Price Differentials Are Not Evidence of Cost Shifting

A recent Business Week article summarized an argument against a public option that is based on the unfounded claims of cost shifting made by insurers and hospitals. In it Jane Sasseen and Catherine Arnst write

Proponents add that government competition would force private insurers to lower premiums, making coverage more affordable for all.

But the business community keeps cranking out studies undercutting such arguments. The insurance industry trade group, America’s Health Insurance Plans (AHIP), compared the lower reimbursement rates for health care paid by public programs vs. private payers. The group claimed the difference reflects cost shifting, which added an estimated $1,512 to the average premiums paid by a family of four. “The existence of the private sector allows that shift,” says Karen Ignagni, the head of AHIP. “If you clamp down on one side of a balloon, the other side just gets bigger.”

Ignagni’s balloon analogy is a false one, and AHIP’s cost shifting argument is faulty. It is based on a study that misapplies the term “cost shift” to price differentials.

In December 2008 Milliman published a report with the unfortunate title “Hospital & Physician Cost Shift: Payment Level Comparison of Medicare, Medicaid, and Commercial Payers” (authored by W. Fox and J. Pickering). The report was produced at the request of America’s Health Insurance Plans (AHIP), the American Hospital Association (AHA), the Blue Cross Blue Shield Association (BCBS), and Premera Blue Cross. AHIP’s December 9, 2008 press release summarizes the report.

You’d think with “cost shift” in the title the report would be about cost shifting. It isn’t. It is about the fact that public and private payers pay different rates to health care providers. The report shows that in the 2006-2007 period Medicare and Medicaid paid $88.8 billion less than private payers for hospital and physician services than they would have if public and private payers paid the same rates for health services.

The report goes on to translate this payment differential into an amount attributable to health insurance premiums. The claim is that private health insurance premiums for a family of four are $1,512 higher per year than they otherwise would be in the absence of the payment differential identified.

The Milliman report is widely misinterpreted, in part due its misleading language. Price differentials, which it describes, do not support the conclusions reached. Just because payers A and B pay different prices does not mean that if payer A paid more payer B would pay less. I’ve made this point elsewhere, as have Uwe Reinhardt and Richard Frank.

Look at it this way: McDonald’s [sic] pays far less per pound of chicken (or beef) than you or I do. That’s a price differential based on market power. Being a far bigger purchaser McDonald’s has far more market power than you or I and commands lower prices. But if McDonald’s suddenly paid more, would we pay less? Do we believe chicken (or beef) costs have been shifted from McDonald’s to us? No. It is a price differential, not a cost shift.

Another example: you take a second job on weekends and it pays less per hour than you make during the week. Does this mean your weekend job shifts costs to your weekday job? If your weekday job cuts your pay, will your weekend job pay more? No. It would be foolish to expect such a thing and strange for any employer to provide it.

If price differentials are not cost shifting, what is? Economists’ definition is consistent with a plain language interpretation: a cost shift is a causal relationship between what is paid by A and paid by B. If changes in price paid by A cause changes in price paid by B then that is a cost shift.

Scholars have looked for such cost shifting in health care and found very little evidence of it. In the rare cases it occurs, it does so at a minimal level. It is a myth that in health care lower prices paid by public payers are substantially offset by higher prices paid private payers. Yet this is precisely what the Milliman report claims (or strongly implies by its use of misleading language).

The Milliman report did not come anywhere near looking for or finding such a causal relationship. It is not a report on cost shifting, despite what it says and the way it is used by its sponsors.

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