Insurer Market Structure and Variation in Commercial Health Care Spending

Concern over high health care premiums among commercially insured Americans has created considerable interest in promoting competition in the insurance industry. For example, the Affordable Care Act calls on states to create insurance exchanges. Yet the impact of insurance competition on market outcomes is complex because of the interaction between insurers and health care providers (e.g., hospitals and physicians). While insurer competition may reduce the spread between insurer costs (largely the cost of medical care) and premiums, insurer competition may also increase the amount that insurers spend for care because it reduces insurer market power relative to providers. Specifically, prices in the commercial sector are the result of negotiations between insurers and providers. Concentration in the insurer market implies greater bargaining power for insurers and thus potentially lower prices paid to providers (Philipson et al. 2010). Research on provider market power suggests cause for concern. Prices paid by commercial payers for care rise with physician concentration (Dunn and Shapiro 2012), and higher hospital market concentration is associated with higher prices for orthopedic and cardiovascular services (Robinson 2011). In addition, hospital consolidation results in substantial increases in hospital prices (Melnick, Shen, and Wu 2011; Gaynor and Town 2012). The extent to which providers can exercise this market power may be related to insurer concentration (or conversely insurer competition). In fact, a growing body of evidence suggests that prices for hospital care fall in more concentrated (less competitive) insurance markets (Moriya, Vogt, and Gaynor 2010; Melnick, Shen, and Wu 2011). These results imply that more concentrated insurance markets can counteract the price-increasing effects of hospital concentration. The reduction in prices does not necessarily imply a reduction in medical spending because utilization may be related to insurer competition (or related to the changes in health care prices that reflect insurer competition). In fact, Bates and Santerre note that in markets with both insurer and provider market power, the reduction in prices may move the market toward an outcome that approximates the competitive outcome because insurer market power may counteract (or overwhelm) provider market power. In markets without provider market power, the reduction in prices associated with insurer concentration may lead to a monopsony outcome (Bates and Santerre 2008). One way to distinguish among these effects is to examine utilization. If insurer market power is offsetting provider market power, one would expect utilization to rise as prices fall. For example, if one imposes a binding price ceiling in a monopoly market, price falls and quantity rises. If instead provider markets are competitive and insurer concentration creates more monopsony power, one would expect utilization to fall as prices fall. For example, a binding price ceiling imposed on an otherwise competitive market would cause utilization to fall as prices fall. Bates and Santerre (2008) report evidence that hospital volume rises with insurer concentration, consistent with the view that insurer concentration offsets provider market power as opposed to generating monopsony power. Existing literature has focused predominately on the impact of insurer market structure on hospital prices, with less research examining the impact across all types of services (e.g., physician services) and spending. The impact on overall spending is important because it is most relevant for premiums. Recent evidence, based on a single merger, found that the insurer merger increased premiums by approximately 7 percentage points (Dafny, Duggan, and Ramanarayanan 2012). Because this includes insurer markups as well as spending effects, it does not address the underlying question about the impact of mergers on prices of care, utilization, and medical spending. In this article, we extend the existing literature on geographic variation by examining the relationship between insurer concentration and spending across all types of services, and further examining the components of spending, measures of prices, and utilization. Given our research design, our work should not be interpreted as implying a causal relationship. For this reason, we do not advocate for less (or more) insurer competition. Our intent is to illustrate an important concern. Specifically, some of the gains from greater insurer market competition may be offset by reductions in provider market competition. This does not imply that we should have monopoly insurers, but it suggests that policies aimed to increase insurer competition may not achieve all possible savings if the gains in insurer market competition lead to less provider market competition. The policy solution may not be to impede insurer competition. It may just make the need to address the problem of high provider prices more imperative. Moreover, some may argue that fee reductions associated with insurer consolidation reflect monopsony power. Understanding the relationship between price and quantity across areas can shed light on that discussion. Specifically, there are many models of competition/bargaining and we do not have a strong attachment to any particular one. The insight from many such models is simple: If the market power on any party rises, the price will generally shift in that party's favor. In our case that would imply greater insurer consolidation would lead to lower prices for care. The impact on quantity is more ambiguous, depending on the initial equilibrium. In general, if the starting price is above the competitive equilibrium, one could tell a story of price reduction leading to higher quantity as the market moves down the demand curve (assuming the demand curve is binding). For example, with a lower price insurers may devote less effort to reducing utilization if those efforts are costly. Alternatively, if the starting price is at or below the competitive equilibrium, we would expect the drop in price to lead to lower quantity as the market scales back along the supply curve. As a general point, observation of prices falling and quantity rising is more consistent with moving toward a competitive outcome than a monopsony one. The welfare consequences of insurer consolidation are more complex. Drawing strong conclusions would require us to know the value of the increased utilization and adjust for the markup in the insurer market. Our societal goal is not simply perfect competition in the provider market. We must worry about premiums. And we would need to worry about the cost of mitigating imperfect competition in either provider or insurer markets.