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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