What’s Driving Provider Consolidation?

Michael F. Cannon

A congressional staffer recently asked me about whether ObamaCare contributes to producer consolidation in the health sector. I figured I would share my response.

Provider consolidation is a concern because greater consolidation means more market power and higher prices. I see three main drivers behind provider consolidation.

1. The first is government regulation generally. Regulation has high fixed costs but low marginal costs. The larger a firm is, the more it can spread those fixed costs and minimize their impact on price per unit. One of the unintended consequences of government regulation is imposes relatively greater costs on smaller producers, especially new entrants, and that it rewards scale. So the more you regulate an industry, the more consolidation you’ll get.
2. The second is government encouragement of excessive insurance. Various government policies encourage more comprehensive health insurance than consumers would choose on their own. That leaves consumers paying for more medical care via health insurance than they otherwise would. To the extent consumers pay via insurance, they don’t really care about prices. Insurers care about prices somewhat, but they face significant constraints when trying to negotiate lower prices or force providers to compete on price. Insurers’ main tool in this regard is to exclude a provider, drug, or device from coverage in order to wrangle greater price concessions. But insurers and providers both know that enrollees aren’t even purchasing their insurance with their own money, and therefore won’t see the savings from those strategies. Both insurers and providers therefore know that enrollees will rebel against any insurer that excludes the drug, doctor, or hospital enrollees prefer. In such an environment, providers know that if they consolidate, they can demand higher prices from insurers, who essentially have nowhere to go. So over‐​insurance rewards consolidation too.
3. The third is government pricing errors. Medicare often pays more for the same service when the patient receives it in a hospital than they do when the patient receives it in a physician’s office. As a result, hospitals buy up physician practices to capture those higher payments, which they then split with physicians. As Cato adjuncts Charles Silver and David Hyman write in Overcharged, “How do hospitals profit by turning some (but not all) independent physicians into employees? When you look at the physicians who become hospital employees, two things stand out. First, many of these doctors provide services that generate payments known as ‘site‐​of‐​service differentials’ that make it advantageous for hospitals to hire them. Second, many of these physicians refer patients to hospitals for profitable treatments. Some do both.” (The latter hearkens back to government encouragement of excessive insurance.) Often, the patient receives the service in a doctor’s office but because that physician group “affiliates” with a hospital, patients and/​or taxpayers end up paying more.

So to the extent ObamaCare (1) increases regulation generally, (2) encourages excessive insurance, or (3) expands government purchasing of medical care (e.g., via Medicaid), it encourages provider consolidation. As it happens, ObamaCare does all of these things.

ObamaCare also encourages consolidation in a way that concerns me less. It encourages providers to coalesce into “accountable care organizations” or ACOs. To the extent ObamaCare’s Medicare ACO experiments are encouraging providers to deliver care in a more integrated way, they could actually improve quality and/​or save money. There’s not much evidence of either actually happening, unfortunately. A review of 56 pilot programs that ObamaCare’s Center for Medicare & Medicaid Innovation launched found that while two ACO pilots saved money, at least as many other ACO pilots lost money, and “the majority of [pilots] do not show significant improvements in quality.” So ObamaCare isn’t covering itself in glory, here. Still, ACOs concern me less.

In Overcharged, Silver and Hyman explain how providers turn market power into higher prices:

Big, prestigious hospitals and practice groups can threaten to take their patients and go elsewhere, so insurers treat them well. Smaller hospitals and practices have less bargaining power, so they get short‐​changed, even when their services are better and less expensive. For these reasons, it is not surprising that the Massachusetts Health Policy Commission concluded that “much of the variation in inpatient hospital prices is likely unwarranted and reflects the leverage of certain providers to negotiate higher prices with commercial insurers.” Third‐​party payment keeps consumers ignorant, and hospitals are using the loyalty of ignorant and cost‐​insensitive consumers to rob everyone blind.

According to a published report, a 2016 study of New York hospi­tals also found that hospitals associated with systems that have large market shares “tend to be higher‐​priced as a result of the[ir] power … in contract negotiations.” Some hospitals were 2.7 times more expensive than others in the same region. And although hospitals often contend that they need higher payments from private insurers to offset underpayments by Medicare and Medicaid, the study disproved that claim. Hospitals that extracted larger payments from private insurers treated fewer patients covered by these gov­ernment programs. Finally, “hospitals with higher prices did not necessarily have higher quality,” and lower‐​priced hospitals were often no worse…

Consider North Carolina, a state with great university hospitals attached to Duke and the University of North Carolina. These institutions can extract top dollar from insurers by threat­ening to leave their networks unless paid to stay. But North Carolina also has many smaller hospitals located in rural areas. Those hospitals can’t steer big patient populations toward or away from insurers. Lacking leverage, they get bargain‐​basement rates. When “[a]sked why some hospitals [in North Carolina] charge so much, Gerard Anderson, director of the Johns Hopkins Center for Hospital Finance and Management, said, ‘Because they can. It’s not any more sophisticated than that.’”

The same goes for physician practice groups. Those with strong rep­utations and lots of patients receive larger payments than others. Because leverage and payments are connected so strongly, hospitals are consoli­dating and buying physicians’ practice groups. Maggie Mahar, a finan­cial writer and health care policy analyst, commented on these trends:

“Across the nation, hospitals have been consolidating, and when they do, they flex their market muscles. Few insurers are big enough to stand up to them.… Large specialty practices with a presence in the community enjoy market leverage [too]. And when physicians are employed by hospitals … those institutions use their market heft to lift doctors’ fees by as much 30 or 40 percent. The ‘bounce’ can be even greater.… ‘Blue Shield of California said that after one group of physicians based in Burlingame, Calif., came under the umbrella of the powerful Sutter Healthsystem in 2010, its rates for services increased about 140%. The insurer said it saw a jump of approximately 95% after a Santa Monica, Calif., group became part of the UCLA Health System in January 2011.’ ”…

The health care sector is a rough‐​and‐​tumble world where bargaining power matters and the strong players control large patient flows. This makes the sector hard for new entrants to break into. Upstarts with small numbers of patients are paid less than exist­ing health care providers even when their services are of higher quality.

In sum, established health care providers have little to fear from new entrants because innovators have difficulty competing with them on qual­ity or price. For the same reason, established providers can comfortably deliver care that is mediocre or worse and can take a pass on technologies that would help patients by improving quality or reducing cost. No matter what they do, patients will keep coming and payers will keep paying. It’s a very cozy arrangement, for everyone but the taxpayers and injured patients.

Read the whole thing.

While you’re at it, read also their latest book, Medical Malpractice Litigation: How It Works, Why Tort Reform Hasn’t Helped.