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BlogRX - Taking the Pulse of the Healthcare Industry

Healthcare is Becoming an Oligopoly

The healthcare industry is becoming an oligopoly, which could portend bad news for consumers.

An oligopoly is an industry structure in which market power is shared among a few large producers.  Although some small producers may also operate in the market, a few large firms dominate.  Though it’s possible that an oligopoly can be competitive and result in high output and low cost, most often market dominance leads to higher prices, less innovation and a loss of social welfare.  The latter result invariably occurs when the industry is also characterized by information asymmetry, e.g., where healthcare providers have more and better information about cost and quality than consumers.

The accelerating pace of healthcare industry consolidation is readily apparent:

Health Insurers

The five largest U.S. health insurers have just shrunk to three, with Anthem’s $48 billion acquisition of Cigna and Aetna’s $38 billion purchase of Humana.  Of the previous five largest insurers, only UnitedHealth Group has sat out the merger wave, at least so far.  Once the mergers are complete, the three largest insurers will control over 130 million covered lives.

The economics of the consolidation are supported by the Accountable Care Act, which rewards scale over competition.  Benefits are standardized, premiums are de facto price-controlled and margins have compressed to commodity levels.  Buying more consumers via mergers is a more appealing option for a health insurer than trying to attract them with innovative products, to the extent the latter is even still legal.

Employers are rightly concerned that this consolidation will be disruptive and lead to a reduced number of coverage options.  A recent employer survey by Aon PLC found that 46% of employers believe the mergers will result in fewer health plan options for their employees, compared to fewer than half as many who believed it will result in better service.

Hospitals and Health Systems

Hospital mergers have climbed every year since 2009, and in 2014 the number of closed deals was 50% higher than the number in 2009.  Three of five hospitals now belong to a system.

In addition to hospital mergers, large regional and national health systems are also rapidly consolidating.  Deloitte recently modeled how far consolidation might go and concluded that within the next ten years the current number of health systems will shrink by half through merger and buyout.

Hospitals have used the market power that results from consolidation to increase their prices.  Data from the Health Care Cost Institute shows that for the three year period 2010-13, hospitals increased the price of inpatient services, even after adjustment for changes in service intensity, by over 22%, more than four time the comparable increase in physician pricing.

Physicians

Physicians have traditionally been the odd-man-out in healthcare consolidation, but they are rapidly catching up.  As the rest of the industry consolidates, growing numbers of physicians are opting for direct employment with hospitals, health systems, and large practice groups. Recent staffing surveys indicate that between half and two-thirds of current physician practice opportunities or searches are for employed positions.

The movement is definitively toward larger, more integrated, economically aligned physician organizations. These can take the form of hospital employment or large, clinically integrated networks (CINs).  Increasingly, physicians and hospitals have interdependent economic destinies.  Without some form of alignment, it will be increasingly difficult for physicians to access managed care contracts in the newly formed integrated care organizations created by the Affordable Care Act.

The Effects of Consolidation

Supporters of health industry consolidation claim that by leveraging their size, payers and providers together have the potential to improve quality and rein in costs by sharing data and best practices.  So far, however, the evidence has not borne this out.  To the contrary, a thorough examination of the research literature reveals that to date, hospital consolidation has reduced quality and lead to higher prices, often exceeding 20% in highly concentrated markets.  Moreover, the rise of cross-market mergers to create regional hospital mega-systems has allowed these systems to demand and receive “all or nothing” contracts in less urbanized out-markets, increasing net reimbursements in out-markets by 14% – 18%.

When insurers negotiate commercial reimbursement rates, larger providers can and do extract higher markups.   Because most people consume medicine where they live, the side with most market leverage can extract higher rents. Insurers can exclude hospitals from their networks, but not if there are few local alternatives. In short, a growing body of evidence suggests that today’s hospital consolidation is more about revenue maximization than efficiency.

John McCracken, PhD