Hospital Price Dispersion

A study by the Center for Studying Health System Change that will be released tomorrow shows that hospitals receive different prices for treating the same diseases. Center President Paul Ginsburg says this about the findings:

“The variation in hospital prices found in this study are (sic) inconsistent with highly competitive markets—at least for markets outside of health care,” said HSC President Paul B. Ginsburg, Ph.D.,

Hospital markets may not be highly competitive, but this argument is silly. One might as well say “The variation in automobile prices is (not “are”) inconsistent with highly competitive markets.” But one would be wrong in either case.

Vertical quality differentiation (i.e., some sellers are better than others) generates price dispersion in competitive markets. It is only in the most basic treatment of competition — in the first week of an intro economics course — that vertical differentiation is ignored. Observed price dispersion is not incompatible with competition.

Moreover, there is severity dispersion within diagnoses (e.g., some hospitals get the sickest patients within DRGs). Medicare ignores this when setting payment rates. But private insurers need not ignore this and can calibrate pricing accordingly. Hospitals getting sicker patients can get higher prices. Again, this is not incompatible with competition.

So what did we learn from this study? That different hospitals get different prices? We also see price dispersion for autors, and for dry cleaning and electric pencil sharpeners, for crying out loud. This isn’t news and there are no policy implications to be drawn from the study. But this is health care, so I predict this study will be front page in the New York Times, even if it fails to tell us anything we didn’t already know.

ACOs and the Looming Antitrust Crisis

The Federal Trade Commission recently held a day-long workshop focusing on Accountable Care Organizations. ACOs will vertically integrate hospitals and doctors and, in the process, achieve what previous incarnations of vertical integration could not. Let’s forget about whether ACOs will actually fulfill the dream of efficient healthcare delivery and focus on the FTC angle – will the creation of ACOs require the creation of provider market power and should he FTC therefore look the other way?

Many health economists have documented the perils of provider market power. Some of my own research has been instrumental in turning the tide against providers, whose monopolizing tendencies used to get a free pass from the courts. But as policy makers move ACOs to the fore, providers are hoping to sweep antitrust under the rug.

The latest salvo comes from the AHA, which last week released a study challenging two recent studies of hospital market power and then strains to connect their findings to ACOs. The AHA report goes a bit overboard in its criticism of these studies. One study consists of little more than anecdotes and should not be criticized for being anything else. The other study is more complex and the criticism is equally complex, mostly along the lines of “if you had measured things slightly differently, your results would have been slightly different.” The AHA report would have readers believe that these two studies represent the entire body of knowledge about hospital mergers. Having summarily dismissed them, the argument against FTC enforcement would seem complete.

The AHA report fails discuss two lengthy review articles prepared on behalf of the FTC and the Robert Wood Johnson Foundation, both of which find overwhelming published evidence that hospital consolidations lead to higher prices. I wrote many of the papers cited in both studies, and the theoretical and empirical advances that I made during the last decade helped form the backbone for FTC recent hospital merger enforcement policy. The authors of the AHA report seem to have ignored my work.

It is not hard to understand why. The reports’ authors work for Lexecon/Compass, a litigation firm whose economists have spent the past two decades testifying on behalf of merging hospitals. (Full disclosure: I sometimes consult on behalf of plaintiffs in hospital antitrust cases.) Over the years, the Lexecon/Compass economists have done exemplary work for their clients, convincing the courts that their clients lacked market power and therefore could not raise prices. Yet time and again these same hospitals substantially raised their prices after the mergers were consummated. The result is that market after market – from the Bay Area to Milwaukee, Cleveland, and Boston, just to name a few – is dominated by a vanishingly small number of hospital systems, and hospital prices have risen through the roof.

Even if we ignore the overwhelming evidence on the evils of hospital market power, it is important to ask what any of this has to do with ACOs. The AHA wants us to believe that all hospital mergers are just part of the effort to create ACOs. But ACOs are more about vertical integration between doctors and hospitals than they are about horizontal hospital mergers, and there is no obvious reason why hospitals have to merge for ACOs to work. Some hospital mergers do have a vertical component, such as when a teaching hospital acquires a community hospital. But my own research has shown that such mergers can increase profitable referrals to the teaching hospital while pushing unprofitable patients outside the system.

Hospitals may not have much of a case for relaxing antitrust enforcement, but physicians might. Like hospitals, many physicians have spent the last two decades merging with one another and have often faced antitrust challenges from the FTC. Physicians will argue that by organizing into groups, they can better afford the information technologies envisioned for ACO success and may also be better positioned to establish internal monitoring and control systems. While the argument is theoretical at this point, all of the benefits of ACOs are theoretical, and the doctors’ theories do have the benefit of being grounded in basic economics of organizations.

Parties to a merger are always quick to tout the synergies they will create and deny that their combination will lead to higher prices. Hospitals played this game with the utmost success in the 1990s and much of the 2000s, and the courts approved hospital mergers on the weakest of theoretical and empirical evidence. Now that the theory and evidence is weighing against mergers, hospitals are playing the ACO card. If they succeed, I fear that any hope of reining in hospital spending will be forever lost.

We’ve All Got the Blues

My late colleague, Walt McNerney, was president of the Blue Cross and Blue Shield Association in the 1970s. I miss him, but I am sort of glad that he doesn’t have to hear all the commotion being made over the profits reaped by today’s Blue plans. I wonder if he would say it was their own damn fault.

Founded during the depression, the Blues represented a win/win for patients who could prepay for their medical care and providers who received a steady source of revenue. The Blues were owned by the providers and Blue coverage was always the most comprehensive (the better to boost demand for medical care.) State laws granted the Blues tax exempt status and in exchange the plans community rated. This allowed for-profit insurers to cherry pick healthy enrollees but the Blues always kept dominant market shares in their territories.

When Walt McNerney took over the leadership of the association, Americans were upset about rising costs. The Blues were still respected insurers and Walt used his position to education Blue plan leaders about managed care. Blue HMOs became some of the most successful in the nation, paving the way for other insurers to offer managed care plans of their own. The Blues also experimented with payment rules and utilization review.

And then the HMO backlash hit. About the only feature of managed care that survived intact is selective contracting. Hospitals and insurers understood the importance of clout and hospitals in many markets merged to suffocate competition. But the largest insurers – the Blues – did not have to merge. Most Blues had market shares in their territories of 40 percent; many had shares above 60 percent. These shares have held steady over the years. With this leverage, the Blues can pay providers among the lowest rates while offering customers the widest networks. That alone guarantees market success, and huge profits.

Blue plan executives see the dollar signs. But nonprofit executives are banned from “inurement” (essentially, compensation based on profitability.) And so Blue executives convinced their boards to convert to for-profit status. They preached the mantra of economies of scale, but the evidence for such economies is minimal. They preached the mantra of capital but they mostly used their capital to enter new markets, and acquire existing plans, and gain even more clout. There was little in it for consumers.

Gone are the days when the Blues did well by doing good. Walt McNerney would hardly recognize many of today’s Blues, with names like Wellpoint, Excellus, and the utterly unimaginative Healthcare Services Corporation. (The latter is a “mutual” –it gets to call itself a nonprofit while paying its CEO about $10 million annually.) These Blues earn returns on assets that dwarf returns in most industries. (In fairness, some Blue plans remain nonprofit, realize minimal returns on assets, and honor the ban on inurement.) And while their total profits are a drop in the ocean of overall healthcare spending, the profit-seeking Blues have settled into a comfortable status quo where market power has become the overarching business strategy. Innovation in healthcare delivery? Forget about it. Payment reform? Forget about it. Let others take the risks. The Blues rake in the profits.

If market clout is their raison d’etre, why tolerate them?

The Cambridge Cabal

It is hard to imagine that fifteen years ago the private sector seemed to have figured out how to contain health spending. One third of privately insured patients were in HMOs and nearly all the rest were in PPOs. While insurers were experimenting with tight networks and capitated payments, providers were responding by forming integrated delivery systems and offering capitated models of their own. Private health inflation was nearly flat, even as Medicare and Medicaid spending continued to grow by double digits annually.

Everyone should know what happened next. Americans rebelled against managed care (the Boston Globe quipped, “People hate its guts.”) HMOs fell by the wayside, PPOs expanded networks to include even the least efficient providers, and powerful hospital systems emerged to dominate markets from coast to coast. Providers struggled to implement integration and capitation due to a lack of performance data. Why make the effort when insurers had reinstated no-questions-asked fee-for-service payments? We now suffer through the purgatory that is managed care “lite.”

Today’s Wall Street Journal calls for the private sector to again take the lead on cost containment. I am afraid that ship may have sailed. Private insurers have been made out as the villains in this drama and are reluctant to do much more than implement pathetic pay-for-performance schemes while standing back and waiting for the government to act.

And act it will. Don Berwick, a Harvard professor who was just nominated to take the reins at the Center for Medicare and Medicaid Services, is a big admirer of the British National Institutes for Clinical Excellence. NICE is a rationing board run by academics who study cost effectiveness data before deciding what services the Brits can receive. David Cutler, the brilliant Harvard economist who is likely to head the Independent Medicare Advisory Review Board, is another scholar of cost-effectiveness methods and is philosophically opposed to price controls. So when it comes time for Medicare to trim spending, you can bet that they will ration a la NICE. This will provide cover for private insurers to do the same. (I predicted all of this in my 2003 book What’s Your Life Worth? which was read by about 25 people who were not family members. I also called for a public discussion of rationing methods; it appears that NICE-style rationing will instead be implemented by stealth.) Medicare is also experimenting with bundled payments and stronger quality incentives; expect the private sector to again follow suit.

The future of cost containment is no longer in the hands of the private sector. Instead, a few bright, well-intentioned academics will call the shots at Medicare, with private insurers playing Monkey See, Monkey Do. Only the academic community cannot agree on the best course of action. Many of my colleagues believe that the state of the art of cost-effectiveness analysis – what they do at NICE and are likely to do at IMAB – is rather pathetic. I tend to agree. Academics also disagree about whether and how to implement bundled payments.

So a few Harvard scholars will soon get to decide what is the best way to control health spending. Except they don’t know what is best, they can only guess. Whatever they do will be an experiment; the entire health system will be their petri dish.

In my world, private insurers and providers would conduct their own experiments. Some would succeed, others would, and resources would flow to those that worked in practice and not just those that made sense in the seminar room. But I afraid that world no longer exists. By demonizing private insurers, the Democrats have made sure that cost containment will be the sole purview of the federal government. I hope that Don Berwick, David Cutler and the rest of their Cambridge cabal get it right. Unfortunately, there will be no way from them or anyone else to know whether they did or not. We will soon find out where their ideas will take us. We can only imagine where else we might have gone.

The Camel, the Needle, and the Massachusetts Connector

Last week’s events in Massachusetts should serve as a disturbing warning to those folks (myself included) who are crossing their fingers and hoping that exchanges will provide a long term fix to the inequities of free market health insurance. The Massachusetts Connector is the prototype for national health insurance exchanges. Last week, Massachusetts Governor Patrick announced that he would reject 90 percent of the requested premium increases for policies offered through the exchange. Insurers countered that they were losing money in the exchange and would withdraw their policies if premiums did not increase. Patrick fired back that insurers would not be permitted to do business in the state if they stopped participating in the exchange. No one knows how this will ultimately end.

This battle over premiums has exposed a critical weakness in the Connector. Although individuals face penalties if they remain uninsured, the fines are modest and many choose not to buy coverage. Not surprisingly, the uninsured are healthier than average. To make matters worse, individuals can move in and out of coverage at any time; the result is that shrewder individuals wait until they need costly medical care before joining the exchange. This drives up costs and has led to the premium spikes. This in turn pushes out relatively healthy individuals and leads to the death spiral that I blogged about last month.

It is a delicate matter to make an exchange work. Whoever is setting the rules for the Pelosicare exchanges will have to balance several objectives:

1) Encourage everyone to participate – offer high subsidies.
2) Avoid being punitive – keep the penalties for not buying coverage low. (Barack Obama derided Hillary Clinton’s proposal to mandate purchases but this was a sensible idea. Even so, mandates do not by themselves mean anything. Punishments must be meted out to those who fail to comply.)
3) Keep popular support for the exchange – ask all individuals to contribute towards their insurance so as to establish individual accountability and avoid further tax increases

It may be easier for a camel to pass through the eye of a needle than to meet all three objectives.

There They Go Again

Some former AMA Presidents have their turn in today’s Wall Street Journal to push for legislation allowing Americans to buy health insurance from insurers in any state. How exactly that would help remains a mystery. Consider my plight in Illinois. I can buy insurance from the local Blue Cross plan, or from United, Aetna, Cigna, or Humana, all of which have Illinois divisions. Let’s suppose I wanted to buy insurance from out of state. I happen to have data on Connecticut’s insurance market close at hand so I will use that as an example. If I wanted insurance from one of that state’s plans, I could purchase from a Blue plan, or from United, Aetna, or Cigna’s Connecticut divisions. Big help! Oh yes, there are also a couple of HMOs in Connecticut. The problem is that I would have to go to Connecticut to see a doctor. Pretty much the same story can be told for every state. We might well need more insurance market competition, but this isn’t the way to get it.

Are opponents to reform so intellectually bankrupt that this is the best they can offer?

Make No Little Plans or, How Republicans Can Be Meaningful Players in the Health Reform Debate

In a virtual carbon copy of their previous Wall Street Journal op-ed pieces, John Kogan, Glenn Hubbard, and Dan Kessler recently (9/25/2009) offered the standard Republican critique of Democratic health reform proposals before laying out their own agenda.  They are long on anti-government ideology and often fall short on economic principles.  But mainly, their ideas lack the power to bring about real change.  Daniel Burnham once said, “Make no little plans. They have no magic to stir men’s blood.”  Republicans have become the anti-Burnhams.

They start by trashing mandates to purchase insurance.  I would agree with them if the uninsured, upon falling gravely ill, had the good graces to forego charity care and die cheaply.  Thankfully, that isn’t how the system works.  Many, perhaps most, providers are willing to treat the uninsured and worry about payment later.  The uninsured are free riders waiting to happen.  We all ought to pay our fair share without forcing providers to go to court to press for payment.

Kogan et al. also trash the idea of uniform coverage, instead arguing that everyone should be allowed to buy the coverage that is best for them.  This type of argument almost always makes sense.  I like the taste of Ghirardelli chocolate, and when I purchase their candy bars this creates value for me and Ghirardelli alike.  And I don’t have to buy vanilla.  But if I feel prone to heart disease and load up on cardiovascular insurance, I am merely engineering a transfer of wealth from my insurer to me.  There is no value creation to speak of.  And what if I skimp on cancer coverage and my prostate goes bad?  Will the hospital turn me away?  Some benefit mandates are silly: acupuncture, podiatry, and so forth.  But these are a sideshow to the main event.

I agree with some of their concerns about the Democratic proposals.  It is foolish to predicate cost savings on future Medicare cuts.  And it is dangerous to predicate funding of insurance expansion on tax increases.  Add the Congressional Democratic tax proposals to proposed increases in state taxes and marginal tax rates will quickly exceed 50 percent.  Maybe this is a clever way to cut health care spending.  What surgeon would want to operate on a Medicare patient when fees are 25 percent lower and taxes eat up more than half of what is left?

All of this is window dressing to Kogan et al.’s own three-pronged proposal: allow insurers to compete across state lines, give a bigger push to high deductible health plans, and fix malpractice. None of these ideas are silly, but none will have much of an impact.  Most local healthcare markets already have 4-6 major carriers, including a Blue plan, United, Aetna, Cigna, and Humana, not to mention some local plans.  A few markets are down to 2-3 choices, but I don’t see how letting someone purchase insurance from Aetna in Massachusetts will improve competition for consumers in Connecticut, who already have a local Aetna option.   Besides, successful insurers must manage local provider networks.  Out-of-town plans won’t make a dent in most markets.

There is nothing wrong with high deductible health plans and the Democrats are committing economic malpractice by trying to limit out of pocket spending.  But unless we are willing to expose individuals to extremely high deductibles, these plans will not influence the marginal purchases of the most severely ill Americans.  And malpractice reform?  We already have it in many states and the best research suggests that if reform goes national, spending could drop by as much as 3 percent, giving us a four month respite from a decades-long cost spiral. This is hardly revolutionary.

It is time for Republicans to abandon their little plans.  Capping or eliminating tax deductibility of insurance is a good start.  But our best chance to make markets work is to reinvigorate managed care, which the Wall Street Journal and many Republicans once equated to socialized medicine.  Fueled by a revolution in health information technology, managed care in the 2010s would be a far cry from the much reviled HMOs of the past.  There have been many proposals to harness competition among managed care plans, from Alain Enthoven’s managed competition, to Stephen Shortell’s vision of competing integrated delivery systems.  These are big plans, worthy of those who truly believe in market-based healthcare.

My Right Wrist

David Dranove:

An article in the Sunday Chicago Tribune about hospital report cards reminds me of just how difficult it is for most consumers to shop for high quality medical care.  There is nothing more important than our health and there is abundant evidence that the quality of health care varies widely across providers and is often unacceptably low.  Yet consumers spend far more time shopping around for cell phones and DVD players than they do for hospitals and doctors.

Evanston Northwestern Healthcare

David Dranove

Will,

The recent 5-0 ruling by the FTC Commissioners in the Evanston Northwestern Healthcare (ENH) antitrust case was a real body blow to those of us who support competition in healthcare.  The Commissioners agreed with a federal district judge’s ruling that Evanston and Highland Park Hospitals had achieved excessive market power by forming ENH.  But instead of affirming the judge’s order to force ENH to split up, the Commissioners instead ruled that ENH could remain intact provided that the member hospitals set prices independently.  The FTC seems to be saying that it is okay for hospitals to dominate a market, so long as they do it with a nod and wink.