• Who Has Market Power?: Health Insurers vs. Providers

    This post has been cited in the 5 August 2009 Health Wonk Review, hosted by Disease Management Care Blog.

    Several recent reports and journal articles describe considerable market concentration among health insurers. And there has been debate in the blogosphere about the merits of competition among insurers. Should consumers worry that increased market power by insurers means higher premiums than would otherwise exist in a more competitive market? Or should consumers rejoice that the buying power of a larger insurer will command lower prices from providers thereby keeping health care costs in check?

    These are tricky questions and ones I’ve raised before. But now I have some answers from–wait for it–health economists (naturally).

    In his 1998 Health Services Research article Managed Care, Market Power, and Monopsony, Mark Pauly lays out some helpful theory. In the case of a monopsony insurer (a market with only one health insurance plan) overall welfare (consumer plus producer surplus) is lower than in the case of a more competitive market. However consumer surplus (the value of the product to consumers less the price they pay) may increase depending on the type of insurer. A for-profit monopsony health insurer may not pass the lower provider prices to consumers through lower premiums. A nonprofit monopsony health insurer, on the other hand, will (in theory).

    OK, what does this mean? It means that, according to theory, consumers get the best deal when the health insurer has considerable market power (monopsony or market share concentrated in very few insurers) and when the insurer is a nonprofit entity (as would be the co-ops recently proposed by Senator Kent Conrad). Nevertheless, a monopsony insurer reduces producer surplus (and therefore overall welfare) by extracting prices from providers below those of a competitive market.

    If you care about the welfare of producers (doctors, hospitals), as the American Medical Association (AMA) does then this is a concern. To what extent should consumers care about the welfare of producers? Perhaps it is relevant to know whether or not the producer market is competitive or monopolistic? If producers are monopolistic and extracting extra profit (rents) then there is justification in breaking them up, doing so would be welfare improving. If the provider market is already competitive then perhaps providers would be unfairly taken advantage of via a monopsony insurer.

    This suggests two ways to achieve lower health care prices: (1) support a trend toward monopsony in the insurer market (welfare reducing though possibly consumer welfare improving, but not always) or (2) break up monopolistic providers (welfare improving). Both would lower prices, and they are not mutually exclusive. If a policy is implemented and we observe a reduction in prices is it welfare improving or not? The answer hinges on distinguishing between cases (1) and (2). Pauly explains that if the quantity of care declines along with price then that signals a trend toward monopsony insurers. A monopsonistic insurer achieves lower prices by holding down demand. On the other hand, if the quantity of care does not decline with price then that signals a trend away from monopolistic providers.

    At least two papers have used the theory expressed by Pauly to test whether insurer market concentration reflects monopsony power or monopoly-busting power. In Do HMOs Have Monopsony Power? (International Journal of Health Care Finance and Economics 1(1), 2001) Feldman and Wholey found that HMOs used their market clout to offset the monopoly power of hospitals. They also found no evidence of monopsonistic behavior with respect to physician services.

    The findings of Bates and Santerre (Do Health Insurers Possess Monopsony Power in the Hospital Services Industry? International Journal of Health Care Finance and Economics 8(1), 2008 [free working paper version]) are consistent with those of Feldman and Wholey. Greater health insurer market concentration is not associated with monopsony power and suggests that insurers use their power to offset monopolistic providers.

    Taken together, the articles reviewed above indicate that insurer market power should not be the focus of attention. Instead, provider (hospital) market consolidation ought to be more closely examined. I would be overstepping my knowledge of the literature to say that antitrust action against large provider groups is the key to more competitive health care markets, but the papers I described above are consistent with that idea. But what of the consolidation implied by the notion of accountable care organizations (ACOs)? I raised this question in a prior post. Some commentators have already pointed out that ACO-type incentives have led to provider consolidation. I  hope policymakers are paying attention.

    On the other hand, how do you think Democrats will get/keep provider organizations on board? Not by threatening to break them up, that’s for sure.

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    • The articles cited here are a bit dated. Joe White’s Markets and Medical Care: The United States, 1993–2005, offers a more skeptical take on a market structure evolving toward bilateral monopoly or oligopoly.
      From the URL above:

      “One might wonder why consolidation among insurers did not allow them to resist the providers’ demand for increased payments. The simple answer is that there were two concentrated parts of the market and one fragmented part. The insurers had to choose between fighting a full-pitched battle with the providers or exploiting their own market power vis-à-vis the employers. Raising premiums to employers was a lot easier. In theory, employers could have demanded restrictive networks (at lower prices). But since everyone had agreed that employees did not like restrictive networks, and providers (especially hospitals) were not willing to discount much to get into such networks, there were not many available for purchase. Individual employers could not invent such a product; they could only shop around and find the relatively best deal by customizing other contract terms, such as cost sharing.”

      • @Frank Pasquale – Thanks, the URL is . The passage you quote highlights another layer of complexity. One can view the health care sector as not merely a two-sided market (providers insurers consumers) but a three-sided one that includes employers as well. Some have gone so far as to call it a four-sided market, throwing in government too. Economic analysis becomes intractable with so many entities and we’re left with anecdotal evidence and stories. It is difficult ground on which to establish anything resembling “truth.”