Key Factors Behind How Much Commercial Insurers Pay Providers

Commercial payers have been experiencing higher healthcare spending than fee-for-service Medicare due to higher prices, according to a report from the Congressional Budget Office (CBO).

CBO observed commercial insurance spending from 2013 to 2018. During that timeframe, commercial insurers’ inpatient and outpatient spending per person rose 3.2 percent annually.

In the fee-for-service Medicare program, per-person spending increased by 1.8 percent per year.

Prices were the main force behind the spending increase, both for commercial insurers and fee-for-service Medicare, CBO found. 

The prices of inpatient and outpatient services for commercial insurance exceeded inflation by around one percentage point in the five-year timeframe, growing on average 2.7 percent annually. In contrast, utilization grew by only 0.4 percent.

In fee-for-service Medicare, prices grew by 1.3 percent per year, while utilization grew by 0.5 percent.

Commercial insurers’ negotiated rates with hospitals often surpass the actual cost of the services and the amount by which they exceed the true cost has been growing larger over time. In 2000, commercial payers reimbursed hospitals 115.7 percent of hospitals’ actual costs. By 2018, commercial payers were reimbursing hospitals up to 144.8 percent of the actual cost.

Meanwhile, in fee-for-service Medicare, payments covered a decreasing share of the actual costs. In 2000, Medicare payments covered 99.1 percent of the actual costs, whereas in 2018 Medicare covered 86.6 percent of the cost.

There are four main factors behind the slope in inpatient and outpatient prices, according to CBO.

First, providers’ market share and concentration can give providers more leverage in rate negotiations with commercial insurers and can also create differences in payment between providers in the same geographic area. The CBO found that consolidation—including vertical integration—boosts prices.

Payers can also use market share to increase their influence, but market share is not the only source of leverage available for providers. Providers can use their unique specialties, quality of care, and less shoppable services to gain an upper hand in negotiations.

Second, input prices can also impact overall service, product, and procedure prices in healthcare. Hospital wages and providers’ input prices--such as providers’ wages and malpractice insurance premiums--were two sets of input prices that were particularly influential in boosting commercial payers’ prices.

CBO found that over 50 percent of price variation across 105 geographic areas could be attributed to wage differences in 2017. However, three areas—Anchorage, Alaska and San Francisco and San Jose, California—were particularly responsible for price increases based on wages.

Meanwhile, in 2017, input prices contributed 27 percent of the price differences in the 42 states that CBO observed.

Third, quality of care also had an impact on a hospital’s leverage in price negotiations. The correlation between quality and price was small but significant, CBO found. This finding did not apply to physician practices.

“It is unclear whether hospitals with higher quality can command higher prices from commercial insurers or whether hospitals with more market power, and thus higher prices, can spend more to improve their quality,” the report noted.

Fourth, providers’ spending on administrative services impacted pricing as well. 

Administrative services that were not related to billing or insurance were particularly costly for hospitals—in 2018, hospitals spent $47 billion more on non-billing or insurance-related administrative services than ones that were related to billing or insurance. Altogether, hospitals and practices spent $440 billion on administrative services in 2018 alone.

However, the tie between administrative costs and pricing decisions remains vague.

Finally, CBO noted one factor that is often blamed for hospitals’ high prices but which did not have a strong impact: cost-shifting.

“If hospitals were able to cost shift, then hospitals with larger shares of Medicare and Medicaid patients (for whom prices are relatively low) would be paid relatively high prices by commercial insurers,” the report stated.

But CBO did not find that hospitals with high concentrations of Medicare and Medicaid beneficiaries also had higher prices. A one percentage point increase in the share of public payer beneficiaries in a hospital’s patient population correlated to merely a 0.1 percent increase in commercial payer prices.

Price increases have particular significance for the population of Americans in employer-sponsored health plans, which encompassed nearly half of the country as of 2019. As a result of higher spending, employers experience reduced revenue and employees’ incomes grow more slowly. Additionally, federal subsidies increase as a result of higher healthcare spending.

“A rise in providers’ prices would increase health insurers’ spending on claims, all else being equal. Insurers could respond to such spending increases by raising premiums, increasing cost-sharing requirements for patients, reducing the scope of benefits, or making other adjustments. In general, insurers’ greater spending would be passed on to employers that purchase coverage on behalf of their employees,” CBO explained.