The Prices That Commercial Health Insurers and Medicare Pay for Hospitals’ and Physicians’ Services

Just over half of the total U.S. population receives health insurance through commercial plans that are offered by employers or purchased by individuals. In recent years, commercial health insurers’ per-person spending on hospitals’ and physicians’ services has grown more quickly than analogous spending by the Medicare fee-for-service (FFS) program, according to analysis by the Congressional Budget Office. The main reason for the growth of per-person spending by commercial insurers—and for the difference from the growth of per-person spending by Medicare FFS—has been rapid increases in the prices that commercial insurers pay for hospitals’ and physicians’ services.

Prices paid by commercial insurers and Medicare FFS differ, and rise at different rates over time, in part because of differences in how the two sets of prices are determined. The prices that commercial insurers pay for services from in-network health care providers result from negotiations between the insurers and providers. Commercial insurers may try to obtain lower prices by excluding providers from their networks, but in many cases, their ability to do that is limited. The prices that Medicare FFS pays providers are set administratively through laws and regulations, and providers can either take them or leave them.

CBO’s analysis and a review of the research literature found that commercial insurers pay much higher prices for hospitals’ and physicians’ services than Medicare FFS does. In addition, the prices that commercial insurers pay hospitals are much higher than hospitals’ costs. Paying higher prices to providers can have several effects. First, it can increase insurers’ spending on claims, which may lead to higher premiums, greater cost-sharing requirements for patients, reductions in the scope of benefits, or other adjustments to plans. Second, it can increase the federal government’s subsidies for health care (that is, the government’s spending on health care plus forgone revenues from federal tax preferences for health benefits). And third, it can slow the growth of wages.

Compared with the prices paid by Medicare FFS, the prices paid by commercial insurers also vary much more among and within geographic areas. Large variation in prices for similar services can be evidence that markets are not operating efficiently.

CBO examined potential explanations for why the prices paid by commercial insurers are higher and more variable than those paid by Medicare FFS. CBO’s analysis and literature review suggest the following conclusions:

• Greater market power among providers consistently leads to prices for commercial insurers that are higher than Medicare FFS’s prices and that vary more widely, both among and within areas. Hospitals and physicians’ groups may have market power because they have a dominant share of the market in an area or because an insurer sees them as essential to its network of providers.
• Some of the variation in the prices that commercial insurers pay for hospitals’ and physicians’ services is explained by differences in the prices of inputs needed to deliver those services.
• Higher hospital quality is associated with higher prices paid by commercial insurers, although whether there is a causal link between quality and prices, and the direction of any such link, is not clear.
• The share of providers’ patients who are covered by Medicare and Medicaid is not related to higher prices paid by commercial insurers. That finding suggests that providers do not raise the prices they negotiate with commercial insurers to offset lower prices paid by government programs (a concept known as cost shifting).