Making Price Competition Work

Wall Street Journal editorial writers and other folk with touching faith in classic economic theory wonder from time to time why competition doesn’t work better in the health care system. (Actually, the WSJ people are sure that it could, if it were not for government bureaucrats and their spendthrift liberal friends).

It does seem as if Adam Smith’s “invisible hand” is affected by a strange palsy as it nears the realm of health care. But why, given the legions of insurers and providers all apparently eager to edge each other out in the race for our dollars?

Theoretically, employer-sponsored insurance—more than 90 percent of non-government coverage—provides two competition opportunities: when the employer selects plans to be offered, and when employees choose from these plans (assuming that more than a single choice is available).

Unfortunately for the reputation of the invisible hand, employers picking insurance options won’t necessarily choose the best value plans. Cost issues aside, they’ll be influenced by the need to avoid the disruption and employee unhappiness that could result from changing plans. Employees won’t want to travel further to a provider, or switch specialists in the middle of treatment, or be forced to leave a well-liked family physician.  Large employers may try to sidestep employee concerns by offering a choice of plan types (like a PPO, an HMO, and a HDHP/HSA), but rarely competing plans within a type; smaller employers may be unable to provide any choices at all, unless they are provided by the same carrier.  The result:  the advantage of incumbency may allow an insurer to bid higher premiums, even though experience with the group should mean lower risk.

Not only are employers likely to lean towards an incumbent, they may find competing proposals impossible to compare. Only the largest employers have the clout to demand that insurers bid against the same benefit specifications; most will struggle to compare whatever off-the-shelf packages insurers believe to be approximate fits to their needs. And small groups—even those using a broker—won’t have that luxury; insurers will offer take-it-or-leave-it choices of their standard small group coverage. And, as in other business arenas, volume counts for a lot. Smaller employers face a double cost whammy: their business isn’t important enough to attract aggressive pricing, and individual risks can’t be pooled among thousands of other employees.

The invisible hand doesn’t shake off its palsy at the employee level, either. Although most workers will have some choice, it will be limited, and “best value” may be impossible to determine. Even more than at the employer level, employees—assuming the employer is paying most of the premium—will pick their coverage to maintain existing provider relationships; only those without such relationships or who must pay a substantial part of the premium themselves are likely to put cost first. If it’s available, HDHP/HSA coverage may appeal to the youngest and healthiest, but—alas for classic economics—at the expense of increasing premiums for other options.

For comparative purposes, it’s worth looking at government programs, if only to see how completely they ignore competitive principles. Medicare Advantage, far from allowing health plans to go head-to-head with traditional Medicare, subsidizes the plans by several percent while encouraging add-on benefits to ensure that comparison is impossible. The Medicare drug program is so popular (read profitable) with insurers that in urban areas there can be fifty or more plan choices, all with different combinations of formulary, pharmacy network, deductible, and monthly premium, proof that more competitors doesn’t mean more effective competition. (Pity the eighty-year-old who must navigate this muddle to pick the best value plan.) State Medicaid programs have tried to create competition among contracted health plans, but such attempts are undermined by inability to pass cost differences on to patients. FEHBP—proposed by almost-but-not-quite-Secretary Daschle as a key part of his reform plan—does rather better, offering a shorter list of choices directly to employees, but unfortunately one in which there is no actuarial equivalence that would help determine best value.

(The difficulties facing employers and employees are not the only failures of price competition in our current system. Elsewhere in the health care jungle, insurers face their own competition problems, which will be discussed in Part 2. Watch this space!)

Meanwhile, what can we do to make health insurance more price competitive? Let’s suppose for one wildly optimistic moment that we could redesign our system without having to worry about the armies of lobbyists for insurers, providers, big business, small business, the medical technology industry, and a raft of well-meaning patient and community groups.

Let’s suppose that insurance choices are made primarily by individuals, rather than employers, and that—except for low-income persons—they must bear some meaningful part of the premium cost. Not everyone will make a best value choice, but wouldn’t this result in much greater price sensitivity on the part of insurers and greater awareness of the implications of personal health decisions by individuals? 

Let’s suppose that we have a standard set of benefits, so that price differences between insurers are immediately apparent. This doesn’t have to mean “one-size-fits-all;” supplementary benefits could be available and priced separately, as they are in other nations with guaranteed health care coverage. Aside from provider network and customer service considerations, wouldn’t this apply the competitive pricing pressure that’s missing today?

Let’s suppose that insurance is guaranteed to be portable, without pre-existing condition limitations, so that the medical shackles that tie workers to their employers (and their insurers), solely to maintain coverage, are broken. Wouldn’t this help to assure that insurers remain price competitive?

Enough, for the moment, of this wild optimism. Part 2 will talk about the insurers’ problems and what in our fantasy world might be done to help the fine folk at our nation’s insurance companies.

Roger Collier was formerly CEO of a national health care consulting firm. His experience includes the design and implementation of innovative health care programs for HMOs, health insurers, and state and federal agencies.

Also by Roger Collier: The Perils of Play or not Pay                                       A Shakespearean Approach to Health Reform

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