Making Health Care Markets Work Better: The Role of Regulation

For the past several years we’ve been hearing about mergers and consolidations in the health care industry, prompting concern about threats to competition in health care markets. While antitrust actions to promote competition are important, they are not enough to ensure we control health care costs and ensure quality. To enable market forces to work properly, we need to address flaws in the structure of the health care markets in which those forces operate. Although it may run counter to the emphasis on deregulation in the current political climate, well-chosen regulation may be necessary to make markets work better, and to avoid the need for more—and more onerous—regulations to counter the adverse results produced by a broken health care market structure.

Threats to Competition

Competition is essential to ensure that providers and health plans are subject to the market forces that drive them to attract patients and subscribers by offering low prices and high quality. If market power is concentrated among providers or plans, they are insulated from those forces.

Threats to competition can be seen in both the health care provider and health plan markets. On the provider side, the push for greater coordination of care across settings, represented most prominently by the creation of accountable care organizations in the Affordable Care Act (ACA), has raised fears that hospitals and physicians, in the name of better coordination, will consolidate to increase their market power. Mergers and acquisitions among health care providers have indeed boomed in recent years, and federal authorities have taken action to block such activity when it is found to be deleterious to competition and consumer welfare.

Historically, increased consolidation among providers has been associated with higher prices and lower quality. But the current emphasis on moving from paying for the volume of services to paying for the value they produce may change that dynamic. In the context of these changing incentives—and with appropriate regulation—collaboration among providers could become a vehicle for producing more coordinated care and lower costs.

While provider consolidation tends to receive more attention, threats to competition among health plans have made headlines recently, with the Justice Department filing suit to stop proposed mergers between Aetna and Humana and between Anthem and Cigna. But health plan markets already are highly concentrated: in 2013, the nationwide average share of privately insured enrollees for the three largest insurers at the state level was 85 percent to 87 percent across the individual, small-group, and large-group markets.

Health plan consolidation can have both positive and negative impacts, and appropriate regulation can enhance the positive while mitigating the negative. On one hand, the market power of health plans in negotiating with providers could be a tool to counter consolidation in hospital markets, and it does appear to be correlated with lower provider prices. But health plan consolidation does not appear to produce to lower premiums, as insurers can use their market power to continue to negotiate high premiums from employers. Actions to restrict the expansion of plans’ market power can help in this regard, but additional regulation may be required.

Market Forces and Market Structure

The market is the structure in which market forces operate; if that structure is operating properly, market forces can do their job to keep prices low and quality high. But if the market structure itself is flawed, market forces may not by themselves produce the desired results—in fact, they may do the opposite.

There are several conditions necessary for markets to function properly. Markets need more than a large number of buyers and sellers; there also must be information available about a product’s quality and effectiveness, and a product’s benefits and costs should be restricted to the consumer, among other conditions.¹  In health care markets none of those conditions is met. Antitrust policy addresses only the need for a large number of buyers and sellers, and it does so incompletely.

Using Regulation to Help Market Mechanisms Work Better

Regulation can help make health care market forces work better to produce the outcomes we desire. The key is to find the right balance: too much regulation, or the wrong kind, can impede the ability of market forces to do the heavy lifting in determining the amount, mix, and distribution of health care resources; too little, on the other hand, can produce equally adverse results.

I’m reminded of an old radio interview that I read about with James Naismith, the inventor of basketball—a game admired for its free-flowing action and the degree to which it rewards creativity. In the interview, he described how the first attempt to play the game deteriorated into a “free-for-all in the middle of the gym floor.” He decided what was needed was a set of rules, to ensure appropriate behavior in the context of extremely competitive circumstances.

So it is with health care (and all) markets: some regulation—such as review of proposed mergers—is necessary both to preserve competition and to enforce the rules of the market. Preserving competition is critical to allowing market forces to function effectively, but the integrity of the market structure within which those forces operate must be protected by rules that ensure that it does not deteriorate into Naismith’s “free-for-all in the middle of the gym floor”—or, worse yet, only one player left standing. Without those rules, markets by themselves will not produce the results we want or the health care system we need.