Last month, one of the nation’s largest health insurers, Elevance Health, announced what seemed like a relatively mundane change to billing requirements for healthcare providers. Elevance will require hospitals to identify exactly where services are delivered and will reimburse certain off-campus services at lower rates.

Just how innocuous was this change? In fact, the announcement provides a helpful glimpse into a much bigger issue in American healthcare: the financial incentives fueling consolidation among hospitals and physician practices, and the government’s role in encouraging it.

To understand why this matters, it helps to know how healthcare prices are determined. In the private insurance market, where most Americans receive coverage, insurers and healthcare providers negotiate the prices they pay hospitals and physicians. Those prices directly affect the insurance premiums insurers charge. Providers, of course, want higher prices, while insurers, motivated to offer competitive premiums to employers and their workers, want lower prices. Each side’s bargaining leverage determines the resulting prices. An insurer with millions of members can drive a hard bargain, but so can a dominant hospital system that no insurer can realistically exclude from its network.

Further complicating matters, healthcare prices depend on where it is delivered. Consider a routine doctor visit. The physician is reimbursed for the service provided and the costs of operating the practice. However, when the office is a “hospital outpatient department,” the same visit generates an additional payment to cover the hospital’s overhead. The distinction is costly. The Health Care Cost Institute found that a primary care visit averaged $116 in a physician office versus $217 in a hospital outpatient setting.

Medicare Payment Policy Helped Create the Problem

Ironically, or perhaps predictably, the federal government has played a major role in creating this pricing wedge.

Medicare has long paid more for care delivered in hospitals versus physician offices. Some rationale exists: hospitals have higher overhead expenses, and they commonly treat more complicated patients. But that justification becomes harder to defend when a hospital acquires an ordinary community physician practice, establishes it as an eligible hospital outpatient department and becomes entitled to higher payments for substantially the same care.

The financial stakes are large. In 2023, Medicare paid 51% more for preventive examinations in hospital outpatient departments than in physician offices. For other office-based services, such as drug infusions, the differences were considerably larger. While some signs suggest Medicare has begun pushing back on these disparities, the issue of “site neutral” payments has loomed large in the debate over Medicare spending for many years.

But what happens in Medicare payment policy doesn’t stay in Medicare. As the nation’s largest payer, Medicare policy influences private payment policy. As a result, commercial insurers face the same issues with providers. This brings us to a defining trend in American healthcare.

Why Hospitals Keep Buying Doctors

For decades, physicians commonly operated independent practices. That model is rapidly disappearing. According to the American Medical Association , the share of physicians working in private practices declined from 60% in 2012 to just 42% in 2024. Nearly half of physicians now work either directly for hospitals or in hospital-owned practices.

There are legitimate reasons for this change. Physicians face increasing administrative burdens and higher operating costs. Hospital systems can provide capital, health IT and administrative support. Integration can also improve care coordination among physicians, potentially reducing duplicated services. However, the opportunities extend well beyond administrative efficiency into questionable financial rewards that drive up health care costs.

First, as noted, hospital ownership can pave the way for higher reimbursement without changing the services delivered. When a newly acquired practice qualifies as a provider-based hospital outpatient department, it can become eligible for better payment arrangements. One study found that prices for services delivered by physicians acquired by hospitals increased an average of 14.1%. Nearly half the increase was attributable to exploiting payment rules.

Second, acquiring physician practices can strengthen hospitals’ bargaining power. A hospital system that controls a substantial network of primary care and specialty physicians may become harder for insurers to exclude. Larger systems can negotiate more favorable contracts, potentially raising prices across a broad range of services.

Third, owning more physician groups can help hospitals capture referrals. Hospitals aren’t necessarily interested in office visit revenue. They are after the specialist referrals, imaging revenue and increased surgical volume. This is where the money is. A recent study found that hospital-physician integration increased use of higher-priced, hospital-based arthroscopies and colonoscopies. Despite higher spending, clinical outcomes stayed the same.

Fourth, hospital acquisitions can unlock highly lucrative drug discounts. Under the federal 340B program, qualifying hospitals can buy outpatient drugs at substantial discounts while insurers reimburse them at rates well above acquisition costs. Acquiring oncology and other specialty practices can expand the volume of drugs administered under eligible hospital arrangements with no obligation that patients benefit. Research has found that 340B eligibility itself encourages hospitals to integrate with oncology practices.

Elevance’s new policy directly confronts one of these incentives. Rather than accepting a higher hospital payment simply because a service is billed under a hospital outpatient arrangement, Elevance wants to know where the care was actually delivered and pay accordingly.

This is an important, highly public application of private purchasing power. Insurers often face criticism for administrative obstacles and opaque reimbursement practices, but they get little credit for negotiating with providers and resisting unjustified price increases. Will this turn the tide against dominant, integrated physician-hospital organizations? Likely, no. But Elevance’s stance could incrementally narrow the financial advantages associated with hospitals vertically integrating with physician groups.

That is the larger lesson. The goal shouldn’t be to discourage hospitals and physicians from integrating when doing so improves care or reduces costs. Instead, it should eliminate artificial financial rewards for integration that produce neither. Medicare and the 340B program have helped create some of these distorted incentives, and commercial payment arrangements have often perpetuated them.

Elevance is trying to restore some market discipline, but a single private insurer can only do so much when the federal government rewards such behavior. Washington cannot keep creating incentives for consolidation and then expect private purchasers to clean up after them.