Katherine Ho’s paper titled “Insurer-Provider Networks in the Medical Care Market” (American Economic Review, 2009; ungated version available) models the bargaining process between insurers and hospitals. It’s fascinating, but far too mathy for a post. (If I can distill it down to something simpler I’ll write more about it later.)
The paper also includes this revealing passage:
The executive director of one hospital system described a potential outcome in such markets [in which managed care is strong and hospitals compete for contracts]: “There are examples where there were too many hospitals in an area and the plans played them off against each other to the point where the price paid was no more than marginal cost.”
The more interesting situation arises when hospitals tailor their characteristics in order to capture positive profits. Interviewees noted that the negotiations could be very different in these markets. A hospital director said the following: “In market X [where hospitals are very strong], the prices [the best hospitals] charge are based on their very high patient satisfaction results and their strong reputation. They can get high prices from any plan in the market and they don’t need them all.” The CEO of a small hospital in a different market had a similar story: “Large [hospitals] in this market can dictate whatever prices they want. The bigger names can demand the higher prices.”
Market structure matters. If we’re to rely on the market for health care the prices (premiums) we pay are a function of the balance of market power between insurers and providers. That’s not the only factor relevant to prices, but it is one driver of geographic and temporal variation in premium levels and changes.