The Threat of Health Care Market Consolidation

by Reihan Salam

Private insurers often play the role of villain in health policy debates. But private insurers are at the mercy of medical providers, particularly those with a great deal of market power. If I’m a private insurer, I have little choice but to play ball with the dominant hospital group or health system in a given region. Because hospitals are obligated to provide care to those who can’t afford to pay for it, governments at all levels have acquiesced as hospitals have consolidated. The idea is that hospitals will use their pricing power for the greater good, to provide uncompensated care and to more broadly serve their communities by, for example, subsidizing the training of medical professionals. It’s not at all clear, however, that this cross-subsidy strategy is the best way to make high-quality medical care more affordable and accessible. Innovative medical providers often find themselves stymied in their efforts to offer low-cost alternatives in regions dominated by politically powerful hospital groups. This in turn means that the cost of medical care, compensated or uncompensated, is higher than would be the case in a more competitive market. 

In theory, the Affordable Care Act was designed to do away with the problem of uncompensated care by dramatically reducing the number of uninsured individuals. With the uncompensated care problem “solved,” there would presumably be less need for the public sector to stand idly by as hospitals consolidate to increase their pricing power. As Chris Pope observes in a new report from the Heritage Foundation, however, the Affordable Care Act has if anything exacerbated the problem of monopoly pricing power in medical care. Yet the story of government’s role in driving provider concentration is not primarily about the Affordable Care Act. The bigger culprit is Medicare, the single-payer health system that represents just over a fifth of all health expenditures in the U.S.

The story behind hospital consolidation is fairly straightforward. Patients strongly prefer medical providers that are close to them. They are shielded from the high cost of care by third-party payment. Local hospitals can thus demand high reimbursement rates from payers in their regions, as customers will revolt if their insurers fail to give them access to name-brand hospitals within easy commuting distance. As hospitals consolidate, their bargaining power over public and private payers steadily increases. 

In a sector dominated by for-profit firms, this bargaining power would translate into higher profits, which government would then be tempted to tax away. But most hospitals are either publicly-owned or they are nonprofit organizations. The high reimbursement rates that flow from bargaining power helps subsidize bloat: more or more generously-compensated staff than is strictly necessary, underutilized facilities, and a lack of spending discipline across the organization, among other things. This bloat is part of motivation for consolidation. Some hospitals are too small or cover too small a region to operate cost-effectively, and Pope explains that mergers of small hospitals have yielded real efficiencies. Mergers of larger hospitals, however, rarely yield significant efficiencies; these mergers do little more than increase pricing power. 

When managed-care organizations (MCOs) gained ground in the 1990s, they used their power to exclude inefficient providers from their networks to hold down costs. Hospital consolidation made it harder for MCOs to exclude a given provider, as it left them with fewer options to choose from. Pope also cites “any willing provider” laws as a restraint on the ability of MCOs to press for efficiency. In the political conflict between MCOs and hospitals, the hospitals had a big advantage: they weren’t evil pencil-pushers trying to deny care; rather, they were your friendly medical provider, always eager to provide it. And when hospitals commanded high reimbursement rates, they insisted that they plowed the money into higher-quality care. According to Pope, the real effect was almost exactly the opposite: the absence of competition meant that high reimbursement rates led to “organizational slack, weaker accountability and performance, and lower-quality care.” Hospitals in regions with little provider competition are less likely to use the best medical equipment and they appear to result in poor health outcomes for heart attack and pneumonia patients. 

Pope warns that regulatory solutions to the problem of hospital consolidation, like more aggressive price controls, will fail because they address the symptoms of hospital consolidation rather than the root causes. (He also points to business models, like ambulatory surgical centers that specialize in certain procedures, that can help drive down costs.) Earlier efforts to contain cost growth through regulation, like state-level certificates of need (CON) laws that regulate hospital capital expenditures (which can determine the number of beds in a facility, its ability to deploy expensive technologies, etc.), over time came to shield dominant hospitals from competition. States that have eliminated CON laws, meanwhile, have seen lower health care cost increases than those that have retained them. 

And so Pope focus on the role of Medicare, which reimburses general hospitals at far higher rates than more efficient ambulatory surgical centers and other independent medical providers. These higher reimbursement rates are justified on the grounds that hospitals care for sicker, older, harder-to-reach patients, but the higher reimbursement rates are not limited to those patients who are in fact sicker, older, and harder to reach. Hospitals are effectively rewarded for underperforming and for spending excessively. When they generate losses by, say, paying inflated prices, they are more likely to receive subsidies for uncompensated care. It is true that hospitals are obligated to provide emergency medical care. Yet emergency rooms can generate substantial revenue for hospitals by accounting for half of inpatient admission. Moreover, the rise of for-profit emergency rooms demonstrates that these services can be provided efficiently. Government-owned and nonprofit hospitals have little incentive to reveal how lucrative these services can be or to run them efficiently. 

In his critique of Obamacare, Pope emphasizes the ways it shields incumbent insurers from competition and prevents new benefit designs from emerging. The law encourages medical providers to organize themselves into Accountable Care Organizations. The goal is to foster productivity-enhancing vertical integration; but Pope maintains that ACOs will also foster horizontal integration that further dampens competition. Independent physicians will face intense pressure to join this integrated organizations as the administrative complexity of operating under Obamacare increases. Overall, I’d say Pope sees Obamacare as playing a fairly limited role in the hospital consolidation story — its failure is that it did so little to reverse the trend, thus belying its claims to remaking the American health system in a way that will eventually yield lower costs and higher quality. 

The heart of Pope’s argument is that sanctioning hospital consolidation and monopoly pricing power as a means of achieving other desirable outcomes, like care for the indigent, is foolish. The government is trusting that hospitals will use revenue from high reimbursement rates to cross-subsidize other desirable services, yet hospitals have generally failed to do so in a coherent or cost-effective way:

Rather than propping up monopolists—and in the process punishing competitors for their relative efficiency—policymakers would better serve their constituents by limiting their interventions to targeted and explicitly funded measures to address specific gaps in the health care delivery system. While the justification offered for subsidizing general hospitals and allowing them to engage in monopolistic practices is a need to extend the provision of care, the result has been to create captive markets that are unresponsive to patients and able to impose unnecessarily inflated prices on the broader community. As a result, taxpayers are often forced to pay several times over for the same supposedly “uncompensated care,” which nonetheless remains inadequately supplied.

Pope ends his report with a series of broad recommendations:

Refuse to prop up monopoly power. Government regulation and spending should not shield dominant providers from competitors. Monopolies are irresponsive to the needs of patients and payers. They are an unreliable method of subsidizing care that tends to both lower quality and inflate costs.

Repeal certificate-of-need laws. Legislative constraints on the construction of additional medical capacity should be repealed. Innovative providers should be allowed to expand or establish new facilities that challenge incumbents with lower prices and better quality.

Subsidize patients, not providers. Public policies should be provider-neutral. Payments should reimburse providers for providing care, period. In particular, publicly funded programs should not operate payment systems designed to keep certain providers in business regardless of the quality, volume, or cost of the treatments they provide. If some individuals are unable to pay for their care, policymakers should subsidize such needy individuals directly.

Allow patients to shop around. Wherever possible governments and employers should put patients in control of the funds expended on their care, and permit them to keep any savings they obtain from seeking out more efficient providers.

Repeal Obamacare and its mandates. Forcing individuals to purchase standardized health insurance establishes a captive market, making it easier for providers, insurers, and regulators to degrade services and inflate costs with impunity. Repealing Obamacare and its purchase mandates is essential to creating a market in which suppliers have the flexibility to respond to consumer demands for better value for their money.

In fairness, one can imagine a reform of Obamacare’s exchanges that would move us in this direction, though it would be a reform so thoroughgoing that most of the law’s Democratic supporters would oppose it.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.