America's Bitter Pill

by Steven Brill

  PENNSYLVANIA TURF WARS

  If more evidence was needed of how the marketplace that forced Alice to sell the family farm seemed to operate as if in its own universe, it was provided by a suit filed in federal court in western Pennsylvania just as Steven and his wife were staring down those hundreds of thousands in bills for treatment of his terminal cancer.

  The suit accused the giant University of Pittsburgh Medical Center (UPMC) of using deceptive advertising to sell its own health insurance product.

  As explained on this page, UPMC and Highmark were the dominant hospital system and insurer respectively in western Pennsylvania. They had been sued for an alleged antitrust conspiracy in 2009 by a smaller hospital chain called West Penn Allegheny Health System. West Penn had charged that the two had formed a “super-monopoly” to crush West Penn and, at the same time, keep other insurance companies from intruding into Highmark’s market.

  Now, little more than two years after that 2009 suit from West Penn, UPMC (the giant hospital system) and Highmark (the insurer) had turned on each other, and their fight had made its way into court, with Highmark suing UPMC.

  UPMC’s chief executive—Jeffrey Romoff, the man who told me he prides himself on his ability to see and remove “impediments”—had apparently decided that his alleged co-conspirator, Highmark, had become another impediment. So Romoff had stepped up the marketing of his own UPMC insurance company—a venture whose activities and marketing he had dialed down during the time of his alleged conspiracy with Highmark. He was spending millions on ads comparing UPMC’s insurance to Highmark’s and urging people to switch to UPMC.

  Highmark’s suit, filed on July 13, 2011, claimed that the UPMC ads were misleading. The major element of the deception, Highmark charged, was that UPMC was “scaring” Highmark’s customers into thinking they could no longer have access to UPMC’s dominant facilities and doctor networks, or would soon lose access, when, in fact, Highmark’s network contract with UPMC extended through 2013.

  How did it happen that these two healthcare giants, who had been accused in a compellingly documented complaint of conspiring with each other, were now litigating against each other?

  According to court documents and what Romoff, himself, later told me, here is what had happened since that 2009 suit was filed accusing them of being joined-at-the-hip partners in an antitrust plot.

  First, investigators from the Justice Department had started looking into the 2009 charges filed against UPMC and Highmark by the smaller West Penn hospital system. The feds were sounding like they, too, were going to conclude that the UPMC-Highmark arrangement seemed too cozy.

  Both sides became nervous.

  UPMC told Highmark that the hospital might have to strike a more competitive pose by revving up its own subsidiary insurance company—the company that the 2009 antitrust suit accused UPMC of agreeing to let die as part of its conspiracy with Highmark.

  Equally bad for Highmark, if not worse, UPMC was going to have to let other, competing, insurers have access to the vast UPMC network of hospitals and doctors, opening the way for them to sell insurance at competitive prices to patients, most of whom were used to being treated at UPMC and would not buy insurance from another insurer if they couldn’t continue to be treated there.

  Along with that, UPMC was going to have to raise Highmark’s rates after their current contract expired, so that Highmark would be forced onto a level playing field with the other insurance companies now allowed into the network.

  Highmark, in turn, told UPMC that it might have to protect itself by helping the West Penn hospital system by sending it more patients. In other words, Highmark was going to try to revive the competitor that Romoff had thought he had vanquished.

  The rationale for everything was the government investigation and the West Penn antitrust suit—which the two defendants were able to get dismissed because of these moves.

  It was then that UPMC had unleashed the ad campaign for its revived insurance subsidiary, which was what Highmark targeted in this July 2011 suit.

  But Highmark had more in its arsenal than a complaint about unfair advertising. In a move that infuriated Romoff, four months after filing the false advertising suit, Highmark announced a deal not just to try to send West Penn more patients, but to buy West Penn—yes, the same West Penn that had sued Highmark only two years before. If UPMC could own an insurance company, why couldn’t Highmark own a hospital chain?

  That announcement would be followed in 2012 by an even more explosive suit, this one brought by UPMC.

  UPMC’s 2012 suit would charge that Highmark had conspired with, and propped up, West Penn in order to drive UPMC out of business. The idea that UPMC could be driven out of business seemed far-fetched, yet UPMC CEO Romoff is one of those people who believes that if you are not moving up you are on your way down. Still more unusual was that Romoff’s complaint essentially admitted the prior conspiracy with Highmark, although it said UPMC had been forced into it.

  “Highmark has maintained a stranglehold on Western Pennsylvania’s health insurance market,” the 2012 UPMC suit would charge, “through a course of unlawful, malicious, and unabashedly anticompetitive conduct … to destroy UPMC as a negotiating entity, starve UPMC Health Plan [the UPMC insurance company] of the revenues necessary to emerge as a significant insurance competitor, and stifle competition from other insurers.”

  One of the central elements of this “unabashedly anticompetitive conduct,” Romoff’s 2012 suit would charge, was Highmark’s alleged strong-arming of UPMC into the conspiracy that had led to the 2009 suit by West Penn against the two of them. Romoff’s complaint would put it this way: “Bowing to both financial reality and the crushing public pressure fomented by Highmark, in June 2002, UPMC capitulated to Highmark’s demands.”

  That was one way to look at it. Another was that by the time of the West Penn antitrust suit and the follow-on federal investigation, UPMC was so dominant that it no longer was worried about West Penn. Therefore, it didn’t need any agreement with Highmark, and the federal investigation offered a convenient reason to end it. It could then weaken Highmark by inviting in other insurers and charging everyone a high price, while keeping prices low for its wholly owned insurer.

  But then Highmark had fought back by adopting West Penn, which now presented a new “impediment” to Romoff and UPMC. With Highmark’s financial power behind it, West Penn might be able to become a real competitor for UPMC’s patients.

  By mid-2014, both sides would have dropped their suits, but the battle among them would continue on a new front. UPMC—whose market share of hospital beds and doctors’ practices was stronger than ever—was still threatening to throw Highmark out of its network, which would cripple Highmark.

  The governor of Pennsylvania had intervened to mediate an agreement to extend their contract to the end of 2014, but beyond that there was little he could do. Hearings were held in the state capital, but there was little the legislators could do, either.

  Through the summer of 2014, UPMC’s advertising for its own insurance company touting its superior access (because of its status as an arm of UPMC) to the best doctors and hospitals would fill airwaves and adorn billboards all over Pittsburgh—except for the space taken up by competing Highmark ads promising, somehow, even greater availability of doctors and facilities. Patients, the vast majority of whom had to rely on Highmark for their insurance and on UPMC for their care, would be caught in the middle. They couldn’t be sure what to believe was going to happen to their healthcare at the end of 2014.

  At a hearing of a state house of representatives committee held as the stand-off was looming, the always-blunt Romoff told one legislator, “Let me agree that UPMC and Highmark are both monopolies.”

  THE MEDICARE ALTERNATIVE

  The same day—July 13, 2011—that Highmark sued UPMC over the hospital’s advertising, a patient a few hundred miles away in southern New Jersey got a radically different look at American healthcare.

&n
bsp; An eighty-eight-year-old man whom I’ll call Alan A. collapsed from a massive heart attack at his home outside Philadelphia. He survived and spent two weeks in the intensive care unit of Virtua Marlton Hospital. Virtua Marlton was part of a four-hospital nonprofit chain that, in its 2010 federal filing, had reported gross revenue of $633.7 million and an operating profit of $91 million. Alan then spent three weeks at a nearby convalescent care center.

  Alan had been covered by Medicare for twenty-three years. Medicare pays hospitals based on the average cost of treating each coded category of illness, plus an allocation for overhead. The Medicare number crunchers—the data and technology people overseen by CMS’s Henry Chao, who was going to be tasked to build the Obamacare federal exchange—do that by averaging the cost of every hospital’s treatment of the same malady. Then, they account for differences in overhead (such as labor costs and rent), based on region, on whether the hospital spends money training upcoming doctors, and on other factors. About 3 percent is added in for operating profit. The result is what Medicare will pay when someone like Alan shows up at Virtua or at the convalescent center where he was transferred.

  Medicare made quick work of Alan’s $268,227 in chargemaster bills from the hospital and convalescent center, paying just $43,320. Except for $100 in incidental expenses, Alan paid nothing because 100 percent of inpatient hospital care is covered by Medicare.

  The ManorCare convalescent center, which Alan later told me gave him “good care” in an “OK but not luxurious room,” got paid $11,982 by Medicare for his three-week stay. That amounts to about $571 a day for all of Alan’s physical therapy, lab tests, and other services. As with all hospitals in nonemergency situations, ManorCare did not have to accept Medicare patients and their discounted rates. But it did accept them. In fact, it welcomed them and encouraged doctors to refer them.

  Healthcare providers may grouse about Medicare’s fee schedules, which they claim they lose money on. But Medicare’s payments must have been producing profit for ManorCare. It was part of a for-profit chain owned by the Carlyle Group, a blue-chip private-equity firm.

  $48.50 FOR LIFESAVING TREATMENT

  About a decade before his July 2011 heart attack Alan had been diagnosed with non-Hodgkin’s lymphoma. He was seventy-eight, and his doctors in southern New Jersey told him there was little they could do. Through a family friend, he got an appointment with one of the lymphoma specialists at the Memorial Sloan Kettering Cancer Center in New York. That doctor told Alan that he was willing to try a new chemotherapy regimen on him, but he warned that he hadn’t ever tried it on anyone Alan’s age.

  The treatment worked. A decade later, Alan was still in remission, traveling up to Sloan Kettering every six weeks to be examined by the doctor who saved his life and to get a transfusion of Flebogamma, a drug that bucks up his immune system.

  With some minor variations each time, Sloan Kettering’s typical bill for each visit was the same as or similar to the $7,346 bill he received during his visit there in the summer of 2011 (just before his heart attack). It included $340 for a session with the doctor. His actual out-of-pocket cost for each session was a fraction of that. For that $7,346 visit, it was about $50.

  The transactions related to Alan’s Sloan Kettering care represented the best the American medical marketplace had to offer—and a regime that for people over sixty-five will not be altered by Obamacare. First, obviously, there’s the fact that Alan was alive after other doctors gave him up for dead. Then there’s the fact that Alan, a retired chemist of average means, was able to get care that might otherwise be reserved for the rich but was available to him because he had the right insurance.

  Medicare, of course, was the core of that insurance, although Alan—along with 90 percent of those on Medicare—had a supplemental private insurance policy, usually called a Medigap policy, that kicked in and generally paid 90 percent of the 20 percent of the costs for doctors and other outpatient care that Medicare does not cover.

  Here’s how it all computed for Alan, using that summer 2011 Sloan Kettering bill for $7,346 as an example.

  Not counting the doctor’s separate $340 bill, Sloan Kettering’s bill for the transfusion was $7,006.

  In addition to a few hundred dollars in miscellaneous items, the two basic Sloan Kettering charges were $414 per hour for five hours of the nurse’s time for administering the Flebogamma and a $4,615 charge for the Flebogamma.

  According to Alan, the nurse generally handled three or four patients at a time. That would mean Sloan Kettering was billing more than $1,200 an hour for that nurse. When I asked Paul Nelson, Sloan Kettering’s director of financial planning, about the $414-per-hour charge, he explained that 15 percent of these charges was meant to cover overhead and indirect expenses, 20 percent was meant to be profit that would cover discounts for Medicare or Medicaid patients, and 65 percent covered direct expenses. Assuming that just three patients were billed for the same hour at $414 each, that would still leave the nurse’s time being valued at about $800 an hour (65 percent of $1,200). Pressed on that, Nelson conceded that the profit is higher and is meant to cover other hospital costs such as research and capital equipment.

  Medicare—whose patients, including Alan, are about a third of all Sloan Kettering patients—bought into none of that math. Its cost-based pricing formulas yielded a price of $302 for everything other than the drug, including those hourly charges for the nurse and the miscellaneous charges. Medicare paid 80 percent of that, or $241. That left Alan and his private insurance company together to pay about $60 more to Sloan Kettering. Of that, Alan paid $6, and his supplemental insurer, Aetna, paid $54.

  Bottom line: Sloan Kettering got paid $302 by Medicare for about $2,400 worth of its chargemaster charges, and Alan ended up paying $6.

  THE CANCER DRUG PROFIT CHAIN

  It was with the bill for the transfusion that the peculiar economics of American medicine took a different turn—a dynamic that in no way will be changed by Obamacare, thanks to the bargain struck by Billy Tauzin and PhRMA.

  By law—the law Tauzin and PhRMA fought to protect in their negotiations with Baucus and the Obama administration—Medicare has to pay hospitals 6 percent above what Congress calls the drug company’s “average sales price.” That is supposedly the average price at which the drugmaker sells the drug to hospitals and clinics. Under the law, Medicare cannot control what drugmakers charge or even try to negotiate a price based on what a giant buyer it is. The drug companies are free to set their own prices.

  Applying that formula of average sales price plus the 6 percent premium, Medicare cut Sloan Kettering’s $4,615 chargemaster charge for Alan’s Flebogamma to $2,123. That’s what the drugmaker told Medicare the average sales price was, plus 6 percent. Medicare again paid 80 percent of that, and Alan and his insurer split the other 20 percent—10 percent for him and 90 percent for the insurer. That made Alan’s cost $42.50. With the $6.00 Alan paid for his share of the other hospital charges, his total cost for his treatment at Sloan Kettering was $48.50.

  In practice, the average sales price for Alan’s Flebogamma does not appear to be a real average. Two other hospitals I asked reported that after taking into account rebates given by the drug company, they paid an average of $1,650 for the same dose of Flebogamma, well below the $2,123 Medicare paid Sloan Kettering. And neither hospital had nearly the leverage in the cancer care marketplace that Sloan Kettering does. One doctor at Sloan Kettering guessed that it was paying $1,400.

  Nelson, the Sloan Kettering head of financial planning, told me that the price his hospital paid for Alan’s dose is “somewhat higher” than $1,400, but he would not be specific. Even assuming Sloan Kettering’s real price was “somewhat higher” than $1,400 (say, $1,600), the hospital would have made about 33 percent profit from Medicare’s $2,123 payment. So even Medicare was contributing mightily to hospital profit—and drug-company profit—when it bought drugs.

  The hospitals and PhRMA had struck a good bargain when they
negotiated Obamacare.

  SALARIES IN A WORLD OF THEIR OWN

  In its latest report on file with the IRS when Alan had his summer 2011 treatment, Sloan Kettering had an operating profit of $406 million even after everything it spent on research and the education of a small army of young cancer doctors.

  The cash flow came from more than just drug markups. There was also the high pricing enabled by a deservedly great brand.

  Insurance companies negotiated discounts off Sloan Kettering’s chargemaster prices, but chief operating officer John Gunn told me that his hospital can drive a hard bargain because insurers want to make sure Sloan Kettering is in their network.

  That brand power produced not only lavish cash flows, but also lavish incomes for the non-doctors who worked to generate it. Sloan Kettering had six administrators making salaries of more than $1 million.

  When I looked at this list of salaries for the Time article, I discovered that compared with their peers at equally venerable nonprofits, these executives were comfortably ensconced in a medical ecosystem that was in a world of its own. For example, Sloan Kettering had two development office executives, or fund-raisers, making $1,483,000 and $844,000. Another New York nonprofit that mines the same field for donors—the Metropolitan Museum of Art—paid its top development officer $345,000. Harvard paid its chief fund-raiser $392,000.

  Asked why salaries at Sloan Kettering are so much higher than those at equally wealthy nonprofits such as the Met and Harvard, Gunn replied, “All of us hospitals have the same compensation consultants, so I guess it’s a self-fulfilling prophecy.”

  Compensation consultants advise clients on what the market-based salary is for executives in a given peer group—CEOs or chief fund-raisers at hospitals of a certain size, for example. So if the same hospital compensation consultants set high salaries for a large portion of the people in each hospital peer group, then those salaries are destined to stay high while still being deemed consistent with the “market.”