The Marketplace Piece
The text and audio of the Nancy Marshall Genzer’s very brief story is already posted on the Marketplace website. I’m quoted as saying, “The vast majority of insurance markets are considered very concentrated. And that’s generally viewed as a threat to the welfare of consumers.”
Those are two true statements. There wasn’t room in the story for the other related things I have said or written, but you can find them elsewhere. In particular, it is still not at all clear that reducing insurer market power without parallel efforts on the provider side will help consumers. Nevertheless, allowing additional insurer market concentration via mergers is, in general, probably not a good idea provided health care providers do not themselves consolidate further.
The much larger and more important point, however, is that other elements of health reform are vastly more important to consumer welfare than the over-sized concern about insurer market concentration. We’re being distracted by that issue for a reason: it plays well and is helping sell the overall reform package by boosting Obama’s and Democrat’s popularity.
A Bit More on Premium Increases
This post is jointly authored by Austin Frakt and Ian Crosby. It is a supplement to our Kaiser Health News (KHN) column, which I also posted on this site on Sunday. If you haven’t read that column yet, do so first. This post links back to many of our prior posts on related issues. Thus it serves as a portal to further reading.
In his recent NY Times opinion piece, Reich claimed that the current antitrust exemption for insurers “is why a handful of insurers have become so dominant in their markets.” As we wrote in our KHN column, this claim is extremely dubious. Moreover, it is far more likely that premium increases are largely due to factors other than insurer concentration.
As we’ve noted previously, the exemption (under the McCarran Ferguson Act) is very narrow, and does not apply to mergers, acquisitions, and most other kinds of conduct by which companies get big. We’ve also noted that there are some types of conduct by which insurers could defend and expand their market share that arguably do fall within the scope of the exemption, but they are sufficiently modest and theoretical that is unlikely they bear much responsibility for the current state of market concentration.
We’ve also made the larger point that even if repeal of the exemption or other forms of stepped up antitrust enforcement were to have a material impact on insurer market power, there is little reason to believe it would produce tangible benefits for consumers absent parallel efforts against providers. A recent paper by Berenson, Ginsburg, and Kemper in Health Affairs documents the upward pressure on costs driven by provider organization and concentration. Based on hundreds of interviews with representatives of hospitals, physician organizations, health plans, and other stakeholders in six California health care markets, the authors conclude that
[t]he shift in who holds the upper hand in negotiating payments—once held by health insurance plans but now resting with health care providers—has had a major impact on California premium trends.
… [P]roviders are developing increased leverage through single-specialty group formation and merger-and-acquisition strategies that do not involve integration. Nevertheless, given the push in Congress and elsewhere to restructure health care delivery with accountable care organizations, it is instructive that whatever their merits in improving quality and efficiency, California-style integrated care systems currently produce higher prices that undermine cost containment.
Other work by health economists, reviewed on this blog, indicates that the high degree of market power held by insurers acts as a counterweight to that held by hospitals. Diluting the insurance market may have small downward effects on insurer profit and administrative efficiency, but it could have large upward effects on prices of health care services. Those higher prices would be passed on to consumers.
Therefore, concentration among providers, and in particular hospitals, must also be addressed. Unfortunately, permitting additional provider coordination and integration via accountable care organizations (ACOs), as envisioned in current health reform legislation, may not help matters. The bundling of payments ACOs would facilitate may save money, but only if the greater market power of additional provider integration does not act to offset those savings.
Taming health care costs will be hard. The job is made harder when we’re looking in the wrong place. Insurers may not deserve the special treatment they’ve received from the federal antitrust exemption. But they also do not deserve the level of blame they’ve received for health care costs.
Popular But Ineffective: Repealing Insurers’ Antitrust Exemption
This post is a slightly modified version of one by Austin Frakt and Ian Crosby that originally appeared at Kaiser Health News last week. Full references have been added for academic papers cited.
It is well known that concentration in the health insurance industry is to blame for rapidly rising premiums. Well known, but wrong. Taking political advantage of this common misconception, last week the House passed a bill to repeal insurers’ antitrust exemption. But even if that bill becomes law it won’t do much good, and politicians’ distraction could actually harm consumers. It’s far more likely that premium increases are largely due to other factors.
Those who claim that the antitrust exemption is the main reason a few insurers have substantial market power don’t understand the narrowness of that exemption’s scope. The law at issue, the McCarran-Ferguson Act, shields most aspects of “the business of insurance” from federal (but not state) antitrust oversight. This means that only those insurer activities dealing directly with providing insurance–think underwriting risk, setting rates, defining benefits, and the like–are not ordinarily subject to federal antitrust scrutiny.
There are exempt insurance practices that, at least in theory and under certain conditions, could help insurers defend and expand their market share against competitors. But the exemption simply does not shield the most straightforward kinds of conduct that make companies big.
Activities not connected with the basic risk-spreading function of insurance are deemed “the business of insurers” rather than “the business of insurance” under the law, and do not enjoy any federal antitrust exemption. Thus mergers and acquisitions among health insurers are as aggressively (or passively) scrutinized as those in any other industry by federal antitrust enforcers.
Health care reform advocates concerned about the high degree of concentration in today’s insurance market cite the more than 400 mergers among health plans allowed over the last 13 years. But repeal of the McCarran-Ferguson antitrust exemption would have literally no effect on this trend. Even if other forms of stepped-up antitrust enforcement or other means of encouraging competition were to have a material impact on insurer market power, there is little reason to believe it would produce tangible benefits for consumers absent parallel efforts targeting the provider side of the market.
While there is some evidence that insurers’ market concentration plays a role in premium increases, that role is small. For example, a National Bureau of Economic Research paper [1] found that only 2.1 percent of employer-sponsored health insurance premium increases between 1998 and 2006 were due to insurer concentration.
It is far more plausible that a high proportion of premium increases are due to a combination of concentration in the provider market and adverse selection, especially in the nongroup market. After all, most premium dollars are not kept by insurers and go toward payment of health care services [2]. Insurers take a little off the top, but not enough to be blamed for anything like the perennially large rate increases.
A recent Health Affairs paper [3] describes the upward pressure on costs driven by provider organization and concentration. Based on hundreds of interviews with representatives of hospitals, physician organizations, health plans and other stakeholders in six California health care markets, the authors conclude that “[t]he shift in who holds the upper hand in negotiating payments—once held by health insurance plans but now resting with health care providers—has had a major impact on California premium trends.” And we all know what those trends have looked like lately.
Perhaps counter-intuitively, large insurers can be bulwarks against high costs driven by provider consolidation. Two papers [4, 5] by health economists in the International Journal of Health Care Finance and Economics indicate that the high degree of market power held by insurers acts as a counterweight to that held by hospitals. Therefore, diluting the insurance market may have small downward effects on insurer profit and administrative costs, but it could have large upward effects on prices of health care services. Those higher prices would be passed on to consumers.
That’s why those who understand our health care system know that costs will not be tamed by a focus on the insurance market alone. The Congressional Budget Office has scored the likely effect on premiums of health insurer antitrust repeal as insignificant. Therefore, concentration among providers, and in particular hospitals, must also be addressed.
Don’t get us wrong–we don’t think that the current antitrust exemption is good law or policy. But cracking down on insurer market power without doing the same against providers may well have the opposite of its intended effect. Taming health care costs will be hard. Attacking insurers is, by comparison, very easy, as well as popular. But in this case, what is popular will not be particularly effective.
References
[1] L Dafny, M Duggan, and S Ramanarayanan (2009). Paying a premium on your premium? Consolidation in the U.S. health insurance industry. NBER Working Paper 15434.
[2] L Dafny, K Ho, and M Varela. (2010). Let them have choice: Gains from shifting away from employer-sponsored health insurance and toward an individual exchange. NBER Working Paper 15687.
[3] R Berenson, P Ginsburg, and N Kemper. (2010). Unchecked provider clout in California foreshadows challenges to health reform. Health Affairs Web Exclusive, February 25.
[4] R Feldman and D Wholey. (2001). Do HMOs have monopsony power? International Journal of Health Care Finance and Economics 1(1).
[5] L Bates and R Santerre. (2008). Do health insurers possess monopsony power in the hospital services industry? International Journal of Health Care Finance and Economics 8(1).
Kaiser Health News Opinion Column
Ian and I have a co-authored Kaiser Health News opinion column out today. We argue that repealing insurers’ antitrust exemption won’t change things much and isn’t likely to help consumers significantly. Further, a focus on competition in insurance markets has the potential to distract policymakers and the public from the principal source of increases in premiums: concentration in the provider market.
Here’s the opening paragraph:
It is well known that concentration in the health insurance industry is to blame for rapidly rising premiums. Well known, but wrong. Taking political advantage of this common misconception, last week the House passed a bill to repeal insurers’ antitrust exemption. But even if that bill becomes law it won’t do much good, and politicians’ distraction could actually harm consumers. It’s far more likely that premium increases are largely due to other factors.
Kinda makes you want to read the whole thing, right?
Sympathy for the Insurance Companies
When assessing the effects of market concentration on competition, antitrust authorities look not just at how many competitors there are in a market, but also how they compete. In one standard model, called Cournot competition, producers set levels of output, and prices adjust in relation to supply. In another model, called Bertrand competition, producers set prices, and produce quantities sufficient to meet demand at the prices they set. In pure Cournot competition, prices vary substantially based on the number of competitors in the market. In a Cournot duopoly (a market with two competitors setting output), the producers will between them extract half of a monopoly profit. But pure Bertrand competition pushes prices down toward marginal costs no matter how many competitors there are.
While the differences between Cournot and Bertrand competition are fundamental concepts of antitrust economics, they seem to have been lost in the race to pin responsibility for rising premiums on concentration in the insurance industry. While the details of competition among insurers is complex and does not strictly follow any simple model, at a basic level they appear to engage in Bertrand competition for the business of insureds, i.e., they set premiums, and write as many policies as corresponding demand requires. In this case, we should expect them to compete prices down toward their costs regardless of market concentration. And we in fact see that insurers’ profit margins are relatively modest despite a longstanding trend of consolidation in the industry.
Providers, on the other hand, seem to engage (again, at a basic level) in Cournot competition. They produce a given amount of capacity — building hospital beds, hiring physicians — and then negotiate with insurers over the price to use it. If this is correct, then concentration in the provider market should have a significant impact on the prices that providers can charge insurers, and that insurers ultimately pass on to insureds. By the same token, concentration in the insurer market should allow insurers to pay lower prices to providers because they are also engaging in Cournot competition on the buy side — they have a certain amount of demand that is set by the needs of their insureds, and they bargain with providers over the price of fulfilling it. But because insurers are engaged in Bertrand competition on the sell side, they will tend to pass these savings on to their insureds notwithstanding their market concentration.
In this simple model at least, the ideal situation for insureds is to have a concentrated insurance market that approaches Bertrand duopoly on the sell side and Cournot duopsony (two buyers who set demand and take prices) on the buy side, with a competitive market for providers. Of course, there are complexities — such as product differentiation, switching costs, and homing asymmetries — that can both attenuate and amplify the effect of this basic market structure for consumers, and I hope to address some of them in later posts. But other things being equal, the implication is clear: concentration in the insurance industry does not necessarily harm and may well benefit consumers, while concentration among providers is a prescription for higher costs.
Administrative vs. Competitive Health Care Pricing
Administrative vs. competitive mechanisms constitute a fundamental dichotomy in health care pricing. For the former think Medicare, for which prices are largely set via political/administrative processes. For the latter think the private non-elderly market, for which prices are set via insurer-provider negotiation. In a recent paper in the American Journal of Managed Care, Chernew, Sabik, Chandra, Gibson, and Newhouse shed some light on the implications for health care prices of administrative vs. competitive pricing. The results are not surprising.
In a retrospective descriptive analysis of geographic variation the authors find that Medicare and large-firm commercial hospital utilization were positively correlated, but spending was not. The authors interpret these results with appropriate caution since they are correlations. However, they are consistent with other work that suggests Medicare and commercial insurers have different responses to hospital competition. Commercial insurers can exploit it to drive costs downward. In contrast, Medicare may be less influenced by the effects of provider competition since it doesn’t negotiate prices (or doesn’t do so in the same fashion as commercial insurers).
The authors conclude,
The potential susceptibility of private payers to provider market power has important implications when assessing the merits of private markets or public markets in setting prices. Administrative price systems have many flaws, which are fundamentally related to the difficulty in determining the appropriate price when costs are heterogeneous, are not known very precisely, are changing over time, and may reflect discretionary provider behavior.
… Yet despite all the concerns about administrative pricing, our analysis appears to suggest that administratively set prices seem to reduce purchaser vulnerability to provider market power. The challenge for policymakers interested in administered prices must be how to mitigate distortions in the price-setting process, although policymakers will never have enough information to establish perfect (economically efficient) prices (bundled or otherwise).
The analogous challenge for policymakers interested in market systems is how to avoid the pitfalls associated with provider market power. It is not clear whether concerns about market systems are more important or will be easier to mitigate than concerns about administered pricing. However, as the country moves forward with changing the healthcare system, these concerns will be paramount.
That’s an even-handed take on the two pricing systems. Neither is perfect from every perspective. Proponents of one can (and do) easily point to flaws in the other. However, given that our system is and will remain a mix of public and private payers, sound policy must attempt to address the issues raised by both.
Before concluding, I also want to highlight what Chernew, et al. say about cost shifting:
[O]ur analysis does not necessarily indicate cost shifting. The pattern of results we observed, particularly the association with market structure, may merely reflect differential market power as opposed to a causal relationship between prices in different sectors.
That market structure has an important impact on the degree of cost shifting has already been covered on this blog. Chernew, et al.’s paper is just one more in a large body of work that suggests that ignoring market structure when considering health care pricing and price dynamics misses the point.
The Trigger: Hacker’s Competitive Check?
Jacob Hacker, the “godfather” of the public option, doesn’t like the Senate’s compromise as it would apply to those below 55 years old. It would tap the Office of Personnel Management to oversee national non-profit health plans, which Hacker believes will increase the market share of Blue Cross and Blue Shield, the “most likely national non-profit to take advantage of this new opening”. He continues,
Without an imminent threat of real competition, a strong benchmark, and effective regulations to back them up, private insurers are likely to raise premiums in anticipation of the implementation of reform.
Hacker is right. While a dominant insurer, or several large ones, can negotiate lower prices, there is no guarantee those low prices will be passed on to consumers in form of lower premiums. One way to get them to do so is via an “imminent threat of real competition” in the form of a federal plan (a real public option) that would enter if premiums are not sufficiently close to costs. That is, a trigger should be defined in terms that protect consumers from the otherwise monopolistic behavior of insurers, among other things. However, preserving the monopsonistic feature of a large buyer is still worthwhile.
This is precisely the notion of contestability, identified in the health economics literature (and elsewhere) and about which I wrote before. A government plan in waiting that serves to keep pressure on private insurers is the right role for a triggered public option even within the current compromise. Whether it is crafted to work in the fashion Hacker seems to endorse and I just sketched out remains to be seen. I am skeptical but hopeful.
Health Care Costs and Market-Theory: Provider Network Externality
Sick of reading posts about market theory and health care costs? If so, skip this one and read this alternative post from the archives. It has nothing to do with health care costs or market theory.
Meanwhile, I’m obsessed with what market theory can tell us about health care costs. It’s a good thing because it’s my job (or part of it). Anyway, let’s revisit my favorite graph, which you might recall from prior posts on this topic. It illustrates how I think insurer market concentration relates to premiums (or health care costs in general), holding health care provider concentration fixed (the curve shifts up (down) for higher (lower) provider concentration).
While this graph explains a lot, it doesn’t explain everything. In particular it abstracts away the role played by what the insurers actually provide for the premium charged. The curve is for the average standardized premium, which means all the variations in benefit packages offered by insurers are taken into account or controlled for, adjusting the premium accordingly.
Of course benefits matter for enrollment, which is the source of insurer market power. The greater number of enrollees, the greater the power of the insurer. Most benefits are of the form “such-and-such is covered for a copayment of thus-and-so.” But one benefit is of a different flavor than all the rest. That benefit is the provider network.
The provider network is the set of providers to which policyholders have access through the insurer. Go outside that network and you’re not covered; you have to pay for the service entirely out of pocket. Of course the establishment of the provider network of an insurer is relevant to the market power of providers and the insurer. The negotiation over rates–payments from the insurer to providers for their services–includes the possibility of exclusion from the network. For a sufficient rate of pay providers will want to be in the network to have access to the volume of patients the insurer can deliver. At the same time, the insurer is only willing to pay so much to a given provider: more for a dominant provider, less for a small player.
What distinguishes the provider network from other benefits is that it exerts a positive externality on policyholders. This type of inter-group network externality is the defining feature of a two-sided market. The greater the number of providers in an insurer’s network, the more a consumer will pay that insurer for access. All other things equal, consumers like access to more providers. They’ll pay a higher premium for such access.
This (two-sided) market-theoretic aspect of health care costs is not reflected in the figure above, nor is it reflected in most theoretical motivation or empirical specification of analysis of health care markets in the literature. This is not a surprise. The foundational work on this is brand new.
Has Additional Insurer Consolidation Increased Premiums?
Leemore Dafny, with colleagues Mark Duggan and Subramaniam Ramanarayanan, has produced yet another fascinating paper on consolidation in the health insurance industry (I mentioned another of her papers in this area in a prior post). Their latest, “Paying a Premium on Your Premium? Consolidation in the U.S. Health Insurance Industry” (NBER, October 2009) examines the effect of health insurer consolidation on premiums and health care workers’ employment and earnings.
Three of the authors’ main results are that due increases in insurer concentration: (1) Between 1998 and 2006 premiums increased 2.1 percent. (2) Between 1999 and 2002 physician earnings declined by 2 percent. And (3) over the same period health worker employment declined 2.4 percent. Let’s put these results in context.
Recall the figure I introduced in an earlier post and reproduced below. It illustrates my hypothesis about the effect of insurer concentration on premiums, for a fixed level of provider market power. In the region in which insurers have a high degree of concentration (around point “C”), I would expect additional concentration to lead to higher premiums. This is exactly what Dafny and colleagues found.
Moreover, the authors find that the additional market power held by insurers not only led to premium increases, it also led to a reduction of input prices (physician salaries) and employment (a signal of reduced demand). The first of these phenomena is consistent with monopolistic behavior while the latter two are consistent with that of a monopsonist.
In brief, the findings suggest excessive insurer market power relative to providers. But how excessive is it? That is, is the market operating closer to point “C” or to point “B”? We don’t know, but a related piece of evidence is that over the time period of the study premiums increased 100%. So the measured effect of insurer concentration on premiums–a 2.1% increase–is quite small relative to the overall increase in premiums and the degree of increase in concentration in the insurance market (the fraction of the market deemed “highly concentrated” rose from 68% to 99% in the study period).
Whether the market was operating closer to point “B” or “C,” the slope of the curve in the region it was operating is modest. Despite the large increase in concentration, the vast majority, about 98%, of the observed increase in premiums was due to other factors, including additional provider concentration, medical technology, increased consumer demand, and so on. This suggests that additional insurer concentration is not an important factor relative to all others. Note that this is a result on the change (the additional) market concentration and says nothing about the level.
Can we therefore conclude that insurer concentration is not a substantial factor in premium inflation? That would be going a bit too far. After all, this study, like all studies, has limitations. It is beyond the scope of this post to go into them but there are several reasons why the results may not be generalizable to the entire health insurance market. Some of the reasons are provided in the paper itself, and a few others were raised when this paper was presented at the 2009 Annual Health Economics Conference hosted by the BU School of Public Health (at the time of this writing some conference papers are still online at the bottom of the web page).
So I am very enthusiastic about this paper but interpret the results with caution. This measured reaction is totally normal. All studies, even good ones such as this, have limitations. That’s why one should base conclusions on a body of work that looks at the same issue from multiple perspectives, using different data and methodology. Nevertheless, this is a good paper on an important problem using appropriate methodology. I encourage you to read the entire manuscript.
Health Care Costs: A Market-Theoretic View
Health reform, even with a public option, will be built largely on a private insurer infrastructure. That means hundreds of billions of dollars will be pumped through insurance companies on their way to payment to providers for health care services. Given this reality, we should all want as efficient a health insurance market as possible.
This appears to be the beginning of an argument for encouraging additional competition among health insurers. Greater competition is the source of greater market efficiency, isn’t it? The answer is, it depends on the market. The simple type of idealized market taught in Econ 101 does become more efficient (in an economic welfare sense) as competition increases. But other types of markets–in particular, so called two-sided markets, among others–do not always behave this way. And health care is one of them.
Let’s first consider the best-case scenario for the consequences of greater competition in the health insurance market. About 85% of insurers’ costs are medical. The remaining 15% is for administration, marketing, management, and profit (profit itself is about 6% at the time of this writing). With additional competitive pressure insurers would compete away some of that 15%. Perfect competition would reduce profit to zero and may force efficiencies elsewhere. So, perhaps the best competition could do would be to cut in half that 15% for administration, marketing, management, and profit.
Figure 1
Now a 7.5% reduction is not chump change. It represents a lot of money, tens of billions of dollars annually. But that’s only an optimistic best case. And it pales in comparison to the cost savings that are available on the provider side, the 85% of insurers’ costs. (Hat tip: Michael Chernew.)
If we really wish to understand what would happen if the insurance market is made more competitive we have to go one step further. There is a reason the health care market is not analyzed in Econ 101. It is much more complex than, say, the market for coffee. In fact, additional competition in the health insurance market could drive costs up. Here’s a a graphical depiction of what I have in mind.
Figure 2
The figure is drawn for a fixed level of provider market concentration. The horizontal axis is insurer market concentration, and the vertical axis is premium for a standardized plan. Relative to the fixed level of provider concentration, insurer concentration is high in the region of point “C,” and premiums are above the minimum possible level. Insurers are charging above the competitive premium level because they have excessive market power. In this region, higher premiums stem from higher insurer profits and/or lack of administrative efficiency (the red zone of Figure 1).
On the other hand, insurer concentration is low relative to that of providers in the region of point “A,” and premiums are again above the minimum because insurers can’t negotiate down to the lowest possible price with providers. Providers have too much power relative to insurers and are charging prices above the competitive minimum. Insurers pass those high prices onto consumers through higher premiums. In this case, higher premiums stem from higher medical costs (the green zone of Figure 1).
As provider power weakens the whole curve shifts downward, and as provider concentration increases the whole curve shifts upward.
If we’re now at point “C” (and this is by no means certain) it may be possible to achieve lower premiums by diluting the insurance market, weakening insurers with respect to providers. But if we go too far, we’ll shoot past the optimum “B” and be no better off. On the other hand, if we’re now at point “B” we should do nothing to upset the insurer-provider balance of power. And if we’re at point “A” then it is the provider market, not the insurance market, that has excess concentration.
As far as I know, nobody knows which of the many local health care markets are operating at “A”, “B”, or “C.” In fact, I have not yet seen any studies that can tell us what mix of insurer-provider market structure achieves the optimal point “B.”
It is worth noting that what is being considered in Washington as the long-term solution to health care costs has less to do with finding an optimal mix of insurer-provider power and more to do a change in the incentives of provider payment. The goal is to shift the entire curve in the figure above downward so that in every type of market–”A,” “B,” and “C”–health care costs and premiums come down. But a downward shift due to payment reform may be offset by a movement leftward along the curve. Such an offsetting effect could be brought about by antitrust action against insurers, weakening their market power with respect to providers. A similar offset could occur through additional integration of providers under a payment reform model (ACOs, CHTs). Both of these potential offsets are included in current legislation.
There is more to say about health care costs from a market theory point of view. I will be returning to this issue and referring to Figure 2 in the near future. The bottom line, however, is that the failure of policymakers to consider the insurer-provider balance of power may prove to be a costly oversight.
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