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The biggest insurers in the U.S. are merging- and in *some* places that could be a good thing

cigna gavel

Well this report from The New York Times about a recent wave of mergers among giant insurance insurance companies sure sounds ominous:

The nation’s five largest health insurance companies are circling one another like hungry lions closing in on prey.

On Friday, Aetna said it would acquire its smaller rival Humana to create a company with combined revenues of $115 billion this year. Anthem is stalking Cigna. UnitedHealth Group, now the largest of the five, is looking at its options. At the end of the maneuverings, three national behemoths are likely to emerge.

Senate majority leader Mitch McConnell (who represents Kentucky where Humana is headquartered) was, of course, quick to blame Obamacare, saying, “The many layers of regulation spawned by the law mandate less choice and reward bigger scale over more competition.” McConnell is mostly wrong– new regulations aren’t the thing motivating insurers to consolidate. Insurers, like companies in any industry, have always eyed mergers as a way to increase market share and profits. The timing of the current deals is related to Obamacare though. The law’s coverage expansion has poured a lot of money into the insurance industry, meaning big insurers have a lot of cash available to acquire other companies.

What’s more interesting though, is the underlying assumption that these mergers are bad news everywhere. If health insurance worked like most other industries, that might be true. However– and this is pretty much our mantra on this site– healthcare is weirdly complicated. In certain places, less competition between insurers could actually be good for consumers.  

Why health insurance is different

If you’ve tried purchasing plane tickets or had to call your cable company’s customer service department lately, you know that when an industry is controlled by a handful of powerful mega-corporations, it generally doesn’t mean great things for consumers. And the same concerns about consolidation– possible collusion to keep prices high and abysmal customer service– apply to health insurance too.

But on the other hand, insurers are the only thing keeping increasingly powerful healthcare providers in check.

Insurers have basically two roles. One is purely administrative– they manage a risk pool and pay out claims, The other is as a healthcare price setter– negotiating with providers to determine what they’ll be paid for the health services they provide. Trying to pay for healthcare on your own is miserable– doctors and hospitals know that for a serious health problem, an uninsured patients is stuck paying whatever rate they charge (even if it means going bankrupt to cover it) and price gouge accordingly. Insurers get better deals by combining the bargaining power of the thousands and thousands of patients they represent. The more of the market your insurer controls, the more power it has to negotiate lower rates from providers like pharmaceutical companies, device manufacturers, and health systems, many of whom are giants themselves.

In other words, with health insurance, it’s not just the balance of power between insurers that’s important, but also the balance of power between insurers and healthcare providers. As Len Nichols, a health economist at George Mason University, put it to the New York Times, “What it all comes down to is the relative market share between plans and the hospitals.”

Four different scenarios

This stuff gets really complicated really fast, so to help get my head around it, a while back I spoke with Richard Mayhew, an insurance expert who blogs at the website Balloon Juice. He said there are basically four different ways the balance of power (which remember is based on market share) between insurers and providers can play out in a region:

insurer provider market concentration chart

Fragmented insurers, fragmented providers. According to Mayhew, the best case scenario is the upper left box– you’d have insurers and a bunch of providers, with no single company really dominating. It’s what economists would call perfect competition— no one controls enough of the market to set prices, meaning providers can’t charge rates that are too high, and insurers can’t pocket extra savings. In theory, consumers get good prices on good care.

However, this scenario is more of an economics textbook ideal than anything; in the real world providers everywhere have been merging, for a couple reasons. Partly it was an unintended consequence of the last wave of insurance company mergers that helped bring prices down in the late 1990’s. Former insurance executive Wendell Potter writes, “Hospitals have merged with each other to regain the negotiating clout they lost temporarily after consolidation in the insurance industry.”

It’s also partly a response to new incentives under the Affordable Care Act. There are many provisions in the law to move away from fee-for-service payments– where providers are paid for every single procedure– and towards a system where providers are paid a set amount per patient or per illness. The idea is that we can save money and improve quality through better coordination of care if one provider– say an Accountable Care Organization– is responsible for all of a patient’s healthcare needs. The flip side though, is that by encouraging providers to merge, it also gives them more power to demand higher rates from insurers.

If providers are already consolidating, then we’re left with the two scenarios on the right of the chart: regions with a handful of powerful providers and either (1) a fractured insurance market, or (2) a handful of equally powerful insurers.

1. Fragmented insurers, concentrated providers. The worst case scenario for a local health care market is when you have a bunch of smaller insurers and only a handful of giant providers. As Mayhew describes it, “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…'” These higher rates turn into higher premiums for insurance customers.

2. Concentrated insurers, concentrated providers. As long as the big insurer doesn’t have a monopoly, this is probably the second best case scenario, according to Mayhew. He writes, “As long as there is no evidence of collusion, big payers fighting big providers keeps pricing reasonable although quite a bit of market surplus is consumed as both sides piss at each other.” The downside is if one side makes a serious move to destroy the other. That’s basically what’s happening where I live in Pittsburgh– the giant provider (UPMC) decided to leave the networks of the dominant insurer (Highmark, BlueCross/BlueShield). Soon a large number of the region’s hospitals and doctors will be out-of-network for many people.

Another plus in the insurer column

Ok, so big insurers are nice because they can negotiate for lower rates from increasingly large providers. But who’s to say that a single dominant insurer doesn’t pocket the savings instead of passing it along to customers in the form of premiums?

Turns out the government does, at least somewhat. As Katherine Hempstead, director of the Robert Wood Johnson Foundation’s work on health insurance coverage, put it “The business is really regulated. … Their rates are scrutinized and they can’t just charge whatever they what.” Every state has an insurance commissioner who, thanks to the ACA, has the power to review premium increases; in many states the commissioner has the power to deny unreasonably large premiums.

The ACA also implements minimum medical loss ratios, meaning insurers have to spend at least 80% (in the individual and small group markets) or 85% (in the large group markets) on actual care. So if an insurer manages to pay really low rates to providers, this provision limits how much of that savings insurers can keep for themselves.

Is there a better way?

You probably noticed that all of this is stupidly complicated. You also might be questioning the wisdom of a system that depends heavily on a handful of monopolistic mega-corporations to keep other giant companies in check, even if they are heavily regulated. You’re not wrong.

The United States is pretty much the only industrialized country where individual insurers negotiate their own individual rates from providers– and it’s one of the main reasons our health care system is so freaking expensive. In other countries, either (1) the government is the only insurer and sets the rates providers are paid, in what’s called single payer, or (2) there are still multiple insurers, but they negotiate together (or the government sets rates for them) so that each provider is paid the same rate by everyone– that’s called all-payer rate setting. Their prices are much lower, because even the biggest insurers can’t get as good a deal as an organization representing every customer. That also means patients don’t have to worry about whether a doctor or hospital is in-network.

Here in the U.S., for some reason we’ve let providers completely off the hook. There’s virtually no regulation of their rates, so they pretty much charge whatever they can get away with. Until that changes, our best hope to keep healthcare rates down seems to be these big insurers or smaller insurers with very limited networks. If neither of those sounds great, then it’s about time to start a conversation about all-payer here.

Update 9/21/16: This is a post that’s been bugging us since we uploaded it. The main point is about balance– in some places where there are a bunch of small insurers and one or two powerful providers, mergers can be a good thing. At least in theory– since we wrote it we’ve seen more and more evidence that in most places when insurers merge they tend to just pocket the savings from negotiating lower rates. There’s still the ACA’s minimum medical loss ratio to prevent that, but it’s unclear whether that rule would be strong enough to lower premiums if there are just three enormous insurers covering 132 million Americans. Apparently the Department of Justice is also concerned, and this week announced that it is suing to stop the merger.

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