The Pandemic and the Economics of U.S. Health Care

The new reality for hospitals and physicians complicates Joe Biden’s public option pitch.
April 17, 2020
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A man walks through the U.S. Capitol Rotunda, empty of tourists as only essential staff and journalists are allowed to work during the coronavirus pandemic March 24, 2020 in Washington, DC. After days of tense negotiations -- and Democrats twice blocking the nearly $2 trillion package -- the Senate and Treasury Department appear to have reached important compromises on legislation to shore up the economy during the COVID-19 pandemic. (Photo by Chip Somodevilla/Getty Images)

Alongside the obvious burdens of the COVID-19 pandemic, hospitals and other medical service providers are struggling from the revenue they have lost from canceled services. With social distancing requirements, patients are deferring appointments and postponing elective procedures. Further, with less driving and other social activity, many fewer patients are requiring emergency care. All of this points to a historic collapse in revenue for the nation’s vast network of medical service providers.

The falloff may last for some time. Historically, economic downturns have led to lower use of medical care, as consumers who are out of work or have lost their insurance pull back on non-emergency services. Consequently, hospitals and physician groups may not see an immediate rebound in revenue when social distancing requirements are relaxed, or even when a vaccine becomes available.

One of the bills among the recent emergency legislation in Congress—the so-called CARES Act—includes a $100 billion fund to support hospitals and other providers. It also bumped up Medicare payments for COVID-related care, and provided advance payments to facilities and physician practices as a bridge loan to help them weather a falloff in other patient revenue. It is near certain that the next round of pandemic-related legislation will provide even more financial support for the health sector, in the form of unrestricted grants and additional increases in Medicare and Medicaid payment rates.

Congress’s rush to provide substantial financial support to medical service providers represents an abrupt shift in political sentiment, driven by the severity of the current crisis. This new environment may upend the policy agendas for both parties. In particular, it is likely to complicate Democratic plans to advance a public option using Medicare’s relatively low payment rates as the next major step in expanded insurance coverage.

For decades, Medicare has developed complex regulations that establish payment rates for the medical care patients need. These rates are not negotiated with the service providers, although the industry engages in substantial lobbying of both Congress and the Department of Health and Human Services. Rather, the government sets the rates and the industry has little choice but to accept them, given the size and importance of Medicare revenue to their bottom lines. In general, Medicare pays far less than commercial plans for the same services.

Medicare rate-setting is central to the design of public option proposals, such as the one advanced by presumptive Democratic presidential nominee Joe Biden. Instead of creating a new basis for paying hospitals and physicians, public option plans simply reference the fee schedules established by Medicare. Doing so allows proponents to claim that these plans are much less expensive on a per-person basis than commercial insurance. Pre-pandemic, that was a selling point. Now, however, with medical readiness on everyone’s mind, further cuts for hospitals and doctors may not seem like such a good idea.

While it is far too early to pronounce on how well U.S. health care performed during this ongoing emergency, there is little doubt that better planning might have avoided some of the current rush to expand capacity and acquire supplies.

One commentator blamed “market forces” for the problem. The suggestion is that in recent years hospitals responded to the pressures of private insurers and employers by eliminating duplication and unnecessary inventory, at the expense of robustness and readiness for the unexpected.

That explanation does not fit with the pre-pandemic view of the hospital industry. The argument made by most analysts was not that hospitals were too “lean and mean.” Rather, it was that hospitals were wasteful and charged too much for their services. Hospital spending was 34 percent higher in 2018 compared to 2008, after taking out growth that occurred because of economy-wide inflation. Over that period, spending on hospital care (adjusted for inflation) grew at an average rate of 3 percent annually.

Increased spending on hospital services has been fueled by commercial insurance. A recent study found that, on average, private insurance paid hospital fees in 2017 equal to 241 percent of Medicare’s rates, up from 236 percent in 2015.

For doctors, the story is similar. In 2017, commercial insurance paid about one-third more per physician service than did Medicare. That gap will widen substantially in future years because current law severely restrains the future growth in Medicare’s fees.

If hospitals and physician practices were stretched financially and thus not fully prepared for this emergency (a contention that requires further examination), the source of the problem would have been cuts in Medicare and Medicaid fees, not “market forces.”

In the Affordable Care Act, Congress permanently reduced the annual increase for hospitals and other facilities by about 1 percentage point. So, for instance, if inflation is 3 percent, hospitals now get a 2 percent bump in payments. Compounded over time, this annual inflation “haircut” substantially reduces what Medicare pays compared to private insurance. The Congressional Budget Office estimated in 2010 that this ACA provision alone would cut payments to hospitals and other providers by $157 billion over a decade, with much more to come in future years.

Congress took a similar step with physician fees in 2015. The Medicare Access and CHIP Reauthorization Act (MACRA) replaced the “sustainable growth rate” mechanism that threatened large annual cuts in physician fees with a new program that severely restrains future increases. Under a base case, physicians get a 0.75 percent bump in fees each year, far below the expected inflation rate of around 2 percent. Doctors refusing to participate in what are called “alternative payment models” get only a 0.25 percent increase each year. Over time, physician fees from Medicare will plummet compared to commercial plans.

Joe Biden’s public option plan would allow many Americans to opt out of private insurance and enroll instead in a government-run plan that uses Medicare’s regulated rates for hospital and physician care. With lower payments for services, the public option is likely to charge premiums below commercial rates, and thus attract some enrollees. Hospitals and physicians will face increased financial pressure if significant numbers of their patients switch from private to public insurance.

But Biden’s plan was written when the political winds for health-care providers were blowing in a different direction. In the current environment, with the pandemic still peaking, proposed cuts in reimbursement rates for hospitals and doctors are a non-starter. It is possible that could change in the coming months if the severity of the crisis recedes. It is more likely that Biden will have to adjust his plan to reflect the new reality.