The Power of the (Medicare) Dollar: Changes in Medicare Payments Affect Private Insurance Payouts

Pricing in medical services is often frustratingly opaque. Researchers have tried to explain prices using everything from the supply of certain types of specialists to the entrepreneurial attitude of physicians from certain communities. This past summer, the variety in pricing could be seen with the release of Medicare charges from healthcare providers across the country.

In an October 2013 National Bureau of Economic Research (NBER) working paper, “Bargaining in the Shadow of a Giant: Medicare’s Influence on Private Payment Systems,” economists Jeffrey Clemens and Joshua D. Gottlieb attempt to quantify the ways in which Medicare payouts can influence payouts from private insurers and the degree to which provider concentration or competition can influence this payout.

In 1998, Congress decreased Medicare payouts for surgical procedures and increased payouts for all other services. This change to the market allows the authors to estimate the degree to which changes in Medicare payouts affect the payouts of private insurers. They can also gauge whether private payouts are affected by the relative concentration of providers (doctors and hospitals) or insurers. To estimate the effects of the change, the authors utilize a two-stage least squares technique in which they estimate the expected change in payout via the change in the statutory formula, to eliminate the endogeneity of the price change, and a simple before and after estimating equation.

The authors theorize that Medicare may affect private insurer payouts in two major ways. First, Medicare patients compete for providers’ services with privately insured patients, so an increase in Medicare payouts may bid up insurers’ payouts as they seek to provide their patients with comparable access. Second, medical service pricing is complex and bargaining to set prices can be prohibitively expensive. For these reasons, private insurers may either enter costly full-out negotiations with providers, or simply propose a “take-it-or-leave-it” offer, often based on a markup of Medicare payouts.

The authors’ main findings are that a $1 decrease in Medicare payments for surgical procedures leads to a $1.30 decrease in private insurer payouts for the same procedures and a $1 change in an across-the-board category of service leads to the same change in the private payout. To consider the impact of competition between providers, the authors construct a Herfindahl–Hirschman Index (HHI, a measure of market share) for all providers in a market and for 32 groups of specialists. They also use a ratio of Medicare to private insurance market shares to consider the effect of competition for providers between patients with Medicare and patients with private insurance. The findings indicate that the effect of a Medicare price change is much stronger in areas with more competition between healthcare providers, and is also stronger in markets where Medicare holds a greater market share.

While many realize that Medicare affects prices in the industry, the degree of control that the government has, and the way competition increases the influence of Medicare payments, the importance of the implications is not as well known. As the US population ages, Medicare will provide insurance for a greater proportion of the population. These results indicate that Medicare’s power to set prices will continue to rise. Reforms to payment structure for Medicare, such as a shift from a cost basis to a system that considers the cost and the efficacy of a service, could have significant impact on the efficiency of the private healthcare market as well.

On the other hand, recent trends towards consolidation by doctors and hospitals offset Medicare’s influence. As these providers move into larger bargaining units, negotiations become more attractive because a change in prices impacts more doctors, and insurance companies may experiment with new payment structures that depend less on Medicare prices. These two effects—Medicare expansion and the consolidation of providers—are likely to happen to differing degrees in different markets. Future research could look into different markets to see the effect on prices for health services.

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