Blue Promise: How Do Hospitals Make Money? Part 1

We all know hospitals provide important medical services in our communities, but do you know how they make their money? Join Dr. McCoy for this Blue Promise discussion to learn more about the price you pay when you access health care at a hospital. The panel includes Shara McClure, DSVP of Texas Health Care Delivery, David Cripe, DVP of Network Management, and co-host Ross Blackstone, Director of Strategic Influence. You can listen to the complete discussion in podcast form on Apple Podcasts and SoundCloud.

Additional links in the How Do Hospitals Make Money Series:

Blue Promise is an online video blog that aims to address complicated health issues with candid conversations from subject matter experts. New editions are published regularly and are hosted by Dr. Dan McCoy, President of Blue Cross and Blue Shield of Texas.

Show Transcript

Music In







DAN: Hospitals provide vital medical services to our communities.


But do you know how they make their money. Today we'll pull back the curtain to help you understand how a hospital business model works.


Thanks for joining us for this edition of Blue Promise. I'm Dr. Dan McCoy I'm the President of Blue Cross and Blue Shield of Texas I'm here with my co-host Ross Blackstone along with a couple of people from our network areas Shara McClure and Dave Cripe.


So tell me about the different kinds of hospitals.





DAVE: There are basically three different types of hospitals. You have your for-profit hospitals your not for profit faith based hospitals and then you have your public hospitals.


And the difference between the three of them is that your for profits are usually public entities that are publicly traded on the stock market.


You also have then your faith based not for profits that have been around since the mid 1800's that are based on different orders of nuns that typically came to the communities in need, built a hospital and then service the people who could not afford care?


And then you have your public entities that are like your government owned county hospitals or state-owned facilities.





DAN: So if I move away and I realize that there's a public hospital I think everybody in their community knows what those hospitals are. As a patient will I tell a difference between a for profit hospital and a not for profit hospital.





SHARA: I think you could.


I think that the way the Hospitals invest in the services they provide or that they invest in amenities you might see a difference in the waiting rooms or the lobby you might see a difference in the types of individuals who are waiting to get service but public hospitals especially in the major metro areas they handle a lot of trauma a lot of E.R. maybe drug overdoses shootings but also a lot of simple services just because that's where a lot of the uninsured patients go to get their care?





ROSS: Public hospitals oftentimes I think most people think that those are those are public service right there. You know it's something that is almost like it's a charity but they still have to make money. They're still a business. They still have to stay solvent to keep their lights on their doors open. So let's talk about how these organizations actually make a profit. How do they how do they make their money?





SHARA: So these hospitals they serve they serve a multitude of patients so they serve insured patients many who were insured by BlueCross BlueShield of Texas and other private carriers they serve Medicare patients they serve Medicaid patients and they also serve uninsured generally the private claims that they submit they drive their profits?


And so if you look at a hospital'sbottom line is generally that payor mix and the high the more they see of private patients the more profit they're going to generate.





DAN: But it makes sense right.


So they're not seeing uninsured patients which wouldn't pay them anything and certainly they do provide that service in the community. But the more paying patients they see the more money they make.





SHARA: I think that's a general that's a general statement.





ROSS: So as of 2011 the combined number of people enrolled in Medicaid and Medicare exceeds the number of full-time private sector workers in the United States.


So if hospitals make most of their money through these fully insured patients and the government the government insured and the uninsured can have an adverse impact to their bottom line. What do they do? How's how's the state of the hospital system today.





DAVE: I think that's going to depend greatly on the hospital you're talking to.


So if you get out into the rural communities you're going to find hospitals that are struggling just because it's a lot of unfunded care a lot of government funded care and not much in the way of private insurance. So those those organizations are having a hard time.


But in the big cities those organizations tend to inflate their prices in a way that it is very profitable for them and they'll place their facilities in a place where you have people who are employed insurance and so they're not expanding into the areas of greatest need? They're expanding in the areas with the greatest funding.





DAN: So Dave let me ask a question often measure the success of a company by the number of cranes they have.





DAVE: Yes.





DAN: It sure seems that in the metropolitan areas there is a lot of cranes around a lot of hospitals so is this industry lucrative. Do they make a lot of money.





DAVE: They make a lot of money. And that's why you see a lot of organizations that typically invested in the tech industry 20 years ago doing so in health care because that's that's the sort of the new place to go. You have an aging population you have rapidly changing technologies and it's an ability to keep the price inflates.





DAN: So when they invest in buildings so you get more and more of this infrastructure and it seems like they're on a recruiting binge to see you get more and more physicians that work at these facilities.


Is it because of scale? Do they get more efficient? And it's maybe easier to get care there or what's the reason for all the growth. How does it add to their add to their bottom line?





SHARA: Well I mean in normal economics you have supply and demand where the more supply your prices go down. But in healthcare it seems that the more capacity that's built in the system the more demand he's created.





DAN: So let me just kind of stop you for a minute there so therefore the bigger the hospital system the higher the prices generally. Is that fair?





SHARA: The more they collect and the more leverage they have.


And one thing we haven't talked about is is the difference between the prices paid in private sector insurance and Medicare and Medicaid.


So for uninsured obviously that can be uncompensated care which for a public hospital might be funded through county or through taxes for a for Medicare Medicaid those fee schedules are set they're set by either the federal government CMS or by states but for private carriers we negotiate our prices.


And so we know that our customers want to go to these marquee hospitals that provide lifesaving services and provide very very comfortable customer service.


And so that's that's where a lot of the hospitals that have leverage they know that employers and patients want to go there.


So they use that leverage at the negotiating table and the bigger they are the more they tend to demand.





ROSS: So Shara you said fee schedule. You know I think a lot of people when they think about accessing something that they want to buy.


There's a list of things and the prices and you know exactly what it's going to cost and it's a little more complicated with hospitals. There's something called a chargemaster.


Explain that explain the charge but it sounds like such a simple question right.


It's complicated.





SHARA: So a Chargemaster is a list of a list of fees. I mean almost think about a hotel.


So you have a rack rate with the hotel. That might be completely different than what you might be able to get online on their Web site or through a broker.


So think of hospital chargemaster the same way the chargemaster is like the like the rack rate is something that they unilaterally determine it's something that's not negotiated it may or may not be based on any benchmark. It's just aÉ





DAN: Shara can they...





SHARA: Éas high as they can





DAN: Échange their rack rate.





SHARA: Anytime they want.





DAN: Anytime they want?





DAVE: But even more complicated than that is a typical hospital will have forty thousand line items in their chargemaster which is what makes it so complicated.


And it's everything from a simple aspirin to a to actual artificial heart valve to sutures and if you have a surgeon who is not as good as say your average surgeon in the market they could?  Every time they pull a suture and it doesn't. They're not happy with it.


It hits the floor and you get charged for it.





DAN: I think this hotel analogy is kind of interesting so basically it's like a hotel.


There's a rack rate that no nobody really pays unless they have no insurance.


For the most part but they can set that rack rate anytime they want no restrictions no federal restrictions on changing it for the most part. But instead of having like maybe seven different kinds of rooms including a penthouse in a suite there's forty thousand items that could be added to that charge list. Is that fair.





DAVE: That's very fair.





DAN: And then unlike a hotel where I get to pick what I order from room service generally patients don't so someone else actually spend the money on their behalf.





DAVE: Right. It's always based on what the doctor orders for that patient and then the staff can pull that.





DAN: This week in the news.


But I think this story could be true anytime it seems like we're always opening of the paper and there's a patient that was admitted for a four day hospital stay and was like a hundred and nine thousand dollars. Is that unusual?





DAVE: Ten years ago yes. Today no.





DAN: Because I mean people see those things and they go oh that's shocking that's a one off.  That's not a big deal but to me it seems like it's become the norm.





DAVE: It has. And it you really have to go back to about 2000 to 2005 when the hospitals realized that they could begin to inflate their chargemaster in interesting ways in order to generate additional funding.


And so as they did that it became sort of a crutch to them and they have to continually lean on their chargemaster because what they do is they look at the next year ahead and say how much money do I want to make not necessarily how much money do I need to make how much money do I want to make and then so they go out and then they set their charges and it's not necessarily an easy across the board.


I'm just going to raise my prices to 3 percent.


Some things go up 30 40 percent and then they'll go to other items and decrease them maybe five or 10 percent so that overall it's 6 7 percent.


And that's when people start their eyes roll back in their head and they don't want to know more.





DAN: Ok it's always like to be fair and balanced let me ask you a question here.


You know I want a hospital.


So when I'm sick and I need to have bypass surgery or some kind of major ailment treated I'd like to have that infrastructure hospital created.


But do you think that maybe there's a balance we need to strike about what we have to spend and what we have to grow.





SHARA: I think there should be a balance.


And some states have laws that try to maintain that balance certificate of need laws to wear kind of like I said before if you add capacity to the system.


It generally drives demand and also drives profitability.





DAN: You brought up the term.


I think it's interesting and people listen to this often and kinda wonder what that is. So that's a good question.


So if I want to open a hospital could i open could open the Doc Dano hospital if I wanted to just if I got capital and hung out my shingle.





SHARA: In Texas you can in Texas you can you have to get a license certainly.



00;11;07;21 DAN: I don't have to have permission from the state to open another hospital.





SHARA: You don't have toÉ Right You don't have to have permission from the state in some states like Illinois you do.


But in Texas understanding the concept of that capacity drives demand.


Many states have have recognized that we need to have some parameters around whether we the community actually needs to add capacity in the health care system in Texas we don't have that limitation.





DAVE: It actually gets back to I want to get back some you asked earlier which is why do hospitals and all these cranes why do they continually build and it gets the both of these questions is that it's all about market share for these large hospitals?


As long as they can maintain an abnormally large market share they can demand the pricing they want and so they keep building facilities even though they may only be half full.


They are there everywhere in the community.





DAN: So let's let's just dissect that for a minute. So what are hospitals building?


Are these hospital rooms or are they outpatient clinics or are they service centers like imaging and things like that?


Are they all of that? But are we still do we still need more hospital rooms today.





SHARA: I think the average hospital I was looking at some information and it looks like the average hospital runs at about 50 to 60 percent capacity on their inpatient beds as we're seeing technology improve.


We're seeing more services provided in an outpatient setting. So if I were to look across the landscape I would say that hospitals yes they're building inpatient beds.


But I think more of the investment is going into outpatient services and we're actually seeing a lot of investment going into emergency rooms.





ROSS: Beckers hospital review had reported that the number of inpatient care compared to outpatient care is balancing out and used to be that it used to be much more inpatient and less outpatient.


Now it's practically equal and the share of outpatient hospital revenue grew from 21 percent to 60 percent just between 2010 and 2015. So that makes a big difference on their on their bottom line.





ROSS: Shara in general what areprofit margins like for hospitals at the end of the day.





SHARA: It varies and it varies depending on the type of hospital we actually see hospitals especially in rural communities losing money. They're in the red and they're closing down as a matter of fact in Texas between 15 and 20 hospitals have closed over the past five years.


But in the metro areas when you have a lot of these very prominent facilities that are growing that have they have the cranes you might see profit margins in the 10 to 15 percent overall but then just on private business we're seeing margins in the 50 to 60 even approaching 70 percent range.










ROSS: So this is an important conversation Dr. McCoy because it really does impact how much we all pay to access the healthcare system and you know to some extent everything contributes to the rising cost of health care.


So let's go ahead and take a quick break here and we can come back at our next segment and talk about the actual profit margin that hospitals make on Blue Cross and Blue Shield members.





DAN: Thanks for joining us for this edition of Blue Promise


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