Sunday, April 01, 2012

Do We Need More Competition from Health Plans or Hospitals?

In a typical economic market, the more sellers of a particular product or service there are, the lower prices will be, because the sellers will compete on price in order to attract customers. This has led many people to believe that the way to get lower health insurance premiums is to have more health insurance companies competing to sell insurance in our region.

However, it’s not quite as simple as that, because health insurance companies are not only sellers of insurance, they’re also the buyers of our healthcare services. They negotiate with hospitals and physicians to set the prices paid for the services individuals and employers receive when they buy a health insurance policy. The more that health plans have to pay for hospital care, the more a health insurance plan will cost. And simple economic theory tells us that, all else being equal, bigger health insurance plans have more clout to negotiate lower prices for healthcare services than smaller plans do.

Most people experience this every day in retail. Consumers don’t buy goods directly from manufacturers; they buy them from retail stores. Does having more retail stores result in higher or lower prices for consumers? Big retailers like Walmart or Target can usually buy products from manufacturers for a lower price than smaller retail stores can, and so they can sell the products to consumers for less. (You may get better service from the smaller retailer, but it's up to you whether you want lower price or better service.)

If there were only one big retailer, consumers would probably see higher prices, because the monopoly retailer could keep the price discounts for itself in the form of higher profits. But conversely, if there were only small retailers, prices for consumers would probably also be higher, because those retailers couldn’t negotiate large price discounts from manufacturers.

What consumers pay depends not just on the number and size of retailers, but on how much competition there is among manufacturers of the product. For example, if there were only one company that manufactured televisions, it wouldn’t matter how many TV retailers there were or how big they were, because a monopoly television manufacturer could set the price as high as it wanted, and both the retailer and consumer would have to pay more to get a TV.

Just like retailers, health insurance companies sit in between the producers of healthcare services –hospitals and physicians – and the ultimate consumers of those services, i.e., patients. The more health plans there are, the smaller each of them will be, and that means they’ll have to pay higher prices to health providers, particularly if there are big hospital systems in the community that can demand high prices from small health insurance companies. It also likely means the health plans will have higher administrative costs as a percentage of healthcare costs, since smaller health plans will have fewer economies of scale. Both of those things will push insurance premiums up. The only thing that competition among the health plans will reduce is their profits.

On balance, having more health plans will be more likely to increase premiums than to reduce them. Under the federal Affordable Care Act, health plans can only retain 15-20% of their premium revenues for administrative costs and profits; the remaining 80-85% must be spent on health care services and quality improvement activities. Even if greater competition among health plans resulted in, say, a 25% reduction in their administrative costs and profits, that would reduce premiums by at most 5% (i.e., 25% of the maximum 20% of premium that can be spent on non-medical expenses), whereas if bigger health plans could negotiate a 10% larger discount on the prices paid to healthcare providers, that could reduce premiums by 8% or more (10% of the minimum 80% of premium that’s devoted to medical expenses).

In fact, research indicates that having more health plans increases the prices paid for healthcare. For example, a 2010 study by Carnegie Mellon Professor Martin Gaynor and colleagues found that having five health insurers in a region instead of four would increase hospital prices by 7%, and a 2011 study by University of Southern California Professor Glenn Melnick and his colleagues found that hospital prices in markets with more health plan competition were 13% higher than in markets with a small number of large health plans.

It’s important to note that what counts is not the total size of the health insurance company, but how many people it insures in the local region, i.e., its local market share. When large national insurance companies enter a market, they may offer lower premiums than existing health plans, but it’s probably not because they’re getting lower prices from hospitals; it’s more likely that they’re just setting their prices below their costs in order to build their business, and paying for those discounts by charging higher premiums in other regions.

Unfortunately, although having bigger health plans can help businesses and consumers pay lower prices for healthcare services, it can also unintentionally encourage the creation of large, monopoly health systems. Since big health plans can demand bigger price discounts from smaller hospitals and physician practices than from large systems, small providers may be forced to either go out of business or merge with the large systems. This is a problem because of the growing evidence nationally that high healthcare costs are being caused by the high prices demanded by large, consolidated health systems. For example, research by University of California Professor James Robinson found that in markets where there were fewer hospital systems, prices were 13%-25% higher for a range of cardiac and orthopedic procedures.

The solution to high healthcare costs isn’t to change the number or size of health plans. The solution is to completely change the way we pay for health care:

• Hospital systems should be expected to compete on both cost and quality. Instead of secretly negotiating prices with health plans, they should make both their prices and quality measures public, charge the same price to all patients regardless of the type of insurance they have, and offer warranties on their care. For example, the Geisinger Health System in Central Pennsylvania now offers cardiac surgery, maternity care, and a number of other procedures for a single, total price, and they don’t charge extra when errors or complications occur.

• Patients need to take responsibility for comparing hospitals on both their cost and quality, and to pay more if they choose expensive hospitals when other hospitals offer high quality care at a lower cost. For example, Massachusetts Blue Cross Blue Shield is asking patients to pay higher copays when they choose higher-cost hospitals.

What we need from health plans is for them to implement new payment systems and benefit designs that support effective competition by providers and more value-based choice by patients. Instead of trying to get more health plans in the region, employers should be choosing the health plans that will support a rapid transition to higher-quality, lower cost healthcare.

(A version of this post appeared as the "Regional Insights" column in the Sunday, April 1, 2012 Pittsburgh Post-Gazette.)


Anonymous Health Insurance Jacksonville Fl said...

Instead of trying to get more wellness programs in the area, companies should be selecting the wellness programs that will support a fast conversion to higher-quality, cheaper medical care.

1:34 AM  

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