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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12 replies »

  1. Doug Asks:
    > One question that I have is why can’t the insurers
    > use states as their group pools, rather than the
    > employer?
    > I’m sure there is some reason, but is it
    > logical or political?
    Well, Doug, it’s both. An insurer could do a state-wide pool, they could but they’d make less money.
    What you are talking about is called “Community Rating”. It means the insurance pool takes all-comers at the very same rate. It pretends that everyone faces the same risk, sets the premiums the same, and then pays the claims. In the Good Old Days, the Blues did essentially this. So what’s wrong with it?
    What if another insurer comes along and says “Hey all you non-smoking dudes at Gold’s Gym, have I got a deal for you! You know how the state-wide companies want $300/month? I’ll sell you the same coverage for only $250/month as long as you keep your gym membership current and work out at least twice a week.” You can imagine many iterations on this idea — weed out the people likely to become ill, and make money hand over fist!
    What does that do to the state-wide pool? Is that good or bad? For whom? Should it be illegal to sell health insurance this way? We sell every other kind of insurance this way don’t we?
    It all comes down to this fundamental clash: our absolutization of individual autonomy versus notions of social solidarity.
    The political questions have to do with many things: ingergenerational wealth transfer, personal responsibility, freedom to contract, and so-forth. The political “freedom to contract” question quickly becomes the dreaded “special interest” doesn’t it? Shouldn’t an insurer be allowed to offer a plan to healthy young men and try to sell it? Should employers not be allowed to pay employees with whatever combination of cash and benefits suits both parties? It’s a free country, isn’t it?

  2. Would we not see more price competition if the employer were not the initial negotiator of price? With the system we have today, my choices are limited to what my employer has negotiated, which does not equal all available options in my state. One question that I have is why can’t the insurers use states as their group pools, rather than the employer?
    If we moved to a state-based insured group (no, not run by the state, but state of residence as a group category) where my individual policy was pooled with every other state resident, then I could make a market-based choice. Then employers could offer payments to my personal medical insurance as a benefit.
    I’m wondering why this isn’t an option for us (aside from the usual special interests)? This would move away from the employer-sponsored system without eliminating private insurers. I’m sure there is some reason, but is it logical or political?

  3. And the large benefit consultants that put out studies are about as innovative as the post office. They won’t jump on board until they start losing business, you’ll see the trend reflected in their books last, and thus their studies after the fact.

  4. My HDHP reference was to the fact small employers can move the market not about the efficiency of HDHPs.
    Along that line though maybe I am just that smart as I do have a magic formula for reducing cost, it’s really simple to, don’t pay an insurance company to finance your small dollar claims. 20% savings and no reduction in benefits.
    Few examples would be over 50 clients on the books right now, and I’m a very small TPA. There is a hundred TPAs doing the same thing I am. Our plans don’t have any cost shift to the employees, we duplicate the same benefits they had before buying the HDHP.
    These things don’t happen over night, it takes years to move the market, look how long it took employers to replace indemity plans with PPOs. Even with Ted Kennedy mandating HMOs it took them decades to dominate the markets they did. I’m but one man MG I can’t save the entire market in one year. 2-3 years ago we where taking this same concept to employers and it wasn’t worth the hassle to them, to much extra work to save only 10-15%. Now they are jumping all over it. Now I have prospects calling us becuase someone told them what we are doing. If the politicians leave us alone for 3-5 years the entire market will be transformed. A carrier selling a $250 deductible plan would be an oddity like seeing an indemnity plan in the late 90s.
    My money is on the politicians killing it before it gets off the ground, it’s not in their best interest for the free market to solve the problem, not to mention what we do takes a ton of tax dollars out of the system. Times like this States don’t stand for that and the Democrats have never been a supporter of ERISA.

  5. Nate – You probably do have a few examples of where full-conversion HDHPs have worked somewhat but the numbers overall for HDHPs haven’t met the hype. The sustained savings haven’t been as great as advertised after the large-one savings (which usually is funded by a notable cost-shift to employees). Just look at the aggregrate numbers from any of the benefit consultants that are out for in their the mid-sized or large-sized employer space.
    You act as if there is some magic formula out there that most employers have simply ignored to control cost increases the past several years since HSAs were authorized after the MMA Act in 2003.
    The reality is that the current state of infrastructure (payment processing) and information (quality, safety, and otherm metrics) needed to make HDHPs work is generally inadequate to make them work as advocates have championed.
    Consumer/patient responsibility is something that has been missing from the equation but frankly I am more interested in more targeted incentives than generally hitting them over the head with a price cudgel in the form of a deductible of at least a few thousand.

  6. The real price competition should occur in the patient/healthcare provider relationship. We have given too much attention to health insurance, when we should be focusing more on health care. Health care became a lot more complex when we started worrying so much about insuring for it.

  7. MG I totally disagree and can point to numerous cases showing that is inaccurate. In Ohio it has become VERY popular for employers to buy a HDHP and self fund back to a lower deductible. Carriers HATE this as it reduces their premium 20-50%. 10 years ago only Nationwide and a couple fringe carriers did it. Then MMO in an effort to grab market share started doing it and that forced Anthem and the test to join in. With the exception of Humana all of the have embraced it because of the market forces.
    Contrast that to CA with their small group reform and minimial demand for HDHP where the carriers forbid you from self funding under their HDHP. Anthem will not allow you to do it in CA. Cross the border to NV and they are fine with you doing it.
    You claim has no basis in reality.

  8. Ugh. More rehashing of the same tired argument that individual employers should and can drive price competition.
    Nevermind the fact that is a lost cause for almost all small employers from an actuarial basis at this standpoint. Even for self-funded employers who have the personnel expertise in-house and make the time/effort available to really tackle health care inflation costs, they just don’t have the numbers in a geographic MSA area to really push effective and sustained change by their employees, providers, and health plans.
    That is why the Bridges to Excellence program and other myriads of efforts by business employer coalitions have largely found their efforts to tackle health care costs through quality and safety initiatives have been stymied. It is a numbers game and they just don’t have enough of them in a single area most times to really make people take notice.

  9. Joe what state are you in? There are ways to gain pricing power it just takes work and time. The problem is for the past 5-7 years employers didn’t care about insurance premiums, they where low enough they gladly bought these 100% plans with minimal cost share and didn’t demand claims information. Now that cost skyrocketed they need to undo the damage they created with their neglect. An employer, especially one with 250 employees should never ever buy a first dollar plan like you had. Even $3000 is a ridiculously low deductible. At a minimum you should have 5K deductible and in most cases should be self funded. That doesn’t mean you have to pass the 5K deductible on to your employees, you can self fund it back down. Your plan has been pissing away money for years, is it the insurance companies fault they took a sucker for their money? If all of what you say is true have you found another broker? Sounds like that one is just sitting back collecting fat commissions.
    Roger have you looked at how regulation has palsied employer’s hands? Self Funded Health Plans didn’t have many of the problems you mention but politicians have gone out of their way the past 10-15 years to kill them off. A self funded plan can change insurance companies but keep the same PPO Network. They allow complete freedom of plan design. Carriers can’t dictate hardly at all under self funded plans they way they do with fully insured plans. That is part of the reason Congress is trying to kill them off, you can’t have 10000 self funded plans doing what they want and trying different solutions when you take over a system. For decades congress has declared they want a small number of huge national carriers federally regulated. An interesting article would be to examine all the damage this has done to our system. I’m biased, being one of the small players they are trying to kill, but has the American Health System been served at all well by large national insurance companies? If not why do we continue down that path?
    “Only the largest employers have the clout to demand that insurers bid against the same benefit specifications”
    In every state we work in once you hit 100 lives you can get carriers to quote just about any plan design you want. This is only an issue for sub 100 life groups.
    “insurers will offer take-it-or-leave-it choices of their standard small group coverage.”
    Isn’t that what most of the State Small Group “Reform” legislation requires? This is more the result of political regulation then market forces.
    “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.”
    If Democrats would stop opposing AHPs as political payback to their Union overlords this wouldn’t be an issue.
    “If it’s available, HDHP/HSA coverage may appeal to the youngest and healthiest,”
    If you model different utilization levels the very sick also come out much further ahead under HDHPs. There is a very small band of people, about 5%, who do worse under an HDHP then a regular health plan.
    “(Pity the eighty-year-old who must navigate this muddle to pick the best value plan.)”
    There are countless websites and agencies that will enter your prescriptions and tell you exactly which plan works best for you. All it takes is for a senior to collect their info, i.e. ask the pharmacist for a print out, and they can have their answer in 10 minutes.
    “Let’s suppose that insurance choices are made primarily by individuals,”
    This would be more effective if individuals made healthcare choices, $200 deductible and $20 co-pay is not insurance it is financing. Employers should be buying HDHPs and that is it. Leave it up to the individual to make their Healthcare Decisions. FSAs and HRAs can provide the financing, both of which provide the individual almost 100% freedom in decision making.
    A mandate that every employer provide a minimum 5 HDHP would be palatable, and those not working need to purchase their own through a pool.

  10. There is one set of supplier/purchaser arrangements that have not been mentioned: provider-health plan. In most markets these exist as essentially an oligopsony where a small number of large purchasers (Medicare, Medicaid, UnitedHealth, Aetna, Cigna, Anthem/Wellpoint, BCBS, etc.) dictate the price to a large number of disaggregated suppliers for a vast array of services. Anti-trust laws are tilted substantially against providers who try to aggregate to gain bargaining leverage, even those groups which make substantial investments in quality improvement. It would be nice to see the FTC permit providers to be able to aaggregate as a networks and compete on quality and value, including negotiating unit prices and shared savings. Current market dynamics substantially restrict true price and value competition.

  11. Just to provide an illustration of what a small company is: the firm I am with has 250+ employees and annual revenues of about $45million. We appear to be completely at the mercy of the health insurers, and this in a state where only non-profits are permitted to sell policies.
    When I started with the firm in 2000 it had what would likely now be considered a ‘Cadillac’ health plan: 100% employer paid premium, low co-pays, no deductible, plus a stipend for uninsured medical expenses. Nine years later: the stipend is gone, premiums up 100%, co-pays up 200%, and employees pay 30% of the premium. All this for a plan with a $3000/person, $6000/family annual deductible.
    The firm used to be able to get multi-year contracts for insurance. No more. No provider in the state will offer a contract longer than one year. The firm has absorbed year-over-year premium increases of over 20%. In 2005, the absolute best deal our broker could deliver represented a 46% premium increase, which ushered in the high-deductible plan.
    Price competition? There is none. The insurers in the state function as a cartel. We are in a strictly ‘take it or leave it’ position. I can tell you this, in the entire universe of our business’s financial transactions: vendors, clients, consultants, etc., no one has the pricing power of those selling health insurance.

  12. Mr. Collier:
    I’m just curious, have you looked at the Dartmouth Atlas lately? You will see that the Medicare fee-for-service program also seems to favor “incumbents.” How else would you explain why the Medicare program tolerates variations in per-capita provider payments of 100% or more (e.g., Miami vs. Minneapolis) which cannot be justified by variations in quality?
    As for your comments about Medicare Advantage, you neglect to mention that roughly half of the “excess” payments to health plans are returned to beneficiaries in the form of lower deductibles, copays, and other added benefits. You also fail to make a distinction between Medicare HMO vs. FFS plans—the HMO plans receive fewer excess payments than the FFS plans and they incur per-capita costs that are slightly lower than traditional Medicare. (These facts are buried in MEDPAC and CBO studies from a couple of years ago.)