Think Tank

How Can California Make Most of Volatile Marketplace?

Competition, the backbone of the free enterprise system, is generally encouraged in U.S. commercial markets. The theory is that more widgets and widget makers will ensure consumers get the best widget value for their dollar.

At the other end of the business spectrum, consolidation — which can be interpreted as the antithesis of competition — is thought to reduce consumer choice and reduce the competitive motive to keep prices low.

However, the more complex and convoluted the market, the more the effects of competition and consolidation can be diluted or redirected to some group other than the ultimate consumer.

In health care, there are multiple markets in play: insurers, hospitals, physicians and other providers all operate in their own individual markets. How competition and consolidation within each one of these markets affects consumers is not always clear.

Competition – traditionally a key weapon in the battle against inflation – has had mixed results in keeping health care prices down in both in the overall health care system as well as in each of these sub-markets.

A recent study by the RAND Corporation suggests that increased consolidation among insurers might reduce hospital prices in some areas.

Hospital prices were about 12% lower in places with the fewest insurers, according to the RAND study, published in Health Affairs this fall.

The RAND study also found that in most markets, hospital market concentration exceeds insurer concentration, which leads to higher hospital costs.

According to another report, this one from the Kaiser Family Foundation, health insurers face “modest” competition in most states. Using a 10,000-point scale known as the Herfindahl-Hirschman Index to assess the level of health insurance competition, the Kaiser Family Foundation report found 45 states scored at least 2,500 for the individual market and 39 states had the same score for the small group market. In this index, the closer to zero, the greater the competition. Markets with a score of 2,500 or more are considered “highly concentrated.”

As the federal health reform law paves the way for adding between three million and six million newly insured Californians to the health care system, competition and consolidation could play increasingly important roles in the success of that system.

How can policymakers best take advantage of competition and consolidation in health care to ensure that the entire system — and ultimately California consumers — benefit?

We got responses from:

We Can Improve on Current Market Dynamics

There have been numerous studies, with varying methodologies, regarding the effect of hospital consolidation on costs and pricing. For the most part, there appear to be economies of scale, rather than just ownership, especially when consolidation of facilities and management are involved. But such economies of scale do not appear to translate to savings or, better yet, improved quality (particularly in competitive markets). In fact, most studies tend to show that hospital consolidation results in increased prices, reduced access and impacted quality (See William Vogt and Robert Town, The Synthesis Project, February 2006).

Recently though, there has been a growing interest in studying whether such consolidation, either by hospitals or insurance companies — particularly in competitive markets – leads to lower premiums and/or “costs” to consumers and/or employers. Notably, in a series of recent papers, the National Bureau of Economic Research has been addressing this question. NBER’s key findings are that:

  • The health insurance market is concentrated and is becoming even more so;
  • Health insurers extract employer-specific rent (higher premiums) from large employers, particularly in markets where there are fewer insurance carriers and when such employers have significant profits — arguing that employer switching costs is a key variable and employers share their rent (profits) with employees by accepting such increases; and
  • “Americans are indeed paying a premium on their health insurance premiums as a result of recent increases in the concentration of this industry. However, consolidation explains very little of the steep increase in health insurance premiums in recent years.”

So the public policy question remains: If consolidation of health care providers and health insurers has not been able to serve the interest of consumers — and the courts have failed to capture the nuance of defining competitive markets to reflect the effects of pricing, quality, access and choice at the consumer level – then who is safeguarding the hen house?

Perhaps the initial claims regarding efficiencies from economies of scale and gains from the “welfare loss” in consolidation/mergers of hospitals/insurance carriers were not meant to particularly help “rationally ambivalent” or “rationally ignorant” consumers as some have noted! Perhaps consumers/employers of large profitable companies are in a temporary Nash equilibrium lull with the health care industry while awaiting the outcome of health care reform. Perhaps the marketplace in California is indeed sorting the multilateral oligopolistic competition between the big boys – large employers, consolidated health care providers and insurance carriers — and leaving the individual and small market premiums to bear a disproportionate cost burden.

Health care reform will never produce a widget. There will always be product differentiation with various valid metrics. But we can definitely improve on the current market dynamics. It behooves our policymakers to deliberately structure and enforce mechanisms that assure:

  • A large number of insurance/health plan participation and offerings of benefit packages and hence pricing levels (mandatory generous benefit package defeats this purpose);
  • Option of several networks of institutional and non-institutional providers to assure access and accessibility based on consumer-driven preferences; and
  • Perhaps most importantly, transparent information for comparing benefit packages and pricing among the various options.

Policymakers Can Choose From Variety of Tools

To those familiar with the U.S. private health insurance market, it probably comes as little surprise that the market is highly uncompetitive. The individual and small group insurance markets in most states are dominated by a single insurer, according to a recent state-by-state analysis conducted by the Kaiser Family Foundation.

California ranks approximately in the middle in terms of the relative competitiveness of its individual insurance market. Although the state has a number of well-positioned insurers, the largest carrier controls nearly half of the market (48%). By commonly accepted economic standards — as measured by the Herfindahl-Hirschman Index, or HHI — the state’s individual market is quite uncompetitive with an HHI of 3,025 (Anything over 2,500 is considered highly concentrated).

Why does this matter?

One concern about uncompetitive markets is that they lead to higher prices for consumers. In the case of health care, this is complicated. Insurers act both as suppliers of health insurance (to consumers) and as purchasers of health services (from health care providers). While a dominant insurer can demand higher premiums, it may also be able to leverage lower payment rates to health care providers. But, even if a large insurer were successful at driving provider rates down, there’s no guarantee that it will pass those savings on to consumers. Aggressive review of premium increases by regulators is one possible policy response, and it may be the subject of a ballot initiative in California next November.

Another concern about concentrated markets is that they limit choices for consumers. On this issue, things could change significantly as the Affordable Care Act (ACA) gets implemented. New insurance market rules going into effect in 2014 prohibit insurers from denying coverage to people with pre-existing health conditions or charging them higher premiums. Eliminating this “medical underwriting” will allow consumers to shop around more freely than they can today. In addition, the new health insurance exchange could provide consumers with online shopping tools that enable them to easily compare health plans based on standardized information.

State policymakers have a variety of tools at their disposal to address uncompetitive insurance markets. But what tools they choose and how they use them depend on what problem they’re aiming to solve.

Provider Consolidation Key Factor in Affordable Coverage

The issue of provider consolidation and its impact on price competition is perhaps the most important factor that will determine whether Californians will be able to afford health insurance in the future.

Our recent national study — which looked at the competitiveness of health plan markets and hospital markets — found that hospital markets are much less competitive than health plan markets nationally and, importantly for consumers, that hospitals operating with little competition are able to charge health plans much higher prices, which are passed on to consumers in the form of higher insurance premiums.

Recent data from California highlight the costs to consumers of ongoing health care provider consolidation and reduced price competition. Between 2001 and 2010, net patient revenue collected by hospitals increased by almost 90%. How much of this increase is the result of increased volume? Less than 4%. The remaining increase is due to increased prices.

While some of this substantial price increase is explained by inflation and new technology and patient case-mix, it is likely that a large portion of this substantial increase is “pure price increase” — due to reduced price competition among California hospitals. There has been both a reduction in the number of hospitals and an increase in the number of hospitals in multi-system hospitals. This consolidation reduces the ability of health plans to negotiate lower price increases.

State policymakers must focus on this problem or we will all be increasingly priced out of the health insurance market in coming years. Laws and regulations are needed to restore price competition among providers (and health plans where needed).

Hospitals in systems should be required to contract individually — not as a single block. This should extend to medical groups that are being purchased by hospitals at a growing rate. Regulations are needed to open up the market for alternatives.

Health plans should be able to design new products that allow them to put hospitals into different cost-sharing tiers based on quality and price. Plans should be able to work with employers to construct customized networks which may be narrower than regulators such as the state Department of Managed Health Care allow.

California passed the first laws to launch price competition, which produced substantial savings for health care consumers. We need a new round of innovative policymaking to restore competition to our health care markets.

Wrong Kind of Competition, Not Enough Competitors

Is there enough competition in health care? It depends on what you’re looking for. From the perspective of those within the health care and insurance industry, it’s obvious that there’s plenty of competition. Health care providers and insurers are constantly engaged in a struggle to gain more patients and enrollees, while maintaining good financial returns. 

But there is another perspective — that of consumers and employers who pay for health care and medical benefits. They see two problems. First, while there’s plenty of competition among health care providers and insurers, it’s the wrong kind of competition. Many hospitals compete primarily by adding the latest in high-tech equipment and super-specialty services rather than improving medical outcomes or efficiency. Most insurers compete primarily by expanding the list of health care providers in their network and by avoiding enrollment of high-cost patients rather than lowering medical costs or improving administrative efficiency. None of the most common competitive tactics provides significant value to consumers or purchasers. 

Second, consumers and purchasers see that in many markets, there aren’t enough competitors. In many communities, there are only one or two hospitals, and many physician specialty groups are virtual monopolies, especially in smaller towns. Even in large metropolitan areas, large hospital chains often occupy a dominant market position. In addition, the insurance market is becoming increasingly concentrated. As a result, these health care providers and insurers are able to exert significant market power in comparison to the fragmented consumers and purchasers, who often end up paying much higher prices than necessary.   

There is a growing body of evidence regarding the effect of market concentration on prices. Everyone inside the industry who is involved in negotiating contracts between insurers and health care providers recognizes the problem, but the general public only recently is becoming aware of the issue. According to an article by Duke Helfand in the Los Angeles Times last March, hospitals in San Francisco receive an average of $7,349 in revenue per patient per day, while hospitals in Los Angeles County receive only $4,389 — a 67% difference, driven largely by higher market concentration in Northern California. A recent article by Avik Roy in Forbes described similar problems of market concentration in Massachusetts, Ohio and other parts of the country. 

What can we do? As a first step, we need to gather information on local market shares, prices and market conduct. This information could be used to publicize the problem, provide data for further research into the dynamics of market power and inform the federal and state authorities about potential antitrust violations.

There is no doubt that this is an uncomfortable issue to talk about. Most physicians and hospitals do not see themselves as greedy people who are trying to maximize income from purchasers and individual consumers. But the evidence is growing that market concentration is a significant factor in high prices. As Jack Welch, former CEO of General Electric, said, we need to “face reality as it is, not as it was or as you wish it to be.” Until we face up to the reality of the effect of market power on prices, we won’t be able to deal effectively with the affordability crisis in health care.