Prices for health care services in the commercial market are a significant driver of high and rising health care premiums. The gap between prices in the US and other countries, the large price-cost margins in the commercial sector, and the wide variation in prices within and between markets suggest that market failures are contributing to our unsustainable rate of health care spending growth. Evidence of shockingly high prices charged by out-of-network providers, particularly when delivered at in-network facilities, contributes to outrage over health care prices: Average charges for out-of-network emergency physician bills, for instance, have been reported at almost 800 percent of Medicare. These apparent market failures have, in turn, led to many calls for regulation to address the situation.
Regulation Of Provider Prices Is Needed
Pro-market economists might resist calls for regulation on the grounds that markets are the best way to allocate resources and that regulation will impede market functioning, resulting in inferior outcomes. Yet, this is not necessarily the case. It has long been recognized that markets can fail and that health care markets have done so. Regulators have the potential, perhaps the duty, to address these failures, particularly in egregious cases such as out-of-network surprise billing. A core question is how broad such regulation should be.
Although market failure is widespread, current health care proposals in the House and Senate solely focus on reducing surprise billing by capping out-of-network prices charged for select services by physicians practicing at in-network facilities. While undoubtedly an important problem on the forefront of many patients’ mindssurprise bills represent only a small portion of the pricing problem. According to our analysis of 2016 data from three large national health insurers (insuring almost 43 million people), about 8.8 percent of these carriers’ spending on health care professionals for those younger than age 65 was for out-of-network care, of which less than two-fifths (3.2 percent of total professional spending) was associated with surprise billing. Of this spending on surprise bills, 58.2 percent was due to prices above national service-specific, in-network median prices. In other words, if all surprise billing above the national median in-network price would have instead occurred at the in-network median, these insurers would have saved about 1.9 percent of total spending on health care professionals. In considering either the narrow problem of surprise out-of-network billing or the broader set of market failures, the question should not be if the government should intervene, but how.
Competition Is Important But Cannot Solve The Problem Alone
One source of excessively high prices is weak competition in the health sector. There is growing evidence that provider consolidation has contributed to rising prices in the private sector. One set of possible government actions to address this market failure is to adopt strategies that promote competition. Yet, stakeholders have found it difficult to find mechanisms that effectively promote competition. Transparency initiatives aimed at increasing patient price-shopping have been largely ineffective, while broader initiatives to publicly release prices have raised concerns that such transparency will alter negotiation dynamics, reducing the willingness of payers to give discounts and, paradoxically, leading to higher prices. Antitrust enforcement is slow, costly, and cumbersome. Arrays of smaller initiatives have the potential to meaningfully ameliorate some concerns, but there is insufficient evidence that such policies can have a broad impact or significantly counteract the basic market failure problems that have been apparent for decades. We should try to promote competition as much as possible, but until we see some measure of success, direct regulation of prices will likely be needed.
Price Caps Can Mitigate The Most Egregious Market Failures
Price caps, if properly structured, can address the most flagrant failures of the market without interfering with it when it is working well (or not unacceptably poorly). Specifically, if the price cap is set high, it will affect only cases of clear excess pricing while allowing markets to function, albeit imperfectly, below the cap. Policy makers will face a tradeoff about how stringent to set the cap, as more stringent caps produce bigger savings but are more disruptive of market interactions. If pro-competitive reforms work, price caps may not be binding—that is, pro-competitive reforms may lead to provider prices below the cap, which would then guard against future abuses.
Importantly, price caps can be integrated with other solutions such as arbitration between insurers and providers or caps on price growth. For example, there is emerging evidence that arbitration, in some settings, can be effective at preventing excessive out-of-network physician prices. That said, there are concerns that arbitration may be inconsistent, administratively difficult, and that it could allow a general upward drift in prices. Price caps can offer an important backstop if other solutions (for example, pro-competitive reforms or arbitration) fail.
Out-Of-Network Price Caps Are A Sensible Start
The clearest and most dramatic market failures occur with out-of-network billing. As a result, it is reasonable to limit regulation to out-of-network prices and allow negotiations between providers and insurers regarding in-network prices to proceed without impediment, except in extreme cases. However, regulation of out-of-network prices, whether broad or limited to surprise bills, must account for the fact that caps on out-of-network prices may affect negotiations on in-network prices. Specifically, if there is an out-of-network cap, insurers may not be willing to offer in-network providers much more than the cap. If providers do not accept that offer, they would be forced out-of-network (and thus receive the capped price). This would lower the in-network price because the providers currently receiving in-network prices above the cap would have to accept lower prices or leave the network. Either way, average in-network prices would fall.
This effect could be dampened for providers that are highly desired by enrollees (perhaps because they are high quality) and can limit beneficiary access to care if they are out-of-network. In this case, those providers may be able to obtain in-network fees above the cap. This flexibility may be an important outlet to support access to high-quality providers but may also allow providers with large market shares to exercise market power. Existing evidence does not provide clear answers about how this will play out, but if Medicare Advantage is a guide, in-network prices may fall considerably when out-of-network prices are regulated, as shown by Laurence Baker and colleagues, Robert Berenson and colleagues, and Julius Chen and colleagues.
A Flexible Policy Would Set Price Caps At A Multiple Of A Low Base Rate
Price caps typically consist of two parts: a base price (for example, Medicare prices or median in-network allowed charges) and a multiple (for example, 150 percent of the base price). In the case where the cap is just the base price, the multiple is implicitly 1.0. Of these two components, the base price is the most important. The multiplier can be set at varying levels of stringency, but different base price choices influence market dynamics in ways that must be taken into account. Specifically, once the base price is set, economic and political forces will act to push it higher. It is important for policy makers to choose a base price to resist such forces. For example, the base price must reflect real prices, not arbitrary charges.
Current proposals would cap out-of-network fees at the median of within insurer in-network service prices in a specified geography. This may put a lot of pressure on high in-networks prices. That may be a desired outcome, but some policy makers may believe that the potential disruption is too great. If this is the case, out-of-network prices could be capped at a higher percentile (say the 75th percentile) of in-network median prices. Setting the cap at a percentile of in-network prices raises the concern that insurers can lower prices for all out-of-network providers by leaving some providers out of network. The incentives to do so will depend on the desirability of keeping high-price providers in the network because of their quality or market position.
We favor basing the percentile on prices in the local market, as opposed to allowing insurer-specific prices. Otherwise policy makers risk exacerbating the advantage that insurers with large market shares (and thus lower fees) have over smaller competitors. However, this creates an operational issue about how data on such prices would be obtained and who would perform the calculations. Moreover, broader markets may be needed in situations with a dominant in-market insurer or provider.
A related approach would set the cap as a multiple of Medicare prices. This avoids a complicated feedback loop on private prices: In-network prices would still face pressure to fall to the cap, but they would not directly affect the cap. However, there are at least three concerns associated with using Medicare prices. First, any distortion in Medicare prices due to challenges in setting prices administratively (political capture, unresponsiveness to changes in the cost of production, and so forth) will get amplified in the commercial market. Of course, Medicare fees need not be perfect, they only need to be better than the alternative, and we know commercial fees themselves are problematic. Yet, there may be merit in retaining some connection to market-based prices. Second, Medicare fees are set based on the estimated cost of serving Medicare patients. Analogous costs for commercial patients, generally younger and with fewer comorbid conditions, may differ, particularly for services not commonly delivered to Medicare beneficiaries, such as childbirth. Finally, to the extent that Medicare prices are transmitted (with a multiplier) to the commercial sector, there will be greater political pressure to raise Medicare prices, causing program expenditures to rise.
Conclusion
Inevitably, providers will resist any type of price controls, in part by appealing to a broad aversion to price setting and a deference to markets. But health care markets have clearly failed in many instances, and all should recognize the need for some intervention. Failure to act will lead to a much more draconian intervention. It is thus in many providers’ interest not only to support action but to help shape that action so that it will allow them to continue serving their mission while being effective at eliminating some of the extreme abuses we are now experiencing. In this spirit, providers should support policies that provide some relief and minimize the likelihood of deleterious indirect effects.
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