The Driving Forces Behind America’s Healthcare Cost Problem

8 min readJun 30, 2020

Part VIII: Yes, Now is the Perfect Time to Talk Healthcare in America

Note: This post is one part of my series, Yes, Now is the Perfect Time to Talk Healthcare in America, which provides an in-depth look at the current healthcare system so that it can be reformed. Click the link or scroll to the bottom to check out the other posts in the series.

Healthcare costs too much in America, and patients bear the brunt. If we hope to reduce costs, we first must understand where the money actually resides. Only then, can we drive impactful change and develop strategies to finance the rest.

In my previous post, I proposed that insurance companies may not be the primary culprits. At the end of the day however, when people get hit with an astronomical bill, they don’t really care who’s to blame so long as it’s fixed.

For too many Americans, a single emergency can cause severe financial exposure. In many ways, insurance companies act as the first line of communication to patients, and create fury by charging enormous costs and denying claims. Unfortunately, these bills aren’t always just “fixed” leaving many to rightfully ask, “Where do these costs come from?” Below, I highlight the primary catalysts driving the healthcare cost problem in our country.

Root Cause #1, Hospital Networks

In the United States, hospitals have developed into lucrative ventures. While hospitals themselves don’t necessarily net much more than private insurers, they effectively incubate profit. In a 2019 study by the University of California Berkeley and reported by The New York Times, nearly half of all American physicians belong to a consolidated hospital group, and this trend has approximately doubled over the last decade.

Similarly, the Healthcare Cost Institute, a nonprofit group, reports that three quarters of all hospital markets would likely meet the Department of Justice’s Herfindahl-Hirshman Index (HHI) standard as highly concentrated and monopolistic-exhibiting enterprises. Moreover, this concentration particularly manifests in metro areas and offers an explanation for the exodus from rural and low-income neighborhoods in America.

According to the Centers for Medicare & Medicaid Services (CMS) and reported by Axios in 2018, hospitals drive the bulk of expenses, and non-profit hospitals aren’t exempt. Hospitals have become profit-maximizing entities which essentially perform a la carte billing for everything from type of procedure to specialist opinion to emergency room visit to ambulance ride to medication.

According to a study by the Annals of Internal Medicine in 2019, administrative costs now account for 34% of total healthcare expenditures. These administrative costs litter hospitals, nursing homes, home care agencies, hospices, and physician practices. While some administrative costs remain functionally essential, the figures have ballooned widely due to a business geared toward devising complicated billing algorithms, strictly itemized charges, and ways to increase profit nested in the hospital network.

With an imbalance of economic power, hospitals then create downstream effects where other stakeholders follow suit. When there are fewer powerful hospitals, they swallow the best physicians and consolidate provider networks too.

At a micro level, we shouldn’t necessarily blame individual physicians for this. In some sense, they’re taking the system that’s been created and perpetuating it by specializing and seeking prestigious opportunities at elite hospitals. Moreover, many hope to pay off staggering medical school loans, while others just want to make more money through their profession.

As collective entities, boards have certainly increased barriers to entry in medical school admissions and licensing obligations, which might be a whole other conversation. But if we truly want to amend a runaway system that has long been far too unchecked, hospitals might be one of the best places to start.

Root Cause #2, Concentrated Industry

In my post on the positive aspects of the current system, you may recall that I highlighted R&D investment. I stated that entities like drug companies and medical equipment manufacturers act as critical players in America’s innovative presence. Still, these enterprises simultaneously spur the cost problem in America. If we can believe that the system isn’t necessarily a zero-sum game, maybe we can accept that manufacturers have some traits reminiscent of both a good and bad actor.

Like hospitals, many parts of the health industry have become extremely concentrated. According to a study by the Open Markets institute and report by Axios in 2019, a few companies control entire markets.

With disproportionate power dynamics, monopolistic pricing hurts consumers. Looking at the pharmaceutical industry, once a drug becomes certified by the Food and Drug Administration (FDA), companies can essentially price the drug at whatever point they think it can sell. They can sell directly to hospitals which can then mark up brand-name drugs as part of their a la carte billing and make an additional profit. They don’t necessarily have an incentive to negotiate down the sticker price and neither does the next key contributor.

Root Cause #3, Pharmacy Benefit Managers

In cases where a drug treats a more common disease, it gets rather complicated. Drug companies will typically sell to Pharmacy Benefit Managers (PBMs) who work as third-party administrators of prescription drug programs for commercial health plans and self-insured employer plans. Important to note, PBMs negotiate on behalf of insurers to lower drugs’ costs but not the price.

In any world, a PBM-like entity plays an important role in the supply chain because it connects the decentralized space of prescriptions, claims, and procurement. However, in recent years, they’ve leveraged their influence over private insurers to gain a more prominent role as cost arbitrators with drug manufacturers.

Since they work on behalf of insurance companies, PBMs don’t necessarily have an incentive to transfer these savings to patients. They represent large commercial insurers who, in turn, cover large employers. These large companies won’t simply uproot their vast insurance plans overnight and neither will private insurers to PBMs.

PBMs will negotiate down the cost that insurers pay to drug manufacturers. Then, once these drugs have been wholesale purchased and allocated to the represented insurance plans, PBMs will earn a rebate from the manufactures. Drug companies will pay these PBMs a little extra in return for getting all product out. As this cycle continues, PBMs are more incentivized to earn higher rebates and cut costs for their private insurers than drive down the sticker price. Drug manufacturers can keep raising the price on the open market as PBMs negotiate larger discounts and rebates. This adversely affects individuals who don’t have health insurance or possess limited drug plans. They will have to pay a much higher price.

As long as an individual has a robust insurance plan through their employer, they may never notice. However, those with higher deductibles, higher co-insurance plans, non-employer based insurance, or those uninsured, become less shielded from the open market. In these instances, they don’t benefit from the discount or rebate via a PBM. Instead, they just see a hiked price. In recent years, PBMs wedged certain medications that drug companies exploited like EpiPens and Insulin — leading some to ration and even forgo these previously commonplace drugs.

If this seems confusing, perhaps visualizing the math can help. In the below example, let’s consider the fraction (10/3) as drug manufacturers’ sticker price. A PBM will negotiate a lower cost for its private insurance client (10/4). In turn, the drug manufacturer has a greater chance of unloading a large amount of its product. Once allocated, the PBM will seek a rebate (1/4) to which the drug company can stand to offset, and say double, on the open market.

Initial Sticker Price: (10/3) = $3.33

PBM-Negotiated Cost: (10/4) = $2.50

PBM-Negotiated Cost with Rebate: (10/4)-(1/4) = (9/4) = $2.25

Profit Earned by PBM: (1/4) = $.25

Employer-based insurance cost: (10/4) = $2.50

Price on open-market: (10/3)+(1/4)+(1/4) = (46/12) = $3.83

Counter-intuitively, when PBMs seek to increase the discount or rebate, they drive up the price point on the open market. Drug manufacturers will seek to offset their lost margin to PBMs. Compounding the problem, the PBM space itself remains heavily concentrated where three firms dominate three-quarters of the market: CVS Health, Express Scripts, and OptumRx of United Health Group.

One can certainly argue that this might be good for those with strong employer-based health insurance. After all, they will be insulated from these price hikes. They probably won’t see lower deductibles, co-insurance, or co-pays, but at least regular payments should stay fairly constant. However, others can argue only about half the country has employer-based health insurance which leaves many severely vulnerable. PBMs seemingly fill a monopolistic vacuum, take a cut, and exacerbate the problem. PBMs have stepped into a price arbitrator role; they once just administered prescription drug claims and procured the drug supply chain.

Key Takeaways

At this point, a few themes probably seem evident. In almost every aspect, the healthcare space has become heavily concentrated; a few players dominate entire segments and seem somewhat unchecked. Still, they provide an important service. We need good hospitals and insurance just as we need good drug companies and manufacturers. At the same time, we probably should state that the healthcare space isn’t the only area where dense markets exist.

Still, we need to turn ire into action and know how to channel it. Insurance companies and drug companies are a familiar foe and should certainly be held more accountable. However, is it really more perverse to say that hospitals need to be reigned in too? Or, that drug companies may be partially fueled by other entities? The system has good actors and bad actors, but almost all of them are blends of the two.

I assert that reforming the system isn’t just a matter of creating more foils but rather disproves the notion that simple fixes exist. And, it’s in Americans’ hands to vote for the change that they want to see.

Thanks for reading! If you enjoyed this post please clap, share, and feel free to add me on LinkedIn to share any feedback. For links to all of the other blog posts included in this series, see below.

1. Yes, Now is the Perfect Time to Talk Healthcare in America

2. The History of Pre-1970s Healthcare

3. The History of Modern Healthcare

4. What is Medicare?

5. The Debate Around the Affordable Care Act

6. Three Areas Where the American Healthcare System Actually Works

7. Three Areas Where the American Healthcare System Fails

8. The Driving Forces Behind America’s Healthcare Cost Problem

9. Voter Attitudes Surrounding Healthcare

10. How the United States Can Fix Healthcare, According to the Presidential Candidates

11. International Healthcare Systems: Western Democracies

12. International Healthcare Systems: Eastern Democracies