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.

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