider insured population.

Ultimately, calculating savings for Texas’ public employee health plans is complicated by the lack of publicly available claims data for what care members receive and where members receive that care. To obtain more precise estimates on the potential savings of any reference price proposal, the Texas legislature should ask ERS and TRS to release data so researchers can answer these questions. Additionally, Texas can appropriate more funds to the state’s All-Payer Claims Database, with the purpose of hiring more data analysts to collect the necessary claims data.

The savings opportunity for America

Given privately insured hospital expenditures approached $486 billion nationally in 2022, the savings from employing reference pricing more broadly — even just for inpatient hospital services — could reach tens of billions every year.

Short of employing reference pricing universally, there are several ways to implement reference pricing in targeted ways, leveraging free-market forces to increase competition among providers that lead, in turn, to lower hospital prices and improved quality of care.

For example, The Fair Care Act of 2022 (FCA) features a provision that would implement reference pricing while giving hospitals the final say on the prices they charge. Specifically, the FCA would give consolidated hospital systems a choice: either voluntarily divest subsidiary hospitals to restore competitive market prices, or accept prices equal to Medicare Advantage rates for all privately insured patients. Notably, the FCA would allow somewhat higher reimbursement rates for critical access hospitals in rural areas.

Importantly, our modeling suggests implementing this and other pro-competitive hospital measures, as outlined in the FCA, would save $107 billion nationwide over ten years.

Whether through a broad or targeted approach, reference pricing can help restore competitive and affordable hospital prices in the United States. By doing so, America would take an important step toward affordable health care for working families today and for generations to come.