Spending for services at hospitals is a large portion of total U.S. health care spending, 42% of all costs for privately paid services. The prices hospitals charge can vary widely by payer. The Medicare and Medicaid programs set what they pay through regulation, within boundaries set by Congress. This is in essence a political process, as hospitals and other providers have large lobbying groups and make substantial political contributions, and they constantly push Congress and the regulators to increase reimbursement.

For private health plans, payments to hospitals are negotiated, usually on an annual basis. That negotiation is a balance of relative leverage. Most areas have few hospital systems, and they tend to be quite large, and therefore have substantial market power. Most areas also may have few health plans, who also have market power. So you get pretty intense negotiations, although often the health plans take the line of least resistance and agree to large payment increases, knowing that they will pass those increases on to their customers — employers and individuals, in the form of higher premiums.

Hospitals routinely claim that Medicare and Medicaid don’t reimburse them at a level that covers the cost of providing services. Research suggests this is not true, but there isn’t much of a profit margin in government program reimbursement. Private health plans claim that hospitals shift costs from government programs onto them. This is probably not technically true if government payments cover costs, but the evidence suggests that hospitals try to get payments from private health plans that are high enough to generate profits across all the hospital’s business. Interestingly, hospital prices vary not just between payer types, but across and within geographic markets and to different health plans in the same market.