Let’s head to fantasy land — no you perverts, not that one… the one where Econ 101 is an accurate description of how the health service markets work. In this world, information is widely disseminated, products and services are clearly differentiated, no single buyer or seller has enough market power to set or demand a price that differs from marginal cost, and all costs and benefits of a purchase/no purchase decision accrue to only the parties involved in a deal.
Yes, as I specified this is fantasy land. It is also the model that fuels the belief that the free market will solve everything so that everyone including those without significant incomes or assets will be better off than today’s status. The model is neat, it is clean, and it is wrong.
Now let’s get down and dirty talking about payer-provider negotiations and agreement zones.
In economics, there is a concept called the GINI coefficient or GINI ratio. It can be a measure of concentration within a segment. The GINI coefficient is the sum of the squares of the proportion of market share of all providers. A perfectly competitive market with numerous participants in it will have a GINI co-efficient approaching zero. A perfectly non-competitive market with only a single supplier will have a GINI coefficient of 1.
There are two relevant markets for health care services. The first is the market of paying entities. These can be insurance companies, state governments for Medicaid and CHIP, the federal government for Medicare and individuals who are uninsured. The second market we need to be aware of is the providers of medical services.
If we take a ratio of the Provider GINI Ratio to the Payer GINI Ratio, we can make some strong inferences about how the local health insurance market works and where relative prices lie.
If the ratio of ratios is close to one, the providers and payers are evenly matched. If the ratio is significantly above one, providers have a market power advantage as the largest provider groups control a significant chunk of sub-markets that the payers need access to. If the ratio is significantly below one, the payers have market power. They can pressure providers to take low rates.
The above is a simple first step to understanding how prices are negotiated. The second step is an extension of the case where both providers and payers are evenly matched. There are two scenarios where payers and providers are evenly matched.
The first scenario is when the payers and provider are both highly concentrated. This means there is a dominant payer and a dominant provider. The policy impact is that these two groups will butt heads and usually find ways to grab almost all of the potential consumer surplus because individuals buying insurance and groups buying insurance have no other good options and the insurance company has no other option but to contract with the dominant provider group.
The other scenario is that the providers and payers are matched but both are fairly fragmented. In this case, the basic econ 101 analysis actually is useful. Everyone has options and everyone has the ability to shop around for a better deal, so prices are fairly low for both insurance and actual reimbursed medical services.
Once you have built a mental model of relative local concentration of payers and providers, the structure of negotiations becomes apparent.
Dominant insurers use their ability to steer hundreds of thousands patients to or from different providers as a stick to get rates that are based on Medicare with a small kicker. This works because a dominant insurer does not need to get every provider in a specialty or concentration into the network. They just need to get enough providers in network to satisfy state regulators. Providers who don’t take the low rates from the dominant insurer have a hard time making up at higher price points the revenue they lose in volume. Areas where there is a single dominant provider in either the entire market or a critical set of specialties will see the providers tell insurers “You either take my rate, or you can’t sell in this county as I’m the only provider in the region…”
State regulation can often come into play here. If a hospital is the only hospital in a county in the middle of nowhere, it will often be declared a vital service and it will be made to take high but in-network rates from all carriers.
Areas where there are a multitude of medium and small payers who can’t threaten the economic existence of a multitude of fragmented providers see effective competitive bidding. Providers can not name their price as insurers and other payers can walk across the street to another provider and sign a deal. Insurers can’t force prices down too much as each individual provider has half a dozen other options to make a living. And finally, areas where there is a single dominant provider and a single, dominant payer see very nasty fights over rents.
This analysis can apply to the entire provider-payer matrix within a region or it can apply to only a few specialties. It is quite possible that a region is mostly competitive and fragmented in primary care and community hospital services while there is a provider concentration advantage in cardiology and dermatology.