In last week’s post, I asked whether we can expect the health-care costs of individuals and families to fall as the number of health insurers competing in a given market area increases – as was so often posited by all sides during the recent health-care debate. (I posed that same question earlier this year in the policy journal Health Affairs.)
As I said last week, a health-insurance contract is unlike a widget (which, in standard Econ 101 discourse, is a simple, standard manufactured good whose price tends to fall to the lowest possible level as more producers enter to compete in the market for widgets). Rather, health insurance, in exchange for one premium, provides what is known as a tie-in sale of a set of services produced by the insurers, along with the care purchased on the insured’s behalf from doctors, hospitals and other providers.
Consider the production cost of the set of services produced by a health insurer, which I enumerated last week — marketing to enrollees, risk pooling, claims processing, disease management, information services and more.
There are apt to be significant economies of scale in the production of most of the services produced by insurers — and that means the unit cost of these services is likely to fall as scale increases, especially for services that rely heavily on electronic-information systems. Why else would small insurers, represented by the Council of Affordable Health Insurance, need 35 to 45 percent of premiums for marketing, administration and profits, while large insurers manage with a much smaller share, often less than 20 percent, devoting a correspondingly larger piece of the premium to paying for health care?
Then consider the cost of the care produced by hospitals, doctors and other providers and purchased for the insured by the insurer, at prices determined in negotiations between insurer and provider.
Common sense suggests that the total cost at which an insurer can procure a given set of health-care benefits from a given provider depends on the insurer’s and provider’s relative market power.
If an insurer would find it difficult to sell policies without having a particular provider in the insurer’s network, then that provider has significant market power over the insurer in negotiations over prices.
This condition prevails in areas where physicians join together in large groups or hospitals consolidate in large systems, as has happened in many markets in the last two decades. Studies have shown, for example, that consolidation in the hospital industry has raised the prices of hospital services significantly.
If a provider cannot afford to lose the patient revenue that an insurer could bring to that provider, the insurer will have more market power over the provider in negotiations over prices, other things being equal. This condition is more likely when an insurer has a large market share in any given area.
If more insurers enter a given market, it will be easier for providers to walk away from the table in negotiations with any one insurer over prices. Consequently, insurers in such markets will pay relatively higher prices. This price discrimination is perfectly legal and rampant in American health care.
An insurer, of course, might seek to reduce the total payments made to a provider not only through lower prices but also through controls of what and how much of a service is provided to patients. When an insurer accounts for a large portion of a hospital’s revenue, a provider who declined to contract under those conditions would lose significant revenue and is therefore likely to put up with the controls, however nettlesome.
It is safe to conclude, then, that the smaller the share that an insurer has in a particular provider’s total revenue, the more it will cost that insurer to procure from that provider the health-care benefits promised the insured. Thus the reduction in health-care costs some people expect from a larger number of insurers is not likely to come on this front, either. In fact, costs are more likely to rise.
This leaves the insurer’s profits as the only line item that might possibly be reduced through competition. These profits can be expressed either as a percentage markup over the insurer’s cost of those services it produces itself, in which case the markup will appear large, or as a fraction of the premium charged the insured, in which case the markup will appear to be much smaller.
From the perspective of the total health-care costs borne by the insured, the relevant profit measure is the fraction of the premium absorbed by the insurer’s profits. That fraction may well fall with an increase in the number of insurers competing, but the total relief for the insured is likely to be very modest.
Over all, however, the cost savings from economies of scale and the price discounts from the added market power enjoyed by larger insurers are apt to swamp, in most cases, any downward pressure on profit margins that might be had from a larger number of insurers.
Econometric research on the effect on prices of the allocation of market power between insurers and providers is challenging, because price can be affected by so many variables and the direction of causal flows (the influences that variables might have on one another) may be more complex than can be modeled with the data at hand. Even so, what research there is tends to support my arguments, such as a nationwide study published earlier this year by Asako Moriya, William Vogt and Martin Gaynor.
A very recent study by Glenn Melnick and associates, currently under peer review and not yet published, explores the effect of the allocation of market power among insurers and hospitals and finds, as theory would predict, that “health plan market concentration reduces hospital prices, while higher hospital market concentration results in higher prices.” The authors also find that “hospital concentration exceeds health plan concentration in most markets.”
In short, the widely held notion that more insurers in a market area will reduce the premiums paid by the insured is not supported by either economic theory or empirical research.