• Insurer vs. Provider Market Power: What’s in It for Consumers?

    Last week Ian and I described the risks involved in repealing health insurers’ exemption from national antitrust law. The argument encouraged a focus on the balance of market power between insurers and providers.

    If health care providers have relatively more power they can charge relatively higher prices. That’s bad for consumers. On the other hand, if insurers have relatively more power they can bargain down the price of care. That’s good for consumers if those lower prices are passed on to them in the form of lower premiums. (Also, lower premiums mean lower tax-funded subsidies. That’s good for taxpayers.)

    Why would an insurer that commands low prices pass the savings on to consumers? Why wouldn’t such a dominant insurer simply keep the savings for itself? These questions focus precisely on the critical balance needed for a welfare-maximizing insurer-provider market relationship. While the questions about health care markets are exceedingly tricky (formally in the domain of two-sided market theory), we can look elsewhere for some intuition.

    Think Wal-Mart. It is a high-volume purchaser of many goods and, as such, commands low prices. It has market power as a purchaser. It also commands a large share of the retail market. From this fact alone it would seem to have substantial market power as a seller, enough that it could charge high prices. But it doesn’t. Wal-Mart is faced with competition significant enough that it must sell its goods at low prices. To a large extent the bargains Wal-Mart achieves as a purchaser are passed through as savings to consumers.

    The competition Wal-Mart faces is not only that of other retailers in the market but also from potential market entrants. If Wal-Mart raises its prices it risks inviting the entrance of other retailers who would offer goods for less. This is the notion of contestability described by Foreman, Wilson, and Scheffler, which I described in an earlier post (Will a Monopsony Health Insurer Reduce Premiums?).

    In the health insurance market, what might be the entrant in waiting? One answer is the fallback version of the public option, which is the version favored by Olympia Snowe and picked by me last spring as the winning political compromise. For the fallback option to be the source of contestability in a market its entrance would have to be triggered on some measure of insurance premium markup. If premiums were found to be too high relative to the prices paid by the insurer for care that would trigger a public option in that market.

    While it may not yet be precisely clear to anyone, economists included, exactly how to structure health care markets to maximize consumer welfare, it is clear that to have any chance of doing so one must view the market as a whole. The market power relationships among providers and insurers and how those relate to government regulation and the threat of market entry of a public plan are critical. One cannot single out insurers (or providers) as the target of reform and expect a good outcome. 

    The health care market is a complex multi-sided system–a system that is broken in more than one way. A broken, complex system requires a comprehensive solution.

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    • For the reasons stated in the earlier post on the subject of McCarran (and my views that it does not increase buyer power but only seller power), I do think buyer power is relevant to a competitive outcome: it just depends on the nature of the person holding it. If it is a for profit buyer, who as a monopsonist depresses prices of the seller and reduces the quantity purchased, then the gain will be distributed to shareholders, as Wal-Mart does. A non-profit buyer, controlled by enrollees, could distribute the gains from discounted purchases back to enrollees, but this is also dependent on whether the non-profit is really controlled by enrollees or is in fact controlled by management which just gives itself a higher salary.

      You might want to look at the economics of agricultural cooperatives to get a model of monopsony/monopoly economics (coop is a monopsonist and sells as a monopolist; coop is a monopsonist and sells in competitive markets.) There is a rich economic literature out there on this subject which has relevance to this argument. Bottom line: for open membership coop in either case controlled by members and without management control to siphon off gains the result is a competitive outcome to the coop members. By getting a monpsony price distributed back to them, they purchase more of the good at a lower price, and then there is an equilibrium. If it is a non-coop buyer, and it is a monopsonist in input/monopolist in output I believe the results are worse. For the agricultural side, you might want to look at some of the work by ag economist Peter Helmberger on the economics of cooperatives, and generally Blair on the economics of monopsony.

      Now, a competitive solution–without having an insurer acquire more market power–is to allow and create a bidding market composed of competing healthcare systems bidding for the right to supply a given population and bidding on a capitated basis. Then, you could use the ASO services of an insurance company to do the administrative work, and have insurance carriers bid for the administrative service function with the providers bearing the risk.

      • @Bill – Contestibility must play a role, as I wrote. Also, inter-group network externalities may encourage an insurer to transfer some of its rents onto consumers in the form of lower premiums (two-sided market theory). Nevertheless, one should not make too much of this without empirical evidence. Actually there is some (I’ve cited it). Therefore, I won’t argue over theory, the preference of which may be a matter of how one views the balance of the literature, which is itself a function of what literature one is familiar with. Your points are well taken.

    • By the way, I would not exclude carriers from being bidders as well, nor would they be excluded as reinsurers of the competing provider plans. In fact, what you want is providers, networks and insurers all bidding on a capitated basis.

    • Austin,
      On the subject of McCarran again, you might want to look at the work of Prof. John Burton at Rutgers. John is an expert on workers comp insurance and has done studies of deregulation of workers comp–that is, where states have denied insurance carriers the right to jointly formulate rates or participate in rating bureaus only for aggregation of loss data, and not for projection, etc. In effect, you move from a pre-McCarran state (rating bureaus, price fixing rates) to an open compeition state (no ability to jointly set rates). What you see is a large number of carriers under the McCarran state, and fewer and larger carriers after deregulation WITH LOWER rates and premiums. McCarran provides an umbrella for non-competition. It does not increase buyer power; its repeal would probably increase buyer power, not reduce it.

    • Ian,
      I don’t know how you get contestability under McCarran where carriers have the right to agree on rates.

    • @Bill – I’m sorry, what specifically is your question for me? Or were you meaning to elicit further comment from Austin?

    • Sorry, Ian, meant Austin and understand Austin’s reply.