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January/ February 2014 After Obamacare

A frenzy of hospital mergers could leave the typical American family spending 50 percent of its income on health care within ten years—and blaming the Democrats. The solution requires banning price discrimination by monopolistic hospitals.

By Phillip Longman and Paul S. Hewitt

One thoroughly investigated example comes from what happened in 2000 when Alta Bates hospital in Berkeley, California (which was and is owned by the hospital chain Sutter), merged with a nonprofit hospital called Summit located two and a half miles away in Oakland. Prior to the merger, Summit officials predicted that it “would give them more clout in negotiating with health insurers,” and sure enough, that proved true.

In a 2008 working paper examining the consequences of the merger, FTC economist Steven Tenn found that Summit was able to raise the prices it charged different insurance companies from between 28.4 and 44.2 percent above what other local hospitals were charging. This was true despite the presence of seventeen other hospitals within a twenty-mile radius, underscoring how hyper local health care markets are.

Another example comes from Illinois, where Evanston Northwestern Healthcare Corporation merged its two local hospitals with nearby Highland Park Hospital in 2000. Following the merger, the new entity was able to grab price increases of between 11 and 17 percentage points beyond what non-merging hospitals in the area charged. At the time, hospital executives boasted in internal documents that

[s]ome $24 million of revenue enhancements have been achieved—mostly via managed care renegotiations [and] none of this could have been achieved by either Evanston or Highland Park alone. The “fighting unit” of our three hospitals and 1,600 physicians was instrumental in achieving these ends.

You may not be accustomed to thinking of hospitals and doctors as “fighting units,” but the phrase accurately applies to the raw power struggle between large-scale purchasers and providers of health care in what passes for the health care “market” these days. Basically, the pattern is that hospitals charge the highest prices to those who have the least power, starting with uninsured patients, who are charged the highest prices of all. Meanwhile, the price that hospitals charge to treat any given privately insured patient depends on whatever deal the hospital has struck with that patient’s insurance company. And who gets the upper hand in these secret deals is basically just a matter of who is bigger than whom, with all parties trying to shift costs onto others rather than competing to provide patients with better care.

Back in the 1990s, the balance of power tended to favor large-scale buyers of health care, as insurers and large employers set up “tight” managed care systems in the form of health maintenance organizations. HMOs forced providers to bid against one another for the privilege of being included in their networks. As a result, while American doctors, and particularly specialists, remained by far the highest paid in the world, they were forced to accept considerable reductions in income. In today’s dollars, the average incomes of specialists declined from $849,194 in 1990 to $610,469 in 2000. Cost savings from lower payments for services were the primary reason health care costs remained contained throughout 1990s. For a few brief “Goldilocks” years, health care costs grew more slowly than the wages of the average American and overall health care spending held constant as a share of GDP.

Yet following this brief interval of sustainable health care spending came the “managed care backlash,” a largely physician-led media and lobbying campaign centering on charges that HMOs were preventing doctors from performing, and even discussing, necessary care. Armed with talking points supplied in part by lobbyists, patients’ rights advocates argued that HMOs were costing lives. This populist theme of corporate callousness (amplified by the hit movie As Good As it Gets) resonated among healthy consumers exasperated by sluggish gate keeping and unstable relationships with primary care physicians, as both physicians and employers cycled among HMOs in search of better deals.

Today, researchers find no evidence that clinical outcomes deteriorated under managed care except in isolated occurrences. Indeed, in general, by cutting down on unnecessary surgery and other forms of overtreatment, managed care generally improved the quality of health care. Hospital stays did shorten and investments in costly technology waned, but not in ways that harmed patients. Meanwhile, nine out of ten dollars in cost reductions came from lower payments for services.

But that result could not hold. The backlash against managed care weakened the bargaining position of insurance companies and other large purchasers of health care by discrediting the narrow networks and utilization reviews that insurers had used to bargain down prices and limit unnecessary volume. Even more significantly, providers resolved to fight back by bolstering their market power through mergers and acquisitions. And as they consolidated in more and more markets, they were more and more able to dictate to insurers and other purchasers of health care what its price would be.

Today, the effects can be seen in the prices providers receive for the same procedures in markets with different degrees of concentration. For example, Berkeley health care economist James C. Robinson has studied the prices hospitals charge insurance companies (and, by extension, insured patients) for different procedures. In concentrated markets, the price for a pacemaker insertion averages $47,477, but in markets that remain comparatively competitive the cost of the procedure averages $30,399.

Similarly, providers in concentrated markets make far larger profits on the procedures they perform. Thus, for example, in concentrated markets, the average hospital makes a return of $20,000 above its direct costs on every angioplasty it performs. But in more competitive markets, while the margin is still astoundingly high, at $10,900, it is nonetheless 90 percent less than in concentrated markets.

More evidence of how consolidation is driving up health care costs comes from Massachusetts Attorney General Martha Coakley, who subpoenaed claims data (reflecting negotiated prices) and contracts from health plans and providers in her state. By examining the behavior of individual hospitals and physician practice groups, Coakley’s office was able to document a strong link between market concentration and price. Within markets, prices charged for the same services typically varied by 200 percent or more. This variation correlated almost exclusively with “leverage”—the relative market position of the provider. Prices did not correlate with quality, patient mix, or a hospital’s status as a research or teaching facility.

The market power of some so-called “must have” hospitals is now virtually unchallengeable. These are hospitals that insurers must include in their networks in order to be able to sell policies in a given area because the hospital enjoys a local monopoly or a particularly strong brand or reputation. Such hospitals use their market power to win “anti-steering,” “anti-tiering,” “guaranteed inclusion,” or “product participation parity” clauses that forbid insurers and employers from using copayments to steer patients toward less costly providers. Thus, a hospital in Oakland might dictate to an insurer: You are forbidden to even tell your customers that they could receive lower-cost chemotherapy at that other hospital in Berkeley.

Phillip Longman and Paul S. Hewitt are, respectively, a senior editor at the Washington Monthly and the author of Best Care Anywhere: Why VA Healthcare Would Be Better for Everyone; and a former deputy commissioner for policy at the Social Security Administration and current vice president for research at the Council for Affordable Health Coverage. The views expressed in this article do not necessarily reflect those of the CAHC or its members.

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