Chargemaster Tomfoolery, Policy Responses, and Unintended Consequences (In Four Charts)

by Karan Chhabra

Nothing gets wonks going like a trove of healthcare data. On Wednesday, when the government released massive amounts of information on what hospitals charge Medicare, well, the wonks got going. Like many of them, I was skeptical of how much they mattered, since charge variations are a tired story. But a quick look at the numbers turned into a long adventure in healthcare economics, with lots of implications for state and national policy. What follows are the highlights of that adventure, without the computer crashes and med school things that fell in between.

CMS offers a useful summary by state, so I started there. The summary spreadsheet listed how much each state averaged in charges and payments for each of the most common DRGs (diagnosis-related groups). I noticed that my home state, New Jersey, seemed to be charging an awful lot. So I checked out how much hospitals charge relative to what Medicare actually ends up paying, which I’m calling “markup” [1]. Nationwide, median markup across all procedures was 216%. I ran some calculations to compare states and, sure enough, New Jersey was far above the rest [2].

average charges all states

Why? I was quick to suspect some Sopranos-style monkey business, but it appears to be—at least partly—an unintended consequence of a state law requiring insurers to cover out-of-network providers (h/t Dan Diamond). In-network hospitals confidentially negotiate rates for procedures with each insurer, which end up far below chargemaster rates. But under this law, out-of-network hospitals get payments that factor in chargemaster rates:

Patients who choose to go out-of-network will be billed based on the hospital charges, while insurers of patients who must receive emergency services at an out-of-network facility will also pay higher rates based on a “fee profile” that takes into account hospital charges … One reason for the high prices might be the state’s requirement that insurers pay for services at out-of-network providers. “It does create this perverse economic incentive for folks to charge more and more and more because they can get paid for it,” Sanders said.

In other words, NJ hospitals can inflate their chargemaster rates without any repercussions to the average insured patient (the state law will make sure their care is covered). So what we have here is a law designed to protect out-of-network patients from inflated charges, but with the apparent consequence of inflating chargemaster charges across the board. The Affordable Care Act includes similar protections for emergency room visits, enacted one year after NJ’s—will they have the same effect? The ACA provisions only apply to insurance plans written after September 2009, and CMS’s data are from 2011, so it may be too early to tell.

I still wondered if New Jersey’s charges appeared inflated because of one single hospital, or if it appeared true across the board. So to Jersey I went. I averaged the markups for every DRG in the dataset, by hospital, to see whether any hospitals systematically inflate charges across their entire chargemasters (blue columns in the graph below). Again, I broke out the markups for uncomplicated strokes (in red), just as an example. The results are in:

NJ charges by hospital

One hospital, Bayonne Medical Center, is orders of magnitude above the rest. For an uncomplicated stroke, they charge an average $101,394—but Medicare only pays them $5,667. The gap between charges and payments shouldn’t surprise anyone following healthcare delivery; Uwe Reinhardt explains it effectively and humorously here. But at this hospital, that gap is astronomical. (The median markup in NJ is 555% whereas the national median is 216%; since median calculations are insensitive to extreme values, Bayonne’s probably not solely responsible for NJ’s eminent position.)

The kicker here? Bayonne Medical Center is the only for-profit hospital in the chart. I’m not suggesting this implies that all for-profit hospitals charge equally obnoxious rates, but someone with nice grants and research assistants should crunch the numbers for all 50 states and let us know.

Here’s the funny thing: New Jersey has laws that protect the poor uninsured, requiring hospitals to bill them only 115% of Medicare rates [3]. The feds have actually proposed a similar regulation but one that would apply exclusively to not-for-profits—under this regulation, those hospitals could only bill patients qualified for financial assistance at the rate paid by Medicare or commercial insurance [4]. The cutoffs for financial assistance vary at each hospital, but they tend to reflect some multiple of the federal poverty line. If this regulation is finalized, not-for-profit hospitals that violate it could lose their tax-exempt status—a threat hospital execs do not take lightly.

The federal law doesn’t apply to for-profit hospitals, though. Since New Jersey’s doesn’t make the same distinction, I wonder why the federal law does—the feds aren’t trying to influence the charges for hospitals like Bayonne in any other state. Yes, the federal policy uses tax exemption as a stick, whereas NJ is using hospital licensure, but the federal government has required other things of hospitals irrespective of tax exemption—why not use Medicare/Medicaid dollars instead, like EMTALA?)

NJ’s law and the federal regulation matter to this debate because they protect the uninsured from chargemaster tomfoolery. Oddly enough, in a way they also disincentivize getting health insurance altogether. Since Medicare pays less than private insurance (115% of Medicare may also be a bargain), it could be cheaper to the patient to go uninsured under the protection of these laws, than to pay insurance’s overheads in the off chance that an emergency admission happens.

Insurance expansion is a crucial part of Obamacare. It also may be in jeopardy thanks to the IRS’s relatively toothless enforcement power for the individual mandate. At the end of the day, if you’re pretty healthy and of limited financial means, refusing to buy health insurance on the individual market is not the craziest financial decision you could make [5].

So what’s a policymaker to do? The two policies I’ve discussed—requiring out-of-network reimbursement, and limiting charges to the uninsured—both create perverse economic incentives. The first encourages chargemaster inflation, and the second undermines health insurance altogether. This is when cynics like me smugly invoke the law of unintended consequences. But there has to be a policy alternative that protects the poor and keeps the system sane, right? It turns out there is, but it’s a bit of a political grenade. So don’t say I didn’t warn you.

Look back at the first chart in this post. I talked about the biggest inflator, New Jersey, more than you probably wanted. What about that blip to the far right? Nope, no math error—Maryland’s markups are almost a hundredfold lower than NJ’s. It’s a story policy wonks know well: the state instituted an “all-payer” system for its hospital pricing in the 1970s, wherein every provider in the state is required to charge every payer the same price for the same service. This isn’t socialism–cash is still coming from the same places, and going to the same hospitals, and everyone is allowed to make money—but it is textbook rate-setting. The result? They’ve closed the gap between charges and payments, and slowed down cost growth in the process:

maryland cost growth

maryland charges versus costs

There are some flaws in Maryland’s system, but they can be remedied—Austin Frakt outlines them smartly here and here. First, it doesn’t make a ton of sense for each hospital to be paid the same amount when there are obvious differences in their amenities (and potentially their quality). It’s as if an upscale restarant were required to charge the same amount for a bacon cheeseburger as Burger King. Price controls by central dictat are also an ungodly administrative hassle. But it does make sense for each payer (insurance, Medicare, etc.) to pay the same amount to each hospital, the same way one restaurant patron shouldn’t pay less (at the same restaurant) because they’re bigger or better-insured. Thus Frakt, Uwe Reinhardt and others turn to Germany’s more market-based approach, where payers negotiate together for one rate for each procedure from each hospital.

This is a huge difference from the current system, where private insurers negotiate separately and confidentially, on the basis of concerns pretty irrelevant to patient care: most of all, market power. But it’s not “price controls,” because prices are reached through negotiation. Assuming we allow the uninsured to pay the same price, it essentially quashes the problem of price discrimination against uninsured patients, affords private payers the same power to bend the cost curve as Medicare, and makes plain sense—where else in the economy are different people forced to pay different prices for the exact same goods from the exact same seller? I haven’t fully come around to all-payer as the solution to all our woes, but 1500 words and four charts later, the proposal has definitely earned my interest.


Update #1, 5/17/13: The New York Times has just published a deeper dive into what’s going on at Bayonne Medical Center, specifically its use of out-of-network status to milk more from the system, and its switch to for-profit status. They have an accompanying editorial here. Go read, but tell ’em I sent you!

Update #2, 5/17/13: There’s an answer to my question in the last paragraph, “where else in the economy are different people forced to pay different prices for the exact same goods from the exact same seller?” It happens a lot when customers are bidding for goods that different people value differently (say, an auction). But the problem here is that with third-party payment, the patients are not the customers and bidders—insurers are. So the advantages of auction-style pricing—namely, pricing that accurately reflects the value of a product to each consumer—don’t apply in the hospital context. Instead, the system we have rewards market power at the expense of those who are most vulnerable. (Thanks to Austin Frakt for his insightful comments.)



1.  If you really want to know what I did in Excel, kudos for your bravery. I defined “markup” as (average charge – average payment) / average payment. I calculated that for each DRG, for each hospital in NJ. So if a hospital billed $2000 and Medicare paid $1000, the markup was 100%. Then I averaged those markups in all the DRGs from each hospital, to arrive at the percentages you see in the chart’s blue column. I broke out strokes in the red column just to make the data a little more concrete. You can access my spreadsheet here.

2. As I mentioned, I calculated the “markup” of every DRG in every state. Then averaged those markups within each state, and again broke out strokes as an example.

3.  Thanks to recent legislation, NJ limits the ability of hospitals to overcharge uninsured people under 500% of the federal poverty line—hospitals can only bill them 115% of what Medicare would’ve paid. But as Reinhardt notes, a family of four with gross income over $117,750 wouldn’t be protected. And more importantly, this isn’t true in every state.

4. For the proposed federal regulation, see page 17 here.

5. Not the craziest financial decision. But for the sake of your own health, as well as the ethics of living in society, it’s pretty dubious.


Karan is a student at Robert Wood Johnson Medical School and Duke graduate who previously worked in strategic research for hospital executives.

Follow him on Twitter @KRChhabra or subscribe to the blog.

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One thought on “Chargemaster Tomfoolery, Policy Responses, and Unintended Consequences (In Four Charts)

  1. Rakesh says:

    Very interesting analysis. It may be worthwhile to send this article to healthcare policy officials in the CMS..

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