Vital Signs Weak: Competition in Health Insurance and Health Provider Markets

Recent Republican attacks on President Obama's proposal to give everyone the option of buying into a new Medicare-like public insurance plan have, as I suggested earlier, put ideological arguments about "Big Government" and "The Market" right at the heart of our public debate once again. Republican opponents of a public insurance plan claim, as ever, that they are the righteous defenders of "Competition." And they cast the public plan's supporters as competition's enemies. But when it comes to health care reform, nothing could be further from the truth.

Markets work when many competitors vie for customers by offering better quality, new products, convenience, or lower prices. To know whether a particular market is working in this way—whether it is competitive, and thus likely to deliver on the benefits for which economists love markets—you have to actually look at it. The extent of competition in a market is what academic types call "an empirical question." You get nowhere, analytically, by just assuming that wherever there are private firms there must be a functioning market—as the self-proclaimed defenders of "The Market" always do.

You get nowhere analytically by making that simplistic assumption—but ideologically and politically, it's a different story. If enough people can be convinced that "The Market" is a kind of all-seeing, all-knowing deity—and "Big Government" its sworn enemy—then you can preserve the kinds of uncompetitive markets that standard economic theory alone would tell us generate excess profits at the public's expense. A few companies can consolidate market power, raise prices (because of the lack of competitive pressure), reap excess profits, and still have plenty left with which to pay off their enablers (such as legislators who keep government off the companies' backs and opinion-makers who keep people reverent, bewildered, prostrate before "The Market").

To make sense of the urgent and resolute (if logically awkward, as pointed out here and here) calls by opponents of the public insurance plan to uphold "Competition" by ensuring there's no competition in health insurance, we should begin by simply turning to the data.

How competitive or uncompetitive are health insurance and health care provider markets? Answering this question will help us not only to make sense of the fervent Republican opposition but to understand the reasons a public insurance plan is so essential if we want to achieve President Obama's twin goals of reining in health care price inflation and offering everyone quality coverage.

It turns out that both health insurance markets and health care provider markets are highly consolidated throughout most of the country. Competition is anything but robust. A single firm dominates the health insurance market (accounts for more than 50% of the market) in 64% of the country's metropolitan areas, and one insurer controls 30% or more of the market in all but 4% of metropolitan areas.

As a recent study by Kellogg School of Management economist Leemore Dafny concludes, "to date there is little empirical evidence to support the assumption of robust competition among insurance carriers." Moreover, "de facto price discrimination is most pronounced in markets with a small number of insurance carriers." Just how uncompetitive does a market have to be for us to have good reason to worry about the exercise of oligopolistic market power (a small number of firms controlling so much of the market they're insulated from competition and able to raise prices at the public's expense)? One measure of markets' competitiveness used by economists and antitrust lawyers to determine when there's good reason to worry is called the Herfindahl-Hirschman Index (HHI). If a particular market has an HHI of 1,800 or higher, the Department of Justice considers it "highly concentrated." For health insurance markets, 34 of the nation's 50 states had HHIs higher than 1,800 in 2004, according to a study by health economist James C. Robinson. This absence of competition in local health insurance markets clearly matters, for us health care consumers and for the nation's overall health care spending. One recent study found insurance premiums 12 percent lower in markets with lower levels of concentration.

"There might be less concern about increasing costs if they yielded commensurate gains in health," noted current Office of Management and Budget director Peter Orszag in a New England Journal of Medicine article he co-wrote in 2007. But they do not. Because of all the consolidation, in short, competition in health insurance markets has "devolved into [rewarding whichever] health plans [have] the greatest market share."

But the astonishing rates of price inflation for health care—putting a heavy strain on both government and family budgets—cannot be accounted for by looking only at the market power wielded by insurers. We also have to look at—among other factors—the extent of competition among the firms insurers pay: health care providers, whether shareholder-owned or non-profit. Insurers have been "able to raise prices consistently above the rate of growth in costs," notes the health economist Robinson. But they would have had much less ability to do so if the "balance of power" between purchasers of health insurance and health care providers had remained as it was until the early 1990s, before the wave of mergers and acquisitions among providers got started.

Since the early 1990s, providers have increasingly sought to merge and grow into multi-facility consortia capable of wielding market power. The mergers and acquisitions were precipitated, in large part, by providers' recognition of their (prior) lack of bargaining power facing oligopolistic insurers. "The consolidation of hospital systems that has occurred in recent years" has by and large succeeded in increasing their bargaining power relative to insurers, according to a recent Urban Institute report—with disastrous consequences for private and public budgets.

Just how uncompetitive are provider markets today? Recall that a Herfindahl-Hirschman Index (HHI) rating above 1,800 suggests a "highly concentrated" market, according to the Department of Justice. By 2000, the median HHI for U.S. health care provider markets was 3,995, according to a 2006 report by Carnegie Mellon professor Martin Gaynor. In many rural areas and small cities, health care consumers face a single monopolist health care provider, or a market in which there are only two or three total providers. Any health care provider wielding substantial market power should be able to negotiate for significantly higher payments from insurers.

And the consolidations have not stopped. In a 2008 memo titled "Are You Ready for the Next Wave of Healthcare Provider Consolidation?," the president of a health care strategic planning consultancy counsels that "some leaders can position their organizations as consolidators, while many others must be realistic about their likelihood of survival if they go it alone."

Such market power-wielding providers can, of course, raise prices to their own benefit, at patients' expense. Moreover, a study of hospital mergers from 1989 to 1996 found "sharp increases in rivals' prices following a merger, with the greatest effect on the closest rivals." In other words, when providers merge to gain more market power, they are not the only ones in the local market enabled to raise prices. Those rivals who are not eliminated can too, due to the weakening of competition. In short, oligopolies work just as simple economic reasoning would expect them to, raising prices to the benefit of the oligopolists at the expense of the public—in health care provider markets, just as in health insurance markets.

And as we'll see in my next post, it is the combination of the two that's really lethal, if we're concerned about both prices and quality in health care.

"For decades the United States has sought to use competition to motivate improvements in the health care system's performance," concludes Robinson. "But competition requires competitors."

As we've seen, competitors are scarce in most health insurance and health care provider markets in the U.S. The next task to take on, then—and a more complicated one—is explaining why this is the case. I'll move from symptoms to diagnosis in my next post, making prescription—a public plan, to rein in price inflation and ensure quality coverage for all—possible.

—Phillip Cryan is a graduate student in the Goldman School of Public Policy, at the University of California, Berkeley. For his Masters thesis, he is analyzing the impact of an employer play-or-pay mandate for health care on employment.

03-12-09 By Phillip Cryan | Comment (4)