Debate Over Hospital Prices Plays Out in California

Hospital charges are the behemoth of health spending, and efforts to control medical care inflation often focus upon hospitals. But it’s a tough struggle because hospitals want to maximize their revenue, while health insurers and their customers want to keep the bills as small as possible.

Many health care players are watching as a case study plays out in California, where CalPERS, which provides health coverage for more than 1.2 million active and retired state and local workers, eliminated coverage at 24 hospitals from its Blue Shield of California HMO network beginning January 1.

Thirteen of those hospitals are part of Sutter Health, which includes medical groups and hospitals in northern California. CalPERS and Blue Shield said Sutter’s proposed prices at those 13 facilities were too high compared to what other hospitals had requested from the CalPERS HMO network, but Sutter maintained that its proposed rates were competitive. CalPERS continued to include 12 other Sutter hospitals under its HMO network.

It’s not clear who is right in the world of hospital charges, where nobody pays the official price and discounts are deep and secret.

Blue Shield said Sutter isn’t competitive, but the health insurer wouldn’t disclose the prices it pays to Sutter competitors. So it’s an impasse. Blue Shield says Sutter charges too much; Sutter says it doesn’t.

It was a simple dollars-and-cents issue, according to Paul Markovich, Blue Shield vice president for large group sales. “CalPERS was looking for ways to reduce their health care costs,” he said. “We shared with them the information that the largest and fastest growing component of costs was the hospital cost, and indicated to them there is a very large range of reimbursement for hospitals in the same area without any improvement or difference in quality.”

Sutter spokesperson Bill Gleeson said, “We offered Blue Shield and CalPERS a way they could achieve substantial guaranteed savings and preserve their members’ ability to access the network.”

But they couldn’t reach a deal, and an estimated 34,000 CalPERS members dropped coverage through the HMO network during open enrollment in December 2004, according to a report by the Bureau of State Audits. Presumably, those CalPERS members are following their doctors to other, higher cost, health plans to keep access to the excluded Sutter hospitals.


CalPERS and Blue Shield estimated that CalPERS could save about $30 million this year and $50 million next year by eliminating the higher-cost hospitals from the HMO network, with about 70% of the estimated savings coming from 13 Sutter hospitals. However, the state auditor’s office examined CalPERS’ decision and in March indicated that the estimates of potential savings might be overstated.

The auditor’s office found that Blue Shield’s analysis is “reasonable in approach but includes some questionable elements and possibly overstates estimated savings.” A hospital savings estimate of $20.8 million could shrink to $8.9 million if different actuarial assumptions are used, according to the state report.

But it’s hard to know precisely what is happening because the world of hospital pricing is a convoluted market. There is an official price for every procedure and service, something like the sticker price on a car that only the most naïve buyers would pay. In the hospital world, only the individual unlucky enough to have no health insurance would pay the official price. Everyone else — those with private insurance and those covered by government programs — gets some sort of discount.

And those discounts are closely guarded, competitive secrets.

The Case for Disclosure

The state report showed that confusion and uncertainty plague the policymaking process, whatever approach is used.

“Both CalPERS and Blue Shield disagree with our conclusion that Blue Shield’s estimate of cost savings related to the exclusive provider network may be overstated,” the state auditor’s report said.

The report suggested that the Legislature should consider giving CalPERS the power to get “relevant documentation” information during its contract negotiations. Presumably, this means CalPERS would get the authority to look inside the closed books of the hospitals and health plans and see the discount schedules and find out who is actually paying what price for hospital treatment.

If CalPERS gets the power to look at the actual prices paid by health plans to hospitals, it would have a mighty club to wield in the struggle over health care costs. Hospital spending is increasing at an annual pace of about 9%, greater than either the general rate of inflation or the growth in wages.

In addition, Sen. Deborah Ortiz (D-Sacramento) has introduced legislation (SB 545) that would make CalPERS health benefits decision-making more transparent. Ortiz said the savings projected by CalPERS in its study with Blue Shield “did not take into consideration the financial — and emotional — costs of forcing employees to scramble to find other health care plans when Blue Shield excluded their hospitals from its system.”

Ortiz’ legislation would require CalPERS to:

  • Provide an explanation of proposed changes in health plan coverage and cost comparisons for similar services;
  • Indicate why such changes are being considered;
  • Conduct public hearings to address the proposed changes;
  • Commission an independent “evaluation and verification” of the cost and availability of comparable health care services, as well as estimated financial savings for CalPERS; and
  • Provide an explanation of board’s final decision.

CalPERS has “no objections to transparency measures in general” and welcomes the idea that it “be enabled to follow the money,” according to a spokesperson. But CalPERS does not support the Ortiz bill. “We’re trying to work through the transparency issue with providers and plans without legislation, if possible,” according to the spokesperson.

The Tiered Network Alternative

CalPERS’ decision to drop some hospitals from its HMO network is just one tool of cost control. Another is to keep access to all the hospitals and create a “tiered” network, with different copays and different deductibles, depending on the hospital the consumer uses. The lowest cost is at the “preferred” hospitals. Anyone who uses a “nonpreferred” facility pays higher out-of-pocket costs through the boosted deductibles and copayments.

From the hospital point of view, a tiered network is a clumsy, unfair approach. “It represents more of a short-sighted reaction by the health plans to some real serious issues,” Gleeson, the Sutter spokesperson, said. “They simply shift costs from the employer side to the consumer, and we don’t believe this is a solution to the fundamental problem facing the industry, fixing the health care financing system. Historically, tiered plans are linked to money, not quality,” he said. “We’ve yet to see a tiered plan that brings the kind of balance we would like to see to costs and quality.”

The CalPERS board had considered the tiered approach, but decided against it in 2004. About one million California residents are members of Blue Shield’s tiered network health plans.


CalPERS’ push against hospital prices was driven by ever-rising health costs, which threaten to offset virtually all the salary increases in a typical worker’s paycheck.

By taking this aggressive approach, CalPERS is positioning itself on the cutting edge of change in the way employers and health plans will be fighting with hospitals over dollars in coming years, according to Robert Laszewski, a consultant for health plans and health care providers. Costs are rising at hospitals “as people are getting more procedures done and there is an increased use of technology,” the former health insurance industry executive said.

Mergers and consolidations in the hospital industry mean there are more chains with increased economic power because hospitals’ market shares, as well as charges, are taken into consideration in health plan negotiations. For example, Sutter is indispensable in prosperous Marin County, where the hospital chain operates two hospitals that compete with a Kaiser Permanente hospital.

Laszewski noted that in recent years “hospitals have been more successful in pushing through price increases.” According to Laszewski, hospitals have surpassed managed care firms as the most powerful player in the health care system.

Regardless of the outcome, CalPERS’ debate with Sutter likely is just the first round of a long struggle over dollars between those who consume health care and those who provide it.

Related Topics

Health Care Costs Health Industry Insight Insurance