The Truth About Fake Hospital Pricing (And What To Do If You Are Uninsured)

A report from a friend inside the industry.

I will describe the hospital industry’s pricing practices in the following paragraphs using an analogy.  

Imagine a Lemonade stand.  As a customer you see no signage that lists prices.  You’re thirsty so you ask the proprietor the price of a glass.  “How much are you willing to pay?” is the reply.  You offer to pay $1 and the young entrepreneur behind the stand enthusiastically accepts your bid and you receive the product.  Notice your question about the price was never answered.  This is the important part of the analogy.  No price was posted and when you asked, the answer was not a direct response but a request for a bid.  Most people would assume the sale price was the $1 paid, but where Hospital pricing is concerned that assumption is incorrect.

Now imagine the end of the day arrives for the Lemonade stand and it is time to do the accounting.  The number of glasses sold has been dutifully recorded and let’s pretend 90 were sold, with 10 given away as charity.  The “gross revenue” (hospital accounting term) can be calculated by multiplying volume (100 glasses) times the price per glass.  What was the price?  And why are we multiplying time 100 and not the 90 sold?  To get “gross revenue”, every glass will be multiplied by the price.  The “gross revenue” will be reduced to “net revenue” (“Net Patient Revenue” in hospital accounting) later.  So, 100 units goes into the “gross revenue” calculation, but again, what was the price?  Assuming each customer bid different amounts, there was an average amount paid.  We could multiply by the average “payment”, but that’s not what hospitals do.  Instead a fake price is made up, let’s say $10,000 per glass of Lemonade. Doing the math: $10,000 x 100 glasses = $1,000,000 of “gross revenue”.  This is what hospitals do.  All of the prices for all their procedures are not published, and they are fake prices.  This allows hospitals to record fake “gross revenue” and report to the government (in the case of Medicare and Medicaid) what the prices for procedures are.

Our Lemonade stand operator does not have $1,000,000 at the end of the day, even though that’s what the account books say for “gross revenue”.  Next charity write offs are recorded.  $10,000 per glass times the 10 charity glasses given away and the charity write off for the day is $100,000.  After completing all the proper paperwork the Lemonade business will be able to deduct this $100,000 from their taxes.  This is what hospitals do.  When you hear or read about hospitals giving money to charity, the numbers are inflated by the fake prices.  Although these prices are fake, they help reduce the tax liability.  Next the Lemonade business needs to account for the difference in the remaining $900,000 of “gross revenue” and the “net revenue”.  After all, the cash payments for the day are much less than the remaining $900,000 of “gross revenue”.  The difference between the $900,000 and the real cash received is calculated and recorded in the accounting ledger as a “contractual adjustment”.  The “contractual adjustment” (hospital accounting term) balances the books and further reduces the income tax liability.  The remaining amount is the “net revenue” before costs.

Hospitals have signed contracts with insurance companies, including Medicaid and Medicare.  These contracts establish the amount insurance providers will pay for a procedure.  Hospital accounting practice is to use their fake price for all procedures.  If the patient has no insurance, then the patient is given a bill for the full amount at the fake price rate.  If the patient has insurance, the hospital is supposed to apply the “contractual adjustment” prior to sending the bill to the insurance company.  Some hospitals are pretty inept at doing this math, but that’s a tangent to the primary story.  The “contractual adjustment” is essentially a partial write off to get the fake price down to the contractual amount the hospital and insurance company have agreed upon.  Prior to the “contractual adjustment” the fake price is used to report “gross revenue”.  The “Net Patient Revenue” is the amount remaining after the “contractual adjustment” is done.  For folks with insurance, they have to pay the patient portion (co-pays, etc.), but the unlucky people without insurance are screwed.  When politicians talk about people going bankrupt because of medical expenses, they’re talking about the uninsured who have been hit with the fake pricing.

To get an idea of how outrageous this practice has become here is a sample of data to which I have access.  This represents about 4 dozen hospitals, so the sample is small compared to the entire country, but it is still indicative of what goes on everywhere.  In 2012 these hospitals recorded the “gross revenue” and the “contractual adjustments” diligently.  The “contractual adjustments” were 66% of the “gross revenue”.  This means the fake prices were 3x what was actually charged to the insurance providers!  The people without insurance, on average, are being charged 3 times what insurance companies pay.  When the uninsured patients can’t or don’t pay, the balance is written off and the tax liability is reduced.  Some uninsured people try to raise the funds, and it breaks my heart that they go bankrupt trying to pay these debts.  If you’re ever uninsured and wind up with a huge hospital bill, go negotiate with the hospital CFO for a 66% reduction in the bill.  Use the government data (link here) as leverage in negotiating with the CFO. Threaten to expose the racket and I bet the CFO will write down your bill to keep you quite.

Of course the problem here is not a market failure.  Insurance companies and hospitals are able to operate with these fake prices and goofy accounting practices because of the past government interventions and existing regulations that have created this crazy system.  The prices just published by the government are the fake prices.  The reason the prices vary so much from location to location, and from hospital to hospital in the same city, is because the hospitals don’t tell each other what the fake prices are.  The hospitals tell no one what the fake prices are.  Since hardly anyone is actually paying these prices, and because the insurance paperwork is so confusing and shows only parts of the bills, hardly any consumer actually knows what prices are.  The absence of a free market has prevented the normal price discovery system from operating.  When gasoline prices go up the local news publishes where to find the cheapest gas.  Every gas station you drive by has their prices on large signs.  Americans know what a free market looks like, but I doubt there are many Americans alive today who know what hospital prices are.  When we hear about a one-off anecdotal case of a person who was charged a fortune in medical expenses, it is easy to assume the cost was from the specific procedures and care provided.  The reality is most of this is from the fake prices.

The really interesting question is why did the government release the price data for the hospitals?  The Medicaid and Medicare reporting requirements have existed for years.  It’s not as if the government now has data that was previously unavailable.  The government regulators have known for decades what is going on, but all of a sudden the pricing data has been released.  In politics everything is done for a reason.  The release of the data was to done to promote an agenda.  Whatever that agenda might be, I’m sure the people who perpetuate and profit from this goofy hospital accounting are not happy this information is getting out.