Concentrate on the problem

Bob Town: 83% of people in MSAs are in concentrated hospital markets (HHI above 2500) and that’s increasing. FTC oversight up. #HealthReform

— Janet Weiner (@weinerja) October 9, 2014

The HHI index for non-wonks is the sum of the squares of  marketshare of the top 50 providers in a given market multiplied by 10,000.  This is a more sophisticated measure of market power than just counting the number of providers as the same number of providers can lead to very different outcomes in pricing as the example below shows:

Concentrated	Marketshare	HHI Value		Dispersed	Marketshare	HHI Value
A	90%	8100		A	20%	400
B	2%	4		B	25%	625
C	3%	9		C	15%	225
D	3%	9		D	27%	729
E	2%	4		E	13%	169
Total	100%	8126		100%	2148

The dispersed market with five providers where the biggest provider has no more than 27% of the market is a reasonably competitive market where Econ 101 logic can come into play to a certain extent.  The concentrated market where a single dominant provider controls 90% of the market means almost all of the surplus value that could be present in a truly competitive market is captured by monopolistic profits as well as management capture for better hookers and more blow. 

My mental model of health care finance is heavily reliant on market power in two seperate markets; payers (insurers) and providers. 

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.

Obamacare/PPACA is mostly an insurance expansion piece with some provider reform.  The insurance expansion piece has several major components that are relevant.  The first is that more people can now afford insurance, and insurance has to be offered to everyone.  Secondly, the cost of entering the individual insurance market for a carrier has been lowered as the markets are far more predictable now and there is a shared language and platform to seel based on price, network and customer service quality.  This is a big deal.  And it has led to more insurers on the Exchanges.  Competition there is working.

However healthcare reform instead of just health insurance access reform is incomplete.  And this leads to a major problem and reform opportunity for the future.

Health insurance as an industry, especially on the Exchanges, will see more players and a diffusion of market concentration.  The introduction of co-ops as well as current insurers making plays for new markets that they can understand now is fragmenting the insurance market.  However the provider side is still consolidating.  The ratio of provider HHI to payer HHI is increasing which leads to providers having more pricing power:

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.

So where are the oppotunties for reform?  The easiest and quickest route is for the Federal Trade Commission to aggressively look at any hospital and major provider group consolidation/mergers/expansion  in regions where there is already a high level of consolidated provider market power.  This theoretically should have broad based political support as it would be pro-free enterprise instead of pro-exisiting business whose leaders and PACS contribute to local officials campaigns.  I would imagine that an FTC that aggressively blocks inter-state consolidation moves would get significant political pushback. 

The second major route would be similar to the route that systemically significant financial institiutions face now. SIFIs get extra regulatory attention and financial requirements, so major consolidated providers could see significant federal changes.  There could be a change in Medicare and Medicaid reimbursement tied to providers whose HHI scores exceed certain thresholds.  A small provider could see regular reimbursement rates, a provider entity that is a moderately concentrated group might see a 1.25% cut in Medicare reimbursement while a provider that on its own brings the regional HHI index to over 2500 could see a 3% cut.  I don’t know what the numbers or the formula should be, but the basic bet of the policy is to call the bluff of consolidation.

Consolidators often claim that their larger size leads to greater scales of efficiency and expertise which leads to better outcomes and lower net costs.  The other viewpoint is that consolidation is an act of monopoly power which leads to either greater profits, better hookers or more blow.  So if consolidators believe that they are more efficient, they would still want to consolidate even if they are getting paid less. 

Health provider reform is the next opportunity for systemic reform to bring down costs.