Curing High Healthcare Prices

For the majority of Americans, the cost of healthcare is a thing of mystery. Go in for a major procedure, and you’ll have no idea what sort of financial statement will waft into your mailbox weeks or months later. And even after the statement (perhaps labeled “this is not a bill”) arrives, it takes a while to figure out how much, if anything, you owe.

This is a genuine problem. But one proposed solution—legally mandated price transparency—has its own pitfalls. In some cases, the impact of mandatory transparency may be negligible—not harmful, but not a cure for high prices. In other cases, this cure may be worse than the disease.

The Appeal of Price Transparency

In competitive markets, easily and instantly available prices are the lubricant that keeps the wheels of those markets turning so efficiently. Knowledge of the prices available tends to decrease the range of prices offered for similar goods and can lower overall price levels as sellers compete for buyers’ patronage.

This is why many consumers and policymakers are drawn to the idea of price transparency in healthcare—that is, legal requirements that healthcare providers publicly list the prices for their services. As the Trump administration explains in its executive order on hospital price transparency (recently upheld by a federal court), “Making meaningful price and quality information more broadly available to more Americans will protect patients and increase competition, innovation, and value in the healthcare system.”

Tacit Collusion: Why the Cure May Be Worse Than the Disease

The received (but sometimes inaccurate) wisdom is that price transparency (in this case mandatory transparency) will spur competition, thereby pushing prices downward. And, as basic economic theory tells us, that also means expanded supplies of those goods and services because sellers will produce more goods and services in response to the increased demand caused by lower prices. The problem is that many or most healthcare markets in the United States don’t fit that textbook description of “competitive.” And under the conditions common to many noncompetitive markets, price transparency—mandatory or not—may have the opposite effect, raising prices and shrinking supplies.

This is owing to a problem that economists call “tacit collusion” and antitrust attorneys call “conscious parallelism.” If competitors talked to one another and agreed to raise prices and cut supplies, antitrust law would likely deem that to be a conspiracy against the public, with the potential for civil and criminal penalties. But with tacit collusion, there’s no need for the competitors to communicate with one another because the publicly available price is itself the communication. As long as one competing firm doesn’t charge more than the others, that firm will not lose customers to its competitors. The competitors effectively become partners in a silent cartel, with the same economic effects as a conspiracy but with no legal penalties.

One reason that tacit collusion occurs is that, with transparent, publicly available prices, no provider has to offer low prices out of fear that his competitors may be seizing market share by undercutting him. And no provider is tempted to undercut because his competitors will immediately see this move and respond in kind.

Tacit collusion requires three conditions: a small number of providers, a high level of difficulty for new providers to enter the market (in other words, a barrier to entry), and mutual knowledge of competitors’ prices. In 2011, a federal court found the presence of tacit collusion in gasoline markets on Martha’s Vineyard, Mass. On that island, there were only a few companies operating gas stations. Local regulations prevented newcomers from opening competing gas stations. And, of course, the pump prices were displayed on large signs for all to see.

These three conditions, the court found, enabled the gas station operators to act like a cartel, raising prices considerably above what they would have been in a competitive market. However, since there was no actual conspiracy—no explicit agreement to raise prices—the court found that the operators had not violated antitrust laws.

Perhaps the most famous example of tacit collusion was that of Danish cement factories in the 1990s. There were only a few manufacturers, and the costs of entering that market were prohibitive. Thus, two of the three conditions necessary for tacit collusion were present. Then Danish antitrust authorities required the competitors to post their prices publicly. Contrary to hopes and expectations, prices rose rather than declined. Having seen the results, the government dropped the transparency mandate later on.

On the Forbes website, Northwestern University economist Craig Garthwaite wrote a clear, illuminating article on what all of this means for pharmaceutical markets—notably, that mandatory price transparency could lead to higher drug prices, directly opposite the hoped-for effect.

Many segments of America’s healthcare sector are ripe for tacit collusion, even when one might assume that competitive conditions exist. For example, there are lots of pharmaceutical companies—which sounds like a competitive market—but in many specific therapeutic markets with specific conditions to be treated, such as anaphylactic shock, there are often no more than two or three sellers.

Furthermore, pharmacy benefit management companies, the middlemen between drug companies and health insurers, are powerful in impact and few in number. The same is true in medical device markets. (Controversy over epinephrine pen pricing provides a good example.) In many communities, there are only a few hospitals or insurers. Even primary care markets can be concentrated when many of the local doctors are employed by larger companies.

The upshot is that sweeping transparency requirements may push prices downward in some markets but upward in a lot of markets. Hence, our recent paper didn’t say that mandatory transparency is always a bad idea. Rather, as we said in our title, transparency mandates should be applied with caution—with a scalpel, rather than with a machete.

Why the Cure May Simply Not Be a Cure

Before making blanket decisions about requiring price disclosure in the healthcare market, policymakers would be wise to consider who will use this information, patients or providers, and when. In general, consumers use prices to change their decisions only about health services that are “shoppable” and relatively impersonal—a relatively small portion of the healthcare market. A “shoppable” health service is one that can be scheduled in advance. Few people are sitting down to compare prices before they call an ambulance during a family emergency, but many are likely to choose a cheaper MRI provider as they schedule an appointment a few weeks in advance. Additionally, MRIs tend to be relatively impersonal and similar across providers.

But other shoppable services may be intensely personal. A patient is unlikely to jettison a trusted doctor because another one down the street is offering a lower price on annual checkups. In some personal areas, consumers generally prioritize long-standing relationships, personal characteristics, friends’ recommendations, and even proximity to home over lower prices.

More importantly, even consumers who are offered greater price transparency often do not use the pricing tools available to them. In one survey of US insurers, by 2014, 94 percent of respondents offered some form of price comparison platform, but less than 10 percent of patients so much as logged onto the platforms. In part, this is because consumers simply do not have the incentive to shop. Health insurance buffers patients against astronomical costs, but also against most of the marginal price differences between services.

Another disincentive is that price tools often feature the same complicated language that plagues hospital invoices, making the tools confusing. It’s even possible that the price-shopping tools are sometimes counterproductive, with some patients wrongly assuming that higher prices imply higher quality. The seeming lack of interest in existing pricing tools presents a critical warning to lawmakers who assume that a lack of information is the main barrier to better health decisions.

Other Possible Cures

In markets poised for tacit collusion—those with few providers and high barriers to entry—we’ve seen how mandatory transparency might be counterproductive. In such cases, it may be more productive for policymakers to focus on lowering barriers to entry rather than on transparency. The threat of new providers entering the markets will likely exert greater downward pressure on prices than price transparency will under most circumstances.

There are many ways this can happen. Eliminate certificate-of-need laws; reduce protectionist medical licensure requirements; allow nonphysicians (such as nurse practitioners) to compete with physicians in providing those services that they are trained to do; expand telemedicine markets; reduce the time, costs, and unpredictability involved in approving new drugs and devices. (Dozens of such ideas are discussed in Fortress and Frontier in American Health Care and in the Healthcare Openness and Access Project (HOAP), both authored or co-authored by one of the authors of this article and published by Mercatus.)

The COVID-19 pandemic has also led to a rush at the federal and state levels to reduce barriers to entry. For example, federal regulators have greatly expanded the availability of telemedicine during the crisis.

On the consumers’ side, a more effective approach to policy might consider how and when to encourage the use of price information—not just demanding transparency for transparency’s sake. First, healthcare providers and insurance companies might voluntarily work together to expand which services are shoppable by selling treatments as a bundle. In the case of a heart attack, for example, the payment could be tied to the full episode of care—a bundle including a certain amount of nights in the hospital, bypass surgery, equipment, and rehabilitation—rather than a long, incomprehensible list of individual services and materials that are arbitrarily priced and invoiced.

Bundling is becoming a more popular approach to care, spurred by bundled payment initiatives from the Centers for Medicare and Medicaid Services. To some extent, this is the idea behind direct primary care practices, through which consumers gain access to physicians, nonphysician providers, clinics, and services, all at a fixed monthly fee. (Like price transparency, legally mandated bundling may be counterproductive, but we’ll save that discussion for another day.)

Second, consumers are more likely to pick higher-value (that is, greater quality-to-price ratio) services when they have greater financial stake in the decision. Some insurance companies have found success in reference pricing, a payment structure in which the patient pays all of the additional cost for a service above a set price threshold, rather than a small percentage of any cost. This system works well in combination with insurer-based price disclosure platforms, especially since the pricing information most relevant to consumers usually comes from their own insurance company, not from their provider.

So far, price transparency initiatives at the state level have not prioritized consumer usage in these ways, and the results show it. Many states disclose prices for inpatient care, surgeries, and other non-shoppable and highly personal services, while very few provide information about shoppable services such as laboratory and imaging services. The vast majority of states display billed charges from hospitals, not anticipated final costs or out-of-pocket costs. And very few include any quality indicators on specific goods and services. As a result, these state initiatives do not greatly affect consumer search behavior or final amounts paid.

Nothing we’ve written here implies that the opaqueness of healthcare prices is a good thing, or that transparency will never improve the situation for consumers and patients. Applied with precision, limited transparency mandates can enable consumers to make more informed decisions and increase competition. However, we also assert that in many healthcare markets, competitiveness would be better achieved by lowering barriers to entry, thereby limiting the ease of tacit collusion among providers.

This essay is taken from the authors’ recent paper, Price Transparency in Healthcare: Apply with Caution.

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