Healthcare costs 101

In recent months we’ve heard much talk about the “cost of healthcare” and how we need to reduce this cost. While the politicians and media have used this term to focus on the amount that patients pay for services received to help gain support for their agenda they have not yet addressed the underlying costs of running a healthcare business (hospitals, doctors’ offices, etc). Since these costs directly impact the end cost to consumers I’d like to open the door to that side of the discussion here.

What most consumers (and almost all politicians involved in the current healthcare “overhaul”) do not realize is that our government’s involvement in the industry is what has driven costs for providers up and up over many years and, as any business would have had to do in order to keep it’s doors open, that cost has been passed to the consumer, right? Well, yes and no. In order to explain this answer let’s start with a brief description of how one might enter the business of healthcare (other than becoming an MD, nurse, or other direct patient care professional).

Healthcare is not an open market industry. New entrants must jump through many hoops if they would like to enter a market area including (in most states) providing proof of public need as determined by a governing body. This process is not as simple as filling out a form and sending it in. It takes anywhere from months to years of preparation, much of which is done with the help of a lawyer that knows the specific body in charge of the market area. This process is not exclusive to those that want to enter a market but also to those that wish to expand there current businesses (build a new building, buy a new piece of equipment, etc). In recent years there has been a government mandate that fewer of these applications be approved. This has caused organizations to spend several thousand dollars on top of actual construction costs to fight for permission to run their businesses. I’m not sure about you but to me this seems likely to limit competition. If I remember my econ 101 class from many moons ago limiting the supply will raise the price of any good or service, but more on that later.

Assume that the application is approved, what now? For our purposes we’ll assume the application is for a new business, not an existing one. You’ll need a building. Of course there are special regulations for any building that will house medical services which do not apply to any other industry. These additional considerations make the construction cost per square foot 2 to 3 times more expensive than a normal industrial building and are largely redundant with current building codes for a given area, just more stringent. Once again a business in the healthcare industry is held to different standards than other business and these standards drive costs.

OK. Now you have an approved application and a building. You’re going to want customers (patients). You can do little to get customers in the door other than marketing and waiting for a need to arise so the next focus is on making repeat customers out of as many as you can. In order to do this you better accept their insurance (in truth, their insurance better accept you). This can actually drive first time customers as well. So how does one go about getting on an insurance company’s providers list? You must negotiate a contract with the insurance company. Contract for what you ask?

Anyone that’s had a medical visit or procedure in the last decade or 2 will remember the difficulty in deciphering the bill you get from the doctor’s office or hospital and the explanation of benefits (EOM) you get from your insurance company. It seems that there is one amount that the doctor’s office charges for a certain procedure yet a different amount that the insurance company allows the doctor to charge you as a member. This is called the allowable. The doctor’s office must reduce the charge to match the amount in the contract. After the charge is adjusted your co-pays, deductibles, etc are applied to come up with the actual amount you owe to the doctor. Some insurance companies have more leverage (insured members) than others and are able to negotiate lower prices and the government (Medicare, Medicaid, etc) has the most leverage of all. In fact, there is no negotiation at all with the Goliath of government. They tell you what they will pay for a given service and define a large number of very specific cumbersome steps that you must follow exactly if you would like to get paid. Virtually no healthcare business aside from very small specialties can afford to go without these customers so they accept the terms and prepare for business.

Not only does the government not give a provider input into what should or should not be covered for a given patient, how much should be charged, etc. but it also can, at any point, institute a new regulation, reporting requirement, etc retroactively and demand the provider return payments on accounts that do not conform even though the services were rendered before the new rule went into place.

Let’s recap. You have to spend tons of money just to be allowed to build an overly expensive building and have your prices dictated to you while always being cognizant that any of the already less-than-cost-of-business payments for services could be taken back if the a governing body thinks up another way to restrict payment. Again, it has been quite a while since I was in school but my 11th grade government class would not classify this as a capitalistic model. If I remember correctly a system in which the government decides who can be in an industry, how they have to go about setting up their business, and what prices they can charge is the first step toward a socialist society. The next step would be the government actually owning and administering the businesses.

Back to your healthcare business. This new business must struggle to expand its market share by providing additional services (each of which requires the proof of public need) and fight with insurance companies to get fair reimbursement for services rendered, not to mention the high costs of trying to collect the monies due from customers. The only industry that provides services before an agreement is made about payment is healthcare. Can you imagine going into an automotive shop, having your engine rebuilt, and them letting you drive off while they decide how to bill you without at least a signed contract saying that you will pay what they charge? Do you think that shop would get the $2,000 they are owed more than 20% of the time? Same goes with healthcare. More is written off as a loss than any other industry in the nation. In order to try and make up for the loss the industry must try to charge as high a price as they can so maybe, just maybe, the cost of providing the service is covered. Even though you may not like the bill you receive it doesn’t mean it’s not a good business practice.

Like anyone I am not thrilled at paying for services that someone next to me had but didn’t pay for. At least at the auto mechanic I know there will be a mark up on parts costs and a labor charge that is associated with the work on my vehicle only. Why can’t we get that type of detail with our healthcare? It’s quite simple in its complexity (or is that complex in its simplicity?). Healthcare is an antiquated industry in its current form and the transition to better, more timely information is only supported when framed around direct patient care. This is why talks around healthcare IT always revolve around the electronic medical record (EMR) but have not broached the subject of detailed healthcare cost accounting standards. Cost accounting, for any other business, is a very important part of decision making. In healthcare it is more of a nuisance. Why? You can’t negotiate prices with your largest client (Medicare/Medicaid) and the negotiations with other clients do not center on actual cost of services provided because you need to make up the lost margin somewhere.

To address the core issue with healthcare costs would lead to true reform of how healthcare is provided in the US. The current plan is to simply move forward with an already inefficient system and expand the governmental influence over the struggling industry. I have had conversations where friends, colleagues, and random people at a party have asked why this matters to the end patient which emphasized to me the complete lack of understanding on the part of some very intelligent people that healthcare is not a guarantee. If you squeeze margins down to a point that hospitals can’t justify being in the business you will start to loose providers. While we may not see quite that extreme of an effect in the next few years you will absolutely see providers unable to maintain margins enough to allow for expansion of services provided, replacement of expensive pieces of medical equipment, etc. Slowly the overall quality of service will begin to deteriorate because you just can’t buy equipment if you aren’t making enough money to cover the costs unless healthcare wants to end up like wall street. I think this is where the average person would start to understand that sometimes you really do get what you pay for.

Understanding the significant costs associated with running a healthcare business is necessary when having a discussion about reducing healthcare costs to the end customer. You wouldn’t tell the tailor or butcher how much their customers should have to pay so why would we, as a capitalistic society, want to reduce competition and mandate pricing for the most important industry to a nations overall happiness? Well, we aren’t talking about retail products. Or are we? Healthcare is such an emotional topic that most loose sight of the fact that the service is just that, a service. It is rendered by a professional that spent years (and money) training for the job no different than the mechanic pays for school that teaches them to fix your car. You may not like how much the service costs but it would cost much more to replace your vehicle or not have that leg set properly.

Recent years have shown that the entry into the healthcare industry, business or direct provider, has slowed significantly due to the tremendous overhead associated with starting up and the continuing high (and rising) costs of business. While reform of the current system is certainly necessary that reform should not forget that inordinate amount of governmental oversight of the industry is one of the main contributing factors to rising healthcare costs. Do we really think that more involvement will solve the problem?