Vertical restraints, ctd.

Earlier this week I summarized a portion of Gaynor and Town’s Handbook chapter on vertical restraints. If you’re already lost, go read that post. What follows is a bit more from the chapter.

Section 7.1.2 is a model of hospital-insurer vertical integration and its effect on hospital prices. I’ll spare you the math. The bottom line is:

A vertically integrated insurer pays its hospital marginal cost, which implies that under a disagreement with another hospital it will have lower disagreement expenditures. To summarize, in this framework, vertical integration leads the vertically integrated hospital to negotiate higher prices with other payers and the vertically integrated insurer to negotiate lower prices with the other hospitals in the market.

“Disagreement expenditures” are the costs of failing to negotiate an exchange. Basically, an integrated insurer — one that pays the hospital with which it is integrated marginal costs — can walk away from a negotiation with one of the hospitals with which it is not integrated at lower expense than it could if it were not integrated with any hospital. That’s just another way of saying marginal costs are the lowest costs an insurer can pay.

Hospital-insurer vertical integration has not been terribly common (Burns and Pauly, 2002). The growth of the phenomenon in the 1990s

coincided with the growth of managed care, and in particular with the perceived growth in managed care organizations’ negotiating power with hospitals. Nonetheless, there are reports that vertical integration and exclusive deals are on the increase in health care, in part because of elements of the health reform law in the US.

Vertical restraints need not entail integration. It also includes

exclusive dealing between physician practices and hospitals (usually for a specialized service, e.g. radiology, anesthesiology, or pathology), and mostfavored- nations clauses between insurers and providers, which require the provider to give the insurer a rate as low as it gives to any buyer (see Gaynor and Haas-Wilson, 1998; Haas-Wilson, 2003, for reviews of vertical issues in health care).

In spite of the interest in this topic, there is relatively little evidence on the effects of vertical restraints in health care. The evidence comes from reduced-form studies.

The remainder of the section focuses on hospital-physician relationships, which, at the moment, is not my key interest. (Provider-insurer integration is.) It seems there has been no recent empirical work on provider-insurer vertical restraints.


Burns, L. R. and Pauly, M. V. (2002). Integrated delivery networks: A detour on the road to integrated health care? Health Affairs, 21(4), 128-143.

Gaynor, M. and Haas-Wilson, D. (1998). Vertical relations in health care markets. In M. A. Morrisey (Ed.), Managed care and changing health care markets (pp. 140 163). Washington, DC: AEI Press, chapter 7.

Haas-Wilson, D. (2003). Managed care and monopoly power: The antitrust challenge. Cambridge, MA: Harvard University Press.


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