Why Your Medical Bill Is So High

Our analysts Andrew Sheets and Mark Schmidt unpack why U.S. healthcare feels so expensive and the potential impacts of rising hospital costs.

Read more insights from Morgan Stanley.

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Andrew Sheets: Welcome to Thoughts on the Market. I'm Andrew Sheets, Global Head of Fixed Income Research at Morgan Stanley.

Mark Schmidt: And I'm Mark Schmidt, Head of Municipal Strategy at Morgan Stanley.

Andrew Sheets: And today on the program, a discussion into one of the biggest mysteries in one of the biggest sectors of the economy. We're talking about healthcare costs.

It's Friday, July 17th at 2pm in London.

Mark Schmidt: At 9am in New York.

Andrew Sheets: So, we're talking today about healthcare, which represents roughly a fifth of the U.S. economy, the bulk of job creation over the last several years, and in my view, honestly, one of the biggest inflation paradoxes that we see in the market.

On the one hand, the high cost of healthcare is taken as a given, and it's something that many Americans still struggle with financially. But if you look at the official inflation data in the U.S., healthcare costs have been lower than normal, and that's been true now for a number of years.

So, what's going on? How do we tie this together? And Mark, you just wrote a report that tries to do exactly that. So, what did you hope to accomplish with this report?

Mark Schmidt: You're absolutely right. It's hard to underline enough just how large healthcare is to the U.S. economy overall. Americans spend nearly $6 trillion on healthcare. That's more than the GDP of the entire country of Germany. And if we think about prices, Americans pay more.

A knee replacement, for example, costs $25,000 in the United States. That same procedure costs just $6,000 in France. Common heart treatments that would cost $3,000 in Germany or $10,000 in Australia cost $34,000 in the U.S.

It also matters for everyone's local community. Healthcare jobs have been growing twice as fast as the rate of job growth in the economy overall. And those are good jobs. They pay above average wages. For many Americans these days, the most secure path to the middle class is a career in healthcare.

Now, this may seem a little bit arcane, but it probably hits close to your portfolio as well. Earlier in the year, when we took a look at how equity separately managed accounts invest, they typically have a core overweight to healthcare. And even though American prices may seem like an American issue, many of the largest and most profitable healthcare companies in the world are actually headquartered in Europe.

So, whether you're sitting in New York or sitting in London, the price of American healthcare probably matters to you.

But as you noted, Andrew, it does feel like a paradox because although Americans cite healthcare costs as one of their top concerns, and although healthcare spending is growing at 6 percent a year or more, the official inflation data says that healthcare prices are in check. And at one point earlier in the year, healthcare inflation, according to official data, even dipped below 3 percent.

It just didn't make a lot of sense, and that's why we got together with our colleagues across equities, fixed income research, public policy, and economics to dig into what was actually going on.

Andrew Sheets: So, Mark, let's dig right into that. I mean, it seems like a perfect encapsulation of the so-called Main Street versus Wall Street perception of the economy.

So, what's going on? How does one kind of square those two numbers?

Mark Schmidt: The easiest way to understand it is that you can't walk through a grocery store and figure out the price of a knee replacement. And that's true both for you and me. It's also true for the government. They have to survey hospitals and health insurance companies.

The trouble is that the prices that health insurance companies pay hospitals, well, those are trade secrets. So, at any given point in time, even for the best government economists, it's not entirely clear what the price trends are. And that's why when you look at the official data, healthcare inflation typically has relatively lumpy jumps in the series.

You could see several months of 0.1 or 0.2 percent official growth in healthcare inflation. Or as earlier this week, you could see certain categories jump to 0.4 or even 0.8.

Andrew Sheets: Another element, Mark, that you talked about in the report is that people are also consuming more healthcare. So, talk a little bit about that. How that factors into this dynamic, and again, is that just going to be the new normal as the population ages and we tend to spend more on healthcare as we get older?

Mark Schmidt: That's right. The good news is that we're living longer lives. The bad news is that means that we have more chronic healthcare conditions to deal with. The good news is that more procedures can be done in outpatient settings, and those, generally speaking, are cheaper. The bad news is that inpatient care, inpatient prices go up as the complexity of procedures that actually happen in a hospital setting increase significantly.

When you balance it all out, it's a situation where, thankfully, the United States and most Americans have the means and the wealth to pay more for healthcare. The flip side of that is that they are paying more for healthcare, and that's why we think that the recent softness in healthcare inflation is actually too good to be true.

Andrew Sheets: Something that jumped out at me from this report, Mark, was just how important hospitals are in this equation. And the experience of the patient and the experience of the hospital can be different economically. And that difference can also matter for how this shows up in official inflation and government statistics.

So, you know, it would be helpful maybe just to walk the listener through. If I go into the hospital and I need knee surgery. You know, how does that look like from my perspective in terms of paying for it, assuming I have health insurance through my employer? How could that look like to the hospital? And how could that look like coming out the other end into the official government statistics?

Mark Schmidt: Well, of course, Andrew, the first thing that you do when you break your leg is you call six hospitals and shop around for the cheapest price, right?

Andrew Sheets: [Laughs] Of course.

Mark Schmidt: So that's actually the problem because when you get care, you're not in a place to ask about the price. And frankly, even if you asked your doctor or nurse what the price is, they probably wouldn't know. Not only is it not their job to know the price, but all of those negotiations happen after the fact – with the prices that the insurance companies negotiate with the hospitals.

After COVID, hospitals had a lot more costs to spread out among the people who were coming in the door, and so they raised prices across the board, not just for procedures that were related to respiratory illness. Naturally, insurance companies noticed that, and they started to push back.

So long after you get a cast for your broken leg – and by the way, I wish you a speedy recovery – insurance companies end up going back and forth negotiating with your doctors for exactly how much they should pay you. And although these prices were loosely set well before you walked in the door, the exact way it gets billed and coded? Well, let's just say there's a lot of back and forth.

For a well-run hospital, the cost of talking to and ultimately getting reimbursement from your insurance company, that alone could be 2 to 4 percent of revenue. And in especially complex cases, that whole negotiation can eat up 5 to 7 percent of the total bill.

You're also right to flag that hospitals really are still the central point of the U.S. healthcare system. Americans spend $2 trillion in a hospital setting. And hospitals overwhelmingly coordinate care for both primary, specialty, and pharmacy services.

Andrew Sheets: Mark, another issue I wanted to ask you about was the Affordable Care Act, Medicare, Medicaid, and how those programs fit into the story?

Mark Schmidt: The One Big Beautiful Bill Act included a variety of measures to slow the overall growth rate of healthcare. Now, for all the reasons we just discussed, that's probably warranted. The Affordable Care Act is another wrinkle. Enhanced subsidies, which were already set to expire – did in fact expire at the end of last year. And as a result, more Americans are now uninsured.

It remains to be seen how that impacts overall costs. In the United States, when you have a health emergency, a hospital is legally obligated to treat you because of a 1990s law called EMTALA. Even if you can't pay, the system eventually does.

Historically, uncompensated care costs have been passed on to individuals and companies with insurance. For now, however, it remains to be seen whether these changes in law and in the overall number of people with insurance will cause healthcare prices to rise or fall.

Andrew Sheets: And Mark, just for the broad-based implications of this, right? It's fair to say that in any health insurance system, there are some people who consume a lot more healthcare. They're unhealthy or they're unlucky. And there are some who consume a lot less.

And, you know, this is something where that overall coverage question matters. Because if you have things that reduce the number of otherwise healthy people who are in those healthcare pools, it can raise the cost for everybody else. Those people who were in some ways subsidizing the higher consumers of healthcare are no longer there.

Is that a fair way to frame it, do you think? And are there potential changes given some of these legislative actions that could lead to changes of what the pool looks like – and what overall costs could look like?

Mark Schmidt: That's a great point. And healthcare is probably the only part of our economy where you would say, "Thank goodness I did not get my money's worth." As we think about it…

Andrew Sheets: [Laughs] Very true. Very true.

Mark Schmidt: As we think about it, most young and healthy people are going to be paying more for their health insurance than they receive in healthcare. Again, that's a good thing. Because American healthcare prices are so much higher than anywhere else in the world, paying in more than you get back? Well, that hits the wallet harder in America than it does in other countries.

And that's why for many people – choice – choosing how much health insurance to have and how much to pay for it, really is central to keeping the American economy dynamic. The flip side, however, is that as Americans get older, more people have Medicare.

Now, Medicare is pretty good if you have it. But the catch is that Medicare prices, according to most independent estimates, do not fully reimburse for the cost of care. So, as more seniors take up more beds in a hospital, that means that commercial prices, the prices for people who have private insurance through their employer, are likely to rise even faster.

Andrew Sheets: So, Mark, I think a good place to close it out and kind of bring this all together is a really important conclusion of this report – is that hospitals have been absorbing a number of these rising costs of healthcare through lower margins for the hospital. And that has resulted in lower ultimate inflation because the inflation is measured out the other side, out ultimately what the hospital earns.

And if you could just maybe talk a little bit more about that. To what extent have those margins been compressed? And what that might mean for things going forward?

Mark Schmidt: That's right. We dug into the finances for hundreds of not-for-profit hospitals in the United States. They are facing higher costs and shrinking margins. Historically, hospitals have partially passed on expense increases of this magnitude.

Now, in their conversations with insurance companies, the biggest benchmark setting of prices happens once every two to three years. So, we're not going to see hospital prices show up in the inflation data overnight. But when we look at hospitals across the country, their budget information and their guidance is consistent with firming prices.

Andrew Sheets: Great. Thank you so much, Mark.

I've really enjoyed the conversation.

Mark Schmidt: Thanks for having me, Andrew.

Andrew Sheets: And thank you for listening. If you enjoy Thoughts on the Market, please share it with a friend or colleague today. And rate and review us on wherever you listen. It helps more people find the show.