Is Treating Medicare Patients Profitable?

This post is the latest in a series that establishes what an optimal health insurance system would look like, how much it would cost and who would pay for it. Past posts analyzed the number of uninsured people in the US (it’s not as many as officially reported), the cost of a single-payer system (it’s larger than officially reported), and the future of Obamacare (it’s likely to fail).

Today’s topic answers the question: do healthcare providers make money from Medicare and Medicaid? The answer is a little complicated and depends on the meaning of “make money”.

Two of the earlier posts dealt with the market power of healthcare providers. For example, in 2017 the average percentage markup by hospitals was 360%. In other words, the average hospital’s undiscounted charges were 460% of its costs. That sounds like a huge markup, but insurance organizations only pay a fraction of the bills they receive due to negotiated discounts. And the uninsured frequently default on their financial obligations to providers.

In a later post we showed that for outpatient and emergency department visits and inpatient stays, private insurers pay a much higher percentage of billed charges than public insurers (i.e. Medicare and Medicaid) and the public insurers in turn pay a much higher percentage than the uninsured do on average.

All three of these healthcare services are provided by short term acute care hospitals. Table 1 combines the results from the 2016 Medical Expenditure Panel Survey (MEPS) for these three hospital-provided service types and includes the average markup percentage for all hospitals.

Table 1. Percent Charges and Price Markups, Short Term Hospitals

Sources: (A) 2016 Medical Expenditures Panel Survey from the Agency for Healthcare Research and Quality, (B) 2017 Health Care Cost Report Information System from the Centers for Medicare and Medicaid Services.

Private insurers pay on average a little less than 49% of billed charges. That means they get a discount of slightly more than 51%. This might sound like a lot, but it isn’t when we consider that hospitals markup their prices way above the cost of providing care and that public insurers get over a 78% discount on average.

The uninsured only pay 6.7% of billed charges. This occurs because the largest bills are for very expensive emergency services. Typically, the uninsured are the least wealthy of all hospital patients and frequently must default on their hospital bills.

When combined with the average hospital percentage markup of 360%, we see that hospitals make a very substantial profit from services provided to the privately insured despite the large negotiated discounts. A 125% markup is very high, much higher than almost any other commercial enterprise one could name.

The story is quite different, however, for the other payer types. The average hospital treats the uninsured at a high loss rate and the average percentage markup for treating the publicly insured is essentially zero.

That zero figure is no accident.  The average discount hospitals are required to give Medicare and Medicaid are calibrated to result in a zero markup. The payments made by CMS cover the operational costs of treating their beneficiaries, but nothing more. Remember that these are accounting figures. They don’t include the cost of capital all hospitals must employ. When the cost of capital is factored in, the average percentage markup for treating the publicly insured is well below zero.

Why then do hospitals continue to treat the uninsured and the publicly insured if they lose money by doing so? There is a short-run answer to this question and a long-run answer.

First, the short run. Capital costs tend to be fixed in the short run, but variable in the long run. So, in the short run the average hospital’s variable costs of treating Medicare and Medicaid beneficiaries are covered by the payments from CMS. Therefore, the CMS payment level (i.e. price) is just above the shutdown point. This is the minimum price at which the average hospital continues to treat publicly insured patients. At this price, it loses money; however, its losses would be even greater if it shutdown (i.e. stopped treating CMS beneficiaries) in the short run.

That explains why the average hospital continues to treat CMS beneficiaries in the short run, but what about the long run? And why would hospitals treat the uninsured even in the short run?

To understand why hospitals willingly treat patients that cause them to lose money, we need to understand the business model of a hospital. A business provides a service to a customer in exchange for money. The typical customer performs three different functions: 1) she chooses how much to buy and which business to purchase from, 2) she supplies the money to pay the price and 3) she receives the service.

In the hospital business, the patient performs only one of these tasks entirely (i.e. she receives he service) and performs one of them partially (i.e. she pays part of the price). The insurer pays for most of the service and the admitting physician chooses how much to buy and which business (i.e. hospital) to purchase from.

So, who is the hospital’s customer, the patient (who consumes), the insurer (who pays) or the doctor (who chooses)? The answer is the doctor. Hospitals market their services primarily to doctors. They don’t market their services to potential patients except in very limited circumstances.

A common way for hospitals to drum up new business is to purchase physician practices. This is an example of vertical integration. Hospitals grant doctors “privileges”. The more doctors with privileges a hospital has, the better off financially it will be. Therefore, hospitals are managed to keep their doctors (i.e. customers) satisfied.

The typical physician’s practice consists of a mixture of patient types. Some are privately insured, some are publicly insured and some have no insurance at all. If you remember, Figure 3 showed that the uninsured pay a higher percentage of billed charges for physician office visits than either of the other payer types. Therefore, physicians make a higher return from treating the uninsured than they do from treating the insured.  A hospital that only treated the privately insured would be of little use to most physicians. Consequently, if the hospital wants to attract physicians (its real customers), it must be willing to treat all types of patients, even ones that can’t pay all their bills.

To my knowledge, there is not a single short-term acute care hospital in the U.S. that does not treat Medicare and Medicaid beneficiaries. And if they treat Medicare and Medicaid patients, then by law they cannot refuse to care for uninsured emergent patients.

Back to the main question: do providers make money from treating Medicare and Medicaid beneficiaries? The answer is they do not directly make money from treating them, but they do indirectly make money from treating them. They make money (i.e. positive net revenues) from treating the privately insured and they must treat the publicly insured in order to treat the privately insured.

The same argument goes for treating the uninsured. By law and by professional custom, life-saving care cannot be denied to a patient on account of an inability to pay.

Next time we’ll see how all the price discrimination, unfunded mandates and cross-subsidization affects the bottom lines of providers and who really pays for Medicare and Medicaid.

Published by TheLoneEconomist

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

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