Who Pays What and Why

It’s time to return to designing an optimal health insurance system. In previous posts we have specified the different types of healthcare that are covered by health insurance, defined and quantified the size of the uninsured population in the US, explained the costs of single-payer healthcare systems, and discussed the high degree of market power wielded by providers as demonstrated by high percentage price markups. Today we continue our discussion of market power and its importance to the healthcare market.

If the price of a hospital stay is greater than the price of an office visit, that is understandable because a hospital stay requires far more resources to supply.  Each hospital patient must be attended by a team of nurses 24 hours a day.  There is also the cost of maintaining the hospital building itself and all the monitoring and surgical equipment. Plus, there are the physician fees for diagnosing the illnesses suffered by the patients and performing surgery.

What is harder to understand is that the price a patient and her insurer pays for healthcare depends as much on who is paying for it as it does on the costs incurred by the provider. In economics, the practice of charging some customers more than others for the same services is called price discrimination.

Price discrimination can only occur when there is an imbalance between the relative market powers of the supplier and the buyer. When price discrimination occurs because of the relatively strong market power of the supplier (i.e. monopoly power), it is considered bad for consumers. Consequently, this form of price discrimination is outlawed by three different acts of Congress: the Sherman Antitrust, Clayton Antitrust, and Robinson-Patman.

When price discrimination occurs because of the relatively strong market power of the buyer (i.e. monopsony power), however, there is less concern for the impact this might have on consumers. Antitrust laws don’t address this form of market power.

In the provision of healthcare, price discrimination is quite common. Providers bill patients the same amount for the same services regardless of who is paying the bill. But after the bill is submitted, health insurers typically negotiate a discount, i.e. a decrease in the amount owed to the provider. Uninsured patients, of course, are legally obligated to pay the full undiscounted billed charges.

This billing custom does not apply to the sale of prescribed drugs from pharmacies, however. Those are “point of sale” transactions, so any discounts are already subtracted from the sale price when reported. We’ll explain this in greater detail later.

Figure 3 illustrates the percent of billed charges paid to providers by three payer types: private insurers, public insurers (i.e. Medicare and Medicaid) and the uninsured. Those who have read my earlier posts will recall that to be truly uninsured one needs to have no other source of payment than one’s own money.

Figure 3. Percent of Billed Healthcare Charges Paid by Payer and by Service Type, 2016

Data source: 2016 Medical Expenditures Panel Survey, Agency for Healthcare Research and Quality.

*There were no instances of an uninsured household purchasing Home Health services.

The percentages illustrated in Figure 3 might seem pretty random, but they actually demonstrate the relationship between prices and market power quite neatly. Remember that the more market power the seller has over the buyer the higher the price paid. The lack of a simple relationship in the graph is due to there being four different buyer types with different levels of market power. Public insurers (i.e. the government) and the emergent uninsured have more market power than the privately insured and the non-emergent uninsured. The heightened market power of the emergent uninsured is due to a law that requires all providers that receive Medicare and Medicaid payments to treat all emergent patients regardless of ability to pay. This is an example of an unfunded mandate. The significance of which will be discussed more in a later post. Figure 4 illustrates the market power ranking.

With the relative market power price theory in mind, let’s look at the different service types one at a time.

Office Visits: The uninsured pay more than the privately insured and the publicly insured pay the least. That is exactly as the theory would suggest. A single office visit is relatively inexpensive and non-emergent. That means that the doctor does not have to see the patient if he doesn’t want to. The doctor has the greater market power. The only way an uninsured patient gets a discount at all is if he defaults on his financial obligation.

Outpatient Visits: The discount structure is very similar to that of office visits except that private insurers pay a little more than the uninsured. Outpatient visits are also non-emergent; however, they are much more expensive than office visits and the uninsured are more likely to default.

Inpatient Stays. For this service type the uninsured pay the least. This implies the uninsured have much more market power than they do for outpatient and office visits. That is true because many inpatient stays are instigated by emergencies. The very large dollar amounts charged for inpatient stays also contributes to the low percentage of charges paid by the uninsured.

Emergency Department: The discount structure of emergency departments is very similar to that of inpatient stays for the same reasons.

Home Health: There are no figures for the uninsured payments for home health services. This is a service rarely purchased by the uninsured. As with all the other services mentioned, private insurers pay a higher price than public ones.

Pharmacy Sales. This is the only service for which public insurers pay a higher percent of charges than both the uninsured and the privately insured. This happens because, unlike all the other service types, Medicare does not pay pharmacies directly.  Rather, Medicare pays private insurers to pay pharmacies on its behalf.  That is why the percent of charges paid by private and public insurers is almost the same.

The uninsured pay a relatively low percentage of charges for pharmaceuticals because, although they have little market power, there is a high degree of substitutability in the sale of prescription drugs. Their demand for pharmaceutical products is relatively price elastic or sensitive to price changes. All their expenditures are “self-pay”. Only a small fraction of insured pharmacy purchases is borne by the insured party. Consequently, drug companies offer the uninsured discounts that they do not offer the insured.

Before I end this post with a brief summary, I should explain how I derived the percent of charges paid for pharmacy sales. As I noted above, pharmacy purchases are “point of sale” transactions. The undiscounted charges are not reported separately from the expenditures net of discounts and write-offs like the other service types. So, how did I derive the figures reported in Figure 3?

The MEPS, the source of data for Figure 3, provides a file of all the drugs purchased by the respondents to the survey. This includes the national drug code (NDC), quantity and the amount of money spent by the insurer and respondent, separately. From these data I calculated the average price per unit for each of the three payer types: private, public and uninsured.

I then found the highest price per unit for each drug (i.e. NDC). The undiscounted charges were the amount of money that would have been spent by each payer type if it had paid the highest price for each drug. The percentage of charges paid is actual expenditures divided by estimated undiscounted charges. I had complete data for 915 different drugs.


So, what’s the big picture here? In general, private insurers pay more than public insurers due to their relatively inferior market power. The uninsured pay the most except when there are exigent circumstances or their demand is price elastic. The next post will combine the post about percentage markups with this post about price discrimination to see who is really bearing most of the financial burden of our healthcare system and why Medicare can be offered with relatively few restrictions.

Published by TheLoneEconomist

I am a PhD economist who studies just about anything and proudly specializes in nothing.

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