The price and cost of healthcare services are seldom related. The recent hue and cry about “price transparency” (addressed in an earlier Forbes.com article) leads the reader to assume that all consumers need is for hospitals and doctors to tell folks what their “prices” (charges) are and things will resolve themselves driving down the cost of healthcare. However, it’s not quite that simple. Doctors and hospitals almost never receive payment for the “retail” rate that they charge for services.
Doctors and hospitals (providers) negotiate with insurance companies (think Blue Cross/Blue Shield, Cigna, etc.) to determine what the providers will be paid for a given service or services. For instance, Company X may offer Dr. Smith a $100 “allowable” for a patient’s office visit and Dr. Smith agrees to be paid $100 for that office visit. Company X and Dr. Smith have effectively agreed that that office visit is worth $100. This allowable is crafted based on the patient’s insurance plan. In Figure 1 we have an example where the patient’s co-pay is $20. So, Company X “allows” a $100 total payment to the doctor constructed of $20 from the patient and $80 paid by Insurance Company X. In “high deductible” plans the entire $100 would be paid by the patient until the deductible is met.
Payment for a medical service (like an office visit) can vary from insurance company to insurance company for the same medical practice with little or no rhyme or reason. That is, Company X might pay Dr. Smith $100 for that office visit where Company Y might pay $90 for the same visit. Some of the insurance company’s payment logic is predicated on the doctor’s market share in their area, the insurance company’s need for that doctor (e.g. a specialist like a cardiologist) to offer the insurance company enough specialist coverage, and the insurance company’s footprint in that market (e.g. their competitive stance). It should be said, too, that while doctors negotiate payment rates with insurance companies, Medicare and Medicaid do not negotiate with doctors. Instead, annually both programs inform doctors and hospitals what they will pay for certain services.
To add a twist, what a doctor charges patients has almost nothing to do with the payment he receives; the two have little to do with one another. In fact, unlike a “normal” business model, payments have little to do with the actual cost to deliver care (in healthcare, the product).
Let’s say you’re a widget maker. You understand the cost to make your widgets and owing to your place in the greater widget market you are satisfied with (and the market will bear) a 20 percent margin. As seen in Figure 2, it costs $80 to produce 1 widget which sells for $100 delivering $20 of profit and a 20% margin.
However, in healthcare that general business model does not hold. In Figure 3, Dr. Smith charges a patient $150 for an office visit. Let’s say the patient has Company X insurance. Company X will pay Dr. Smith an agreed upon rate of $100 for an office visit. Dr. Smith must then write off the remaining balance of his charge because he has agreed with Company X to collect only $100 for that office visit. The patient is not responsible for the $50 remaining; the difference between the charge and the allowable.
Interestingly, many doctors lack a structural process for determining their actual cost to deliver their “widget” (office visit) so they often operate based on the revenue and volume of different “widgets” (office visits, minor surgical procedures, etc.) produced within their clinics. Most doctors deliver a variety of clinical services whose direct and variable costs are at times difficult to divine. So, the “charge” for the service has nothing to do with the revenue received or the profit margin generated per “widget” produced (procedure performed).
If Dr. Smith negotiates with Company Y, as seen in Figure 4, he may have the same charge for his product but you can see that Company Y will only pay Dr. Smith $90 for an office visit. He now must write off $60 as uncollectible.
Many consumers can now look past the “noise” of their explanation of benefits (EOB – billing statement) and get to the crux of what their doctors are paid. Using some absurd numbers (but a real-world example of the mechanics) to convey the message, let’s say I went to my doctor for an office visit. As shown in Figure 5, If the charge was $4,500 and the allowable (what Insurance Company X pays my doctor) is $100, my insurance company offered the argument to me that they have saved me $4,400! (The difference between the charge and the allowable.) The fallacy is, and my insurance company knows this, that regardless of what my doctor charges for a service, in this example, Company X has stated they will only pay him $100 for this procedure.
What transpired is that the doctor negotiated with the insurance company and agreed to be paid $100 for each of these procedures performed, regardless of what the doctor charged. Why would a doctor bill an exorbitant amount for a procedure? Candidly, he may run into an insurance company that will pay him his full $4,500 charge and he is willing to write off the remainder, on an ongoing basis, for the glimmer of hope that he is able to bill and collect $4,500 from some other insurance company.
While “price transparency” is laudable, understanding the true “cost” of healthcare requires more nuance. In fact, recently the Trump administration posited the prospect of mitigating patients’ “surprise medical bills.” Practically what that “means,” given the hyper-partisanship in Washington right now, is this may take a while.
Nonetheless, what doctors and hospitals get paid is a bit more prickly than folks understand. But it is attainable if consumers perform legwork on what their doctor will receive for the services provided.
This article originally appeared on Forbes.com.