Why Your Medical Bill is So Expensive

Everyone knows our medical system is expensive. There’s been books written on the topic. As a medical student, I’ve often felt idiotic when someone asked me about their healthcare bill in the hospital, and I’ve responded that I don’t know anything about it and I have to resort to talking to them about their treatment.

It’s the Prices, Stupid

Let’s say that you just woke up, and have a terrible headache. You feel your forehead, and it’s burning, and your limbs are aching too. You decide it’s time to go and see a doctor. You go to the emergency room, and they admit you with a pneumonia. They prescribe you some medicine, you stay in the hospital for one day, and they send you home. Two weeks later, you wake up and find that your bill is … $4000?

You call the hospital and insist that it’s a mistake. They repeatedly tell you some mumbo-jumbo in healthcare talk about the services that they rendered, and that it’s perfectly legal to charge you this price, which in other countries is much less. How is this possible, nay, legal in the richest country in the world?

This becomes complicated when you realize healthcare pricing is one big mess. When you go to the hospital, you may find that one hospital charges a different amount than another hospital, and this can vary by a factor of seventeen. Why would this happen?

Every hospital has a system which they use to set their prices. This document lists the price for certain procedures, and it is called a charge master. It lists every procedure and supply item used in said procedure, and can contain tens of thousands of charges. These bills are usually inflated, and when you see people complaining about a Tylenol costing $20 at a hospital, this is what they are seeing—the charge masters’ inflated price.

Charge masters are set by hospitals, and usually are inflated prices because they act as a starting point for negotiations with insurance companies. Unfortunately, they vary between hospitals and often are inflated by 400% or more, with the implicit understanding that when insurance companies negotiate prices, they will pay less than that. The hospital may increase prices for certain parts of a procedure or supply item in different amounts, making it hard to compare prices of hospitals for elective procedures. In an emergency, it is impossible to compare prices of different hospitals. This becomes further complicated when hospitals change prices ad-hoc, without any external constraints. This is why, when you open the bill, it’s for $400 for a simple clinic visit.

The Complex World of Healthcare Insurance

The process looks a little different if you have insurance. There are two types—government provided and employer-sponsored insurance. The U.S. government provides two types of insurance: Medicare and Medicaid. Together, they account for about two-thirds of the revenue that hospitals make, so it’s a pretty important part of their revenue stream. Medicare is a national insurance program for those who are 65 and older, some younger people with disabilities, and people with end-stage renal disease, or ESRD. For inpatient services like a hospital stay, Medicare pays hospitals a flat fee according to a list of many diagnosis related groups, or DRGs. For outpatient visits like your clinic visit, it would be the same system, but categorized under ambulatory payment classifications, or APCs.

The Insurance Sisters: Medicaid and Medicare

This can get a bit abstract, so let’s use a hypothetical example about your clinic visit. If you were insured by Medicare, this is how the payment would look like. There would be no negotiating because the national insurance like Medicare doesn’t negotiate, and it pays a flat fee. The APC for your particular clinic visit, which is 2.0, is multiplied by a base rate set by the Center for Medicare and Medicaid Services, which may be $50. Medicare will reimburse the clinic only $100. Congress updates the weights for the APCs and the DRGs yearly, and they reflect the so-called market-based price index of hospital inputs changes yearly. In essence, it is a system of centrally administered prices which accounts for all services and supplies associated with a certain procedure into one lump-sum fee. There is more complexity to the Medicare system (including modifiers which can change this underlying price) but this is how it works, in a nutshell.

The other side of this is Medicaid. Let’s say that you had Medicaid, and this provider that you went to see accepted it. Because Medicaid is a national insurance program for those with limited income and resources, it oftentimes provides less of a reimbursement than Medicare or private insurance. It also varies in the number of reimbursements that physicians get because it is administered by each state.

However, each dollar spent on Medicaid on the federal level is matched by one dollar at the state level through the federal medical assistance program. There are three systems in place which states use to cover Medicaid costs on a fee-for-service, or pay-as-you-go basis. The first one is cost-basis where the cost of the provider is what the payer, in this case, Medicaid, will pay for the hospital. This arrangement is usually only done in critical access hospitals, a title given to eligible rural hospitals to treat residents who would otherwise be really far from a hospital where they could get treated. The second payment system is our friend, the DRG system, which Medicare has used to set their rates—states use this same base payment multiplied by certain modifiers to decide what a hospital will get after providing service to those patients enrolled in Medicaid. The third one is per-diem, or per day cost. If you were in the hospital for a day, the hospital (using historical data) would charge you based on the visit, and Medicaid would have a discounted rate, and they would pay less based on the government’s setting of prices below the market rate which commercial insurers would have to pay. It’s one of the advantages of the government. The problem comes in when these discounts fall short of the operating costs of the hospitals, which they often do, and are covered by commercial insurers.

Employer-Sponsored Insurance

Moving on to the second part of the equation, employer-sponsored insurance. This is the insurance you’re probably mad at because they don’t cover the medication, and you’re left with an exorbitant bill. Let’s use our example of our pneumonia stay to apply to the commercial insurance. At hospital A, the charge master price is set at a certain level, and Medicare and Medicaid already have a discounted rate which the hospital has to accept. Now, to make up for the losses that they are or may be taking on Medicare patients and hopefully turn a profit, they charge exceeding what they charge for those insured with national insurance, but less than their charge master prices. Private health insurances pay deeply discounted prices from the sticker, charge master prices, per-diems, or DRGs.

The three payment systems work like this: for your pneumonia, once the hospital files a claim for payment, the insurance company calls the billing department up and negotiates for a payment rate or the DRG. The item under consideration under the DRG system is the conversion factor, which is usually higher than Medicare or Medicaid. Then, they will reimburse up to that rate. Unfortunately, these prices have been kept secret because they are proprietary—which makes it hard for the consumer to price shop. They don’t know how much their insurance has negotiated the price of their hospital stay down to, and honestly, most people aren’t aware that there was negotiation of any kind.

(I can’t get no) Insurance

Let’s say that you had no insurance at all—and you were billed for the charge master price. This would be the worst outcome for you. If you cannot negotiate it down, then the hospital can use a separate collections’ agency to collect that money. It should be noted that most of the uncompensated care that is provided is never made up—the hospital absorbs it as bad debt. This bad debt includes underfunding from Medicare and Medicaid. This hurts not only the person who is presenting for care, but also society at large. When one has to delay care based not on the access to care but rather the ability to pay, it affects the severity of their disease. A stage I cancer can progress to stage IV, and other conditions can progress much rapidly due to the weakened immune system. There are now means-tested discounts for those who are uninsured, along with charity care programs which can help those who are not eligible for Medicaid or Medicare to gain help to pay for their care.


In this post, I’ve only talked mostly about the inpatient prospective payment system (IPPS) and the ways that insurance covers and pays for them. There is another discussion on what copayments might be, coinsurances, along with a discussion of how to best alleviate the exorbitant prices of the healthcare system. While “Medicare-for-all” solutions have been floated to solve the complexity of the administrative bloat which facilitates these payment schemes, it might be harder to implement given the cost of labor in the United States.

Yet another discussion could be had about payment for prescription drugs, health equity, and solutions based on market forces (competition between hospitals to drive down prices). Financing of healthcare has always fascinated me, and continues to, because it lays bare some of the incentives which are driving trends which we see in digital health, sharing of electronic records between hospitals (interoperability), and startups in healthcare targeting some of the plans in Medicare (including medicare advantage). As you can see, there are so many varied topics which I have yet to learn and write about.

I wanted to set out to learn a little more about how bills are actually paid in the United States healthcare system, and put it in plain English. You would think it should be easy because people should know how much they pay for their health. Unfortunately, even physicians often don’t know what patients pay, and we aren’t taught this in medical school. My friends often ask what I think of the healthcare system, and I try to think about what I have learned, and end up coming short on what to tell them because it’s hard for me to codify some of the incentives which drive healthcare. This is just my way of trying to start doing it in a way which I actually understand, and in words which don’t confuse people.

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