Litigation Economics

In personal injury and product liability matters, claimed medical losses and damages are often expressed as their original charged or billed amounts. While this might make sense in many industries, it doesn’t make sense in the health industry. Charges for the exact same service in the exact same geographic area vary substantially, even after statistically adjusting for differences in input prices (like wages) and patient characteristics. This is because of a fundamental disconnect between medical care prices and the associated value of those services. Why the disconnect? Three reasons. First, as the U.S. health care system grew rapidly following World War II, the industry was largely organized as non-profit. As the industry expanded, policymakers expected non-profit entities to offer sufficient levels of “charity” care to justify their tax-exempt status; that is, to show evidence of “community benefit.” One way for healthcare providers to report high levels of charity care was to keep their charges high, accept lower rates on a per case basis, and classify the difference as either charity care or bad debt.

Although the industry now contains a mix of non-profit (75%) and for-profit entities (25%), such pricing behavior is ingrained and has largely continued. Second, health care entities generally find it more effective to bargain and adjust list prices from an arbitrarily high chargemaster (i.e., the healthcare “price list”) rather than a price list more reflective of reasonable value (RV) or fair market value (FMV). Third, health care organizations typically have high “fixed costs” and relatively low “variable costs.” The implication of this is that many hospitals and other healthcare provider organizations have declining average costs and relatively low marginal costs. This further increases the range of compensation a provider can and will accept in full satisfaction of its charges, because they can accept amounts below their average costs (but above or equal to their low marginal costs) and continue to earn positive rates of return. These widespread pricing practices suggests that health and medical prices are not per se reflective of RV and FMV and are typically significantly higher than what would be considered RV or FMV. The Wall Street Journal observed that even hospital executives themselves do not believe that list prices represent the value of services. Fortunately, health economists have developed methods and tools to adjust charged amounts to be more reflective of RV and FMV.