Why Hospitals Cry Poor: Cross-Subsidization Explained

This video provides an in-depth exploration of why hospitals in the United States consistently report financial difficulties, a phenomenon the speaker terms "crying poor." Dr. Eric Bricker, an expert in healthcare finance, begins by discussing the context of Medicare underpayment to hospitals, establishing why this financial dynamic is a critical issue for the entire healthcare ecosystem. The presentation covers the progression of how hospitals manage these losses through a process called cross-subsidization, where they overcharge privately insured patients to offset shortfalls from government programs.

The core of the video details the mechanism of cross-subsidization. Dr. Bricker uses a compelling example of an elderly gentleman named Rick, who, despite a miraculous recovery from severe pneumonia, represents a significant financial loss for the hospital due to Medicare's reimbursement rates. He quantifies this loss, estimating that a typical hospitalization costing $100,000 might only be reimbursed $50,000 by Medicare, resulting in a $50,000 deficit. To compensate for these recurring losses, hospitals turn to employer-sponsored health plans. The video illustrates this with the example of a scoliosis surgery, which might cost the hospital $50,000 to perform but is billed to an employer-sponsored plan at a significantly inflated rate, potentially generating a $250,000 profit to cover the losses from multiple Medicare patients.

A critical aspect highlighted is the role of health insurance carriers in this system. The video explains that a substantial portion of the overcharged amount from employer-sponsored plans, specifically around 15% (or $52,900 on a $352,000 bill in the example), goes towards administrative fees, commissions for brokers and consultants, and profit margins for the insurance companies. This creates a perverse incentive where insurance carriers benefit from Medicare underpayment because it necessitates higher charges to employer plans, thereby increasing the base on which their percentage-based administrative fees are calculated. Dr. Bricker concludes by discussing the alternative of hospitals running their own health insurance companies, which would align incentives to reduce costs and administrative overhead. However, he notes that most hospitals lack the "will and skill" to undertake such a daunting task, leading them to continue lobbying the government for increased Medicare reimbursement and negotiating higher payments from private insurers.

Key Takeaways:

• Systemic Hospital Financial Struggles: Hospitals consistently "cry poor" primarily due to significant underpayment from Medicare for services rendered, creating a fundamental financial deficit in their operations.
• Cross-Subsidization as a Core Strategy: To offset Medicare losses, hospitals rely heavily on cross-subsidization, where they charge substantially higher rates to patients covered by employer-sponsored health insurance plans.
• Employer-Sponsored Plans Bear the Burden: The financial burden of Medicare underpayment is effectively transferred to employers and their employees through inflated charges for services covered by private insurance.
• High Administrative Costs: The current cross-subsidization model involves substantial administrative costs, estimated at 21% of the Medicare underpayment amount, which goes to health insurance carriers, brokers, and consultants.
• Insurance Carrier Incentives: Health insurance carriers are financially incentivized to maintain or even increase Medicare underpayment, as it leads to higher charges for employer-sponsored plans, thereby increasing their 15% administrative fees and profit margins.
• Benefits for Brokers and Consultants: Insurance brokers and benefits consultants also benefit from this system, as their commissions are tied to the overall cost of employer-sponsored plans, which are inflated by cross-subsidization.
• Alternative: Hospital-Owned Insurance Plans: A potential alternative involves hospitals establishing and operating their own health insurance companies, which would align incentives to reduce actual costs of care and administrative overhead.
• Barriers to Change: Most hospitals lack the necessary "will and skill" (people, processes, and tools) to successfully transition to owning and managing their own health insurance plans, making systemic change difficult.
• Lobbying and Negotiation: In the absence of internal reform, hospitals resort to lobbying the government for increased Medicare reimbursement and negotiating higher contracted rates with private insurance companies.
• "Employer Welfare State": The current system effectively creates an "employer welfare state," where employer-sponsored plans subsidize the underpayments of government healthcare programs.
• Inefficiency of the System: The 21% administrative "friction" in the cross-subsidization process highlights a significant inefficiency within the US healthcare payment system, indicating substantial waste.
• Impact on Healthcare Stakeholders: Understanding these complex financial dynamics is crucial for all stakeholders in the healthcare ecosystem, including pharmaceutical and medical device companies, as it influences market access, pricing strategies, and overall commercial operations.

Tools/Resources Mentioned:

• KFF.org (Kaiser Family Foundation)
• AHA.org (American Hospital Association)
• "16 Lessons in the Business of Healing" (Dr. Bricker’s book)

Key Concepts:

• Cross-Subsidization: The practice where hospitals charge privately insured patients significantly more for services to cover the financial losses incurred from underpayment by government programs like Medicare.
• Medicare Underpayment: The phenomenon where the reimbursement rates provided by Medicare to hospitals are often less than the actual cost of providing care.
• Employer-Sponsored Plans: Health insurance plans provided by employers to their employees, which typically have higher reimbursement rates to hospitals compared to government programs.
• Loss Ratio: The percentage of premiums that an insurance company pays out in claims. An 85% loss ratio means 85% goes to claims and 15% to administrative costs, profits, etc.
• Administrative Costs: The overhead expenses associated with managing health insurance plans, including fees for insurance companies, brokers, marketing, and profit margins.

Examples/Case Studies:

• Rick's Pneumonia Hospitalization: An elderly gentleman with Parkinson's recovers from severe pneumonia and a bloodstream infection. The hospital's actual cost was $100,000, but Medicare reimbursed only $50,000, resulting in a $50,000 loss for the hospital.
• Scoliosis Surgery: A young woman undergoes extensive spine surgery. The actual cost to the hospital is $50,000. However, an employer-sponsored plan is billed $352,000, with $300,000 going to the hospital (after the 85% loss ratio) and $52,900 to administrative costs, generating a $250,000 profit for the hospital to offset Medicare losses.