HMGT 435 WEEK 5 DISC 5

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335

HAS COMPETITION BEEN TRIED—AND HAS IT FAILED—TO IMPROVE THE US HEALTHCARE SYSTEM?

Critics claim that market competition has been tried but has failed to improve the US healthcare system. Healthcare costs are rising rapidly, and per capita healthcare spending is the highest in the world, yet many

Americans are without health insurance. More of the middle class are finding that health insurance has become too expensive, life expectancy is lower than that in other countries, and the infant mortality rate is higher than that in some countries with lower per capita healthcare expenditures. In other words, is it time to try something different? Specifically, is it time for more government regulation and control of the healthcare system? “Some say that competition has failed, I say that competition has not yet been tried.” Alain Enthoven (1993, 28) wrote that statement in 1993, and it continues to be correct today.

This chapter discusses how medical markets differ from competitive markets, why making medical markets more competitive is desirable, what changes are needed to bring about greater competition, whether competitive markets are responsible for the growing numbers of uninsured, and what role the government plays in a competitive medical care environment.

Criteria for Judging Performance of a Country’s Medical Sector

The health of a population, as measured by life expectancy or infant mortal- ity rates, is not solely the consequence of the country’s medical system. How people live and eat are more important determinants of life expectancy than whether they have good access to medical services when they become ill. Life expectancy is related to a number of factors, such as smoking, diet, marital status, exercise, drug use, and cultural values. Although universal access to health insurance is desirable, studies have shown that medical care has a smaller effect on health levels than do personal health habits and lifestyle (see chapter 3). Therefore, assessing the medical care system on measures that are affected more by lifestyle factors is inappropriate. After all, the financing and delivery of medical services has been based on treating people when they are ill and not on keeping them well.

21

C o p y r i g h t 2 0 1 9 . H e a l t h A d m i n i s t r a t i o n P r e s s .

A l l r i g h t s r e s e r v e d . M a y n o t b e r e p r o d u c e d i n a n y f o r m w i t h o u t p e r m i s s i o n f r o m t h e p u b l i s h e r , e x c e p t f a i r u s e s p e r m i t t e d u n d e r U . S . o r a p p l i c a b l e c o p y r i g h t l a w .

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Health Pol icy Issues: An Economic Perspect ive336

Several healthcare organizations in the United States have gone beyond treating people when they become ill and have tried to lower costs by preventing illnesses that are expensive to treat. Reducing hip fractures among the elderly and instituting monitoring mechanisms for diabetes patients, for example, have been shown to prevent more costly treatments later. The financial incentives for these organizations differ from the typical fee-for-service payment incentives used predominantly in the United States and other countries.

Assuming the purpose of a medical care system is more narrowly defined—that is, treating those who become ill—what criteria should be used to evaluate how well that system performs? The criteria should be the same as those used to evaluate the performance of other markets, such as housing, food, automobiles, and electronics—markets that produce necessities and luxuries. The following are the performance criteria of a medical care system:

1. Information. Do consumers have sufficient information to choose the quantity and type of services based on price, quality, and other characteristics of the services being supplied?

2. Consumer incentives. Do consumers have incentives to ensure that the value of the services used is not less than the cost of producing those services?

3. Consumer choices. Does the market respond to what consumers are willing to pay? If consumers demand more of some services, will the market provide more of those services? If consumers differ in how much they are willing to spend or want different types of services, will the market respond to those varied consumer demands?

4. Supplier incentives. Do suppliers of goods and services have an incentive to produce those goods and services (for a given level of quality) at the lowest cost?

5. Price markups. Do the prices charged by suppliers for their services reflect the costs of production? (This occurs when suppliers compete on price to supply their services.)

6. Redistribution. Do those who cannot afford to pay for their medical services receive medically necessary services?

To the extent that the medical sector approximates the first five criteria, the system will produce its output efficiently, and medical costs will rise at a rate that reflects the cost of producing those services.1 The type of services available, as well as the new medical technology adopted, will be based on what consumers are willing to pay.

Competitive markets—compared with monopoly markets or markets with government controls on prices and investment—come closest to achieving the first five criteria. Competitive markets are the yardstick by which all markets

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 337

are evaluated, and they underlie the antitrust laws. Proponents of competition believe the same benefits can be achieved by applying competitive principles to medical care. Competitive markets, however, do not help those unable to afford the goods and services produced. It is government’s role, not the market’s, to subsidize those with low income so that they can receive the necessary amounts of food, housing, and medical services. When adequate subsidies in the form of vouchers for health insurance are provided, through a competitive market, to those with low income, providers have incentives to produce those services efficiently, and patients have a greater choice when using them.

Market forces are powerful in motivating purchasers and suppliers. The search for profits is an incentive for suppliers to invest a great deal of money to satisfy purchaser demands. Suppliers innovate to become more efficient, develop new services, and differentiate themselves from competitors, thereby increasing their market share and becoming more profitable. Incentives exist in both com- petitive and regulated markets. The incentives appropriate to a competitive market are those for which both the purchaser and the supplier bear the cost and receive the benefits of their actions. When a purchaser’s and a supplier’s costs and benefits are not equal, the market becomes less competitive and its performance suffers.

How Medical Markets Differ from Competitive Markets

The Period Before Managed Care Before managed care began to grow in the 1980s, health insurance cover- age was predominantly traditional indemnity insurance. Patients had little or no out-of-pocket cost when they used medical services, and hospitals and physicians were paid on a fee-for-service basis. Information about providers was nonexistent, as it was prohibited by medical and hospital associations, and accrediting agencies (e.g., The Joint Commission) did not make their findings public. Insurance companies merely passed higher provider costs on to employers, who paid their employees’ insurance premiums. Medicare and Medicaid greatly reduced their beneficiaries’ concern regarding medical prices. Medicare paid hospitals according to their costs, and physicians were paid on a fee-for-service basis. Medicaid paid hospitals and physicians fee-for-service.

Regulatory policies at the state and federal levels, enacted at the behest of provider groups, led to greater market inefficiency. Restrictions were imposed on any form of advertising; on the tasks different healthcare professionals were permitted to perform; on entry into markets by new hospitals and free-standing outpatient surgery centers; on health maintenance organizations (HMOs), which were required to be nonprofit; and on which healthcare providers were eligible for payment under Medicare, Medicaid, and even Blue Cross and Blue Shield. Neither patients nor physicians had any incentive to be concerned about

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Health Pol icy Issues: An Economic Perspect ive338

the use or cost of services. Comprehensive health insurance results in a “moral hazard” problem; patients use more services because their insurance has greatly reduced the price they must pay. The additional benefit of using more services is much less than it would be if the patient had to pay more of the cost. Exhibit 21.1 illustrates how payment for medical services has changed since 1960.

Private insurance and government now pay for most medical services; out-of-pocket payments by patients have declined from almost 50 percent of total medical expenditures to just 10.6 percent. Furthermore, physicians, because they are paid on a fee-for-service basis, have a financial incentive to provide more services. Given the lack of patient and provider incentives to be concerned about the cost and use of services, too many services are delivered. Wide variations in care occur because factors other than clinical value are used to decide whether the services should be provided, and rapid increases have occurred in the growth of medical spending.

To control rapidly rising medical costs from the late 1960s to the early 1980s, federal and state governments used regulatory approaches. The medical sector was placed under wage and price controls from 1971 to 1974, health- planning legislation placed controls on hospital investment, many states used hospital rate regulations, and Medicare instituted hospital utilization review and

Year

Pe rc

en ta

ge o

f N at

io na

l H ea

lt h

Ex pe

nd it

ur es

19 60

19 70

19 80

19 90

20 00

20 10

20 16

100%

90%

80%

70%

60%

50%

40%

30%

20%

10%

0%

State and local funds

Federal funds

Private health insurance

Out-of-pocket payments

Note: The private health insurance category includes other private funds.

Source: Data from Centers for Medicare & Medicaid Services (2017).

EXHIBIT 21.1 Trends in Payment

for Medical Services,

1960–2016

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 339

limited physicians’ fee increases. Medicaid simply reduced payments to hospitals and physicians. These regulatory approaches failed to slow rising medical costs.

Managed Care Managed care was the reaction of large employers to an out-of-control healthcare system that brought about rapidly rising health insurance premiums. Under pressure from large employers and unions, health insurers and providers became adversaries. Health plans negotiated price discounts with providers and instituted cost-containment measures that reduced use of services (gatekeepers, prior authorization for specialist and hospital services, and coverage for care in settings less expensive than the hospital). These cost-reduction measures achieved large savings in insurance premiums, as shown in exhibit 20.3. When employees were offered a choice of health plans and given an opportunity to save on monthly premiums, they switched plans. Price competition penalized high-cost plans.

However, a backlash against managed care and its cost-containment methods occurred by the end of the 1990s. As more low-risk users switched to HMOs because of less expensive premiums, those remaining in traditional indemnity plans (patients with chronic illnesses and those with established pri- mary care physician and specialist relationships) faced high premiums. (Adverse selection caused premiums to rise more in traditional indemnity plans.) They joined HMOs to reduce their premiums but were dissatisfied with the restric- tions on access to providers. The backlash against managed care was likely driven by those who felt compelled to join HMOs.

Managed care was, at most, an example of partial market competition. Although managed care competition achieved large private-sector cost savings for a limited time, much of the previous regulatory and economic framework under which competition occurred was unchanged. Any market framework includes a set of consumer and supplier incentives, and market performance responds to these incentives. When these incentives influence consumers and suppliers to consider the full costs and benefits of their decisions, market outcomes are efficient. At times, however, the legal and economic framework within which consumers and producers make their choices distorts the costs and benefits of these incentives, in which case markets perform inefficiently.

The following sections provide examples of how the medical care mar- ket’s legal and economic framework has distorted consumer and producer incentives—and, hence, their choices—and led to inefficient market outcomes.

Demand-Side Market Failures

These market failures on the demand side have limited the expansion of greater competitive forces.

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Health Pol icy Issues: An Economic Perspect ive340

Tax-Exempt Employer-Paid Health Insurance When an employer purchases health insurance on behalf of employees, these contributions are not considered taxable income to the employee. Compared with other employee purchases paid for with after-tax income, the purchase of insurance is subsidized; thus, employees pay less for insurance than they would if they had to buy the same amount with after-tax income. When the price of a good or service is reduced, consumers will purchase a greater quantity of that service (known as the law of demand).2 The price of insurance, when pur- chased by the employer, is not the same for all employees. Those in the highest income-tax brackets receive the largest tax subsidies. On average, changes in the out-of-pocket price of health insurance result in a proportional change in the quantity of insurance demanded.3 (A 5 percent decrease in price leads to an increase of about 5 percent in the quantity demanded.) The tax subsidy for health insurance results in employees purchasing more comprehensive cover- age with lower deductibles and lower cost sharing (and additional benefits, such as vision and dental care) than they would if they had to pay the entire premium themselves.

Incentives have been distorted because consumers do not pay the full cost of health insurance or of their medical services. When consumers pay, out of pocket, only a small fraction of the provider’s price, they are less aware of and concerned with the prices charged by medical providers.

Health Plan Choices Health plan competition could have been stronger for several reasons. First, many employers limited their employees’ choice to only one health plan.4 For competition to occur among plans, employees must be offered a choice. Yet throughout the 1990s and still today, about 80 percent of firms providing health benefits offer employees only one choice of health plan. Large firms are more likely than small firms to offer a choice of plans (55 percent compared with 17 percent) (Kaiser Family Foundation and Health Research & Educational Trust 2017, 65). When employees are unable to choose among substitutes, the single plan being offered has less incentive to respond to employees’ preferences.

Second, many employers that offer employees a choice of health plans either contribute more to the higher-cost health plan or contribute a fixed per- centage of the premium to the plan the employee chooses. A fixed-percentage contribution provides a greater dollar subsidy to the more expensive plan, thereby reducing the employee’s incentive to select the less costly plan. (If the employer pays 80 percent, the employee opting for the more expensive plan pays only 20 percent of the price difference, not 100 percent.) The more efficient health plan is at a competitive disadvantage because the more expen- sive competitor is more heavily subsidized. When employees have a choice of plans, and the employer contributes a fixed-dollar amount, most employees will

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 341

select a more restrictive plan—such as an HMO. “For example, 70–80 percent of active employees and dependents covered by the University of California, CalPERS, and Wells Fargo in California [each company makes a fixed-dollar contribution] choose HMOs” (Enthoven and Tollen 2005, w5-429).

Third, when competing managed care plans offer broad networks with overlapping providers, the plans are not sufficiently differentiated and do not offer employees real choices. Overlapping provider networks make it difficult for the plan to control costs (because it cannot exclude providers) and for employees to identify quality differences. The plans are not competing on their providers’ ability to manage care, on the quality of their providers, or on patient satisfaction, and they have little incentive to invest resources to do so, because all plans with the same providers will benefit. Consumers should be able to select among health plans that vary in premiums, quality of care, access to providers, provider network, and so on.

Fourth, few employers pay insurers risk-adjusted premiums for their employees. Paying the same premium for an employee who is older and has more risk factors than a younger employee, who is less likely to incur a large medical expense, gives insurers an incentive to engage in risk selection by seek- ing out younger employees. Paying risk-adjusted premiums gives insurers an incentive to compete on price for higher-risk employees. Insurers also must compete on how well they can manage the care of high-risk enrollees rather than on how well they can entice low-risk employees to join their plans.

Lack of Information Historically, healthcare providers have been opposed to being compared with one another. The Federal Trade Commission’s (FTC) antitrust suit against the American Medical Association—affirmed by the US Supreme Court in 1982— involved the association’s prohibitions on advertising. A consumer seeking information on a provider’s prices and quality was unable to find it. (Consumers with limited cost sharing also had little incentive to search for a lower price.) Lack of information on how well one provider compares with another enables each competitor to charge higher prices or produce lower-quality care than they could if consumers were informed about both providers’ prices and quality.

Wide price variations—unrelated to quality or other attributes of the service—are unlikely to persist in a price-competitive market. Knowledgeable purchasers will shun overpriced suppliers of a service. Currently, price infor- mation for medical services is difficult to obtain, and the services included in the stated price are not transparent. For example, a study by Rosenthal, Lu, and Cram (2013) tried to determine elective pricing data (bundled payment that includes hospital and physician fees) for total hip arthroplasty, a common elective surgical procedure. The authors experienced difficulty obtaining price information and observed a wide variation in the prices quoted.

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Health Pol icy Issues: An Economic Perspect ive342

One of the tenets of a competitive market is that consumers not only bear the cost of their choices but also are informed purchasers. If consumers do not have access to information about provider quality, providers have little incen- tive to invest in higher-quality care because they receive the same fee as those who do not. In recent years, provider quality and patient satisfaction measures have been collected on report cards and disseminated to employees during open enrollment.5 One study found that two years after publication of a report card, “more than 20 percent of bottom-quartile surgeons stopped practicing [coronary artery bypass grafting] surgery in New York . . . whereas only about 5 percent of surgeons in the top three quartiles did so” (Jha and Epstein 2006).

Tax subsidies for purchasing health insurance have led to a demand for more comprehensive insurance—with lower out-of-pocket payments and larger employer subsidies for more expensive health plans—and have lessened consumer incentives to choose more efficient health plans. Tax subsidies, com- bined with a lack of information on health plans and providers, have resulted in a healthcare market where purchasers have insufficient incentives and limited opportunity to make informed choices.

Medicare and Medicaid About half of all medical expenditures are made by federal and state govern- ments. Incentives for beneficiaries and Medicare and Medicaid’s provider pay- ment policies have an important effect on the market’s performance, similar to the impact of tax subsidies. Most Medicare beneficiaries have supplementary health insurance to cover their Medicare cost-sharing requirements. Because those with low income are covered by Medicaid, there is no cost sharing. Thus, neither Medicare nor Medicaid beneficiaries have any incentive to be concerned about provider prices or their use of medical services.

Although Medicare allows beneficiaries a choice of health plans, the elderly have not had a strong financial incentive to choose lower-cost, restrictive Medicare Advantage plans. Only if Medicare were to provide a fixed dollar contribution, with beneficiaries paying the additional cost of a more expensive health plan, would enrollees have an incentive to switch from the more costly, traditional fee- for-service plan. Medicaid enrollees, on the other hand, are not given a choice of health plans. Medicaid may enroll some of its enrollees (young, low-cost) in a health plan, but most Medicaid expenditures on behalf of the aged and disabled are paid on a fee-for-service basis to hospitals, physicians, and nursing homes.

Supply-Side Market Failures

Provider Consolidation The greater the number of healthcare providers in a market, the greater the competition among them to respond to purchaser demands. Conversely, when

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 343

only one provider is in a market, the patient has no choice but to go to that provider. Providers respond when the purchaser has a substitute provider from which to choose. A monopolist provider has no incentive to innovate, improve quality, respond to patients’ needs, or offer lower prices.

Considerable provider consolidation has been occurring. When hospitals in a market merge, insurers have fewer to negotiate with. The antitrust laws are meant to prevent suppliers, such as hospitals and physicians, from gaining market power. Unfortunately, the FTC had been unsuccessful in prevent- ing hospital mergers that decrease competition. Federal judges, ruling in the merged hospitals’ favor, believed that merged nonprofit hospitals would not exercise their market power as for-profit hospitals would. Consolidated hospitals and single-specialty groups dominate certain markets (Berenson, Ginsburg, and Kemper 2010). One consequence of the movement toward accountable care organizations (ACOs) and hospitals employing physicians has been fur- ther consolidation of the provider market in many areas. As the number of competitors has declined, health plans have been forced to pay higher prices, which are passed on to consumers in the form of higher insurance premiums (Ginsburg 2016).

Federal and State Regulations The federal and state governments have enacted a number of anticompetitive regulations that limit price competition and result in higher health insur- ance premiums. These regulations address such areas as the training of health professionals and the tasks they are permitted to perform, entry into medical markets, pricing of health insurance policies, health insurance benefit coverage, and rules covering provider networks.

More than 2,200 state mandates (as of 2017) have been enacted that specify the benefits, population groups, and healthcare providers that must be included in health insurance policies (National Conference of State Legisla- tures 2018). Large business firms are legally exempt from these state mandates since they self-insure their employees, which most large organizations do. The higher cost burden of these state mandates falls predominantly on individuals and small businesses, raising the cost of insurance and thereby making health insurance unaffordable to those who prefer less expensive health plans.

The Affordable Care Act (ACA) substituted its own insurance require- ments; it specified 10 “essential” benefits that must be included in any qualified health plan. Many of these mandated benefits exceed the insurance coverage people previously purchased. Many of these essential benefits, such as maternity and newborn care as well as pediatric coverage, are not applicable to certain population groups, such as single and older men. These additional benefits have increased the cost of insurance, and the higher premiums have led many to decide the benefit of having health insurance is outweighed by its cost; being uninsured is preferable.

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Health Pol icy Issues: An Economic Perspect ive344

Although some of these state and ACA mandates may be beneficial, many individuals and small businesses would rather have insurance they can afford than no insurance at all. Insurers are unable to compete by offering insurance benefits preferred by many.6

When community rating was required in state individual insurance mar- kets, such as New York and Vermont, all types of individuals or small businesses were placed in a common risk pool, and all were charged the same premium. Firms whose employees were engaged in high-risk jobs were charged the same as organizations whose employees had low-risk jobs. Firms that provide incentives to employees to engage in healthy lifestyles were charged the same premium as those that do not. Community rating eliminates price competition among insurers. Instead, insurers have an incentive to engage in favorable risk selec- tion. Community rating increases the price of insurance to low-risk individuals, thereby leading many to drop their insurance.

The ACA regulates the pricing of health insurance. A modified form of community rating is required in federal and state health insurance exchanges. The medical costs of caring for individuals in their 50s and 60s (up to 65 years of age) are higher than those for younger individuals. The ratio is 5 or 6 to 1. The ACA requires insurers to use a ratio that is 3:1. The effect of using a smaller ratio is that younger enrollees incur higher premiums to subsidize older enrollees, even though younger individuals may have much less income. Price competition by insurers to sell insurance according to an age group’s actuarial experience is unlawful. These higher premiums have reduced the demand for insurance by younger individuals.

State certificate-of-need (CON) laws prohibit competitors from enter- ing a market. The CON process protects existing providers from competition, thereby giving monopoly power to the existing hospital, home health agency, hospice, and nursing home. Training of healthcare professionals emphasizes process measures of quality (e.g., years of education) as a prerequisite for licensure. Reexamination for relicensure is not used, and physicians have rarely been evaluated on outcomes-based measures of quality. Innovative methods of training healthcare professionals are inhibited when rigid professional rules specify training requirements. State practice acts specify the tasks that healthcare professionals are permitted to perform; these regulations are based on political competition among health associations over which profession is permitted to perform certain tasks. A greater supply of health manpower is available, and care can be delivered less expensively when performance is monitored and flexibility is allowed in the tasks that healthcare professionals are permitted to perform.

Any willing provider (AWP) laws limit price competition among phy- sicians (and dentists). Health plans had been able to negotiate large price discounts from physicians by offering them exclusivity over their enrollees. The 13 states with AWP laws that apply to physicians enable any physician to have access to a health plan’s enrollees at the negotiated price. As a result

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 345

of AWP laws, physicians have no incentive to compete on price for a health plan’s enrollees because they cannot be assured of receiving a higher volume of patients in return for a lower price.

Lack of Physician Information Competitive markets assume that demand-side and supply-side participants are well informed. Physicians, who act as the patient’s agent and as a supplier of a service, are considered to be knowledgeable about their patients’ diagnoses and treatment. Further, physicians are assumed to act in their patients’ best interests. If these assumptions are incorrect, medical services are not being provided efficiently, quality of care is lower, and the cost of medical services is higher than it otherwise would be.

Wide variations exist in the medical services provided by physicians in the same specialty, to patients with the same diagnosis, and across geographic regions (Institute of Medicine 2013). These variations in medical services are likely attrib- utable to two factors. First, physicians are not equally proficient in their diagnostic ability or in their knowledge of the latest treatment methods. These wide varia- tions have given rise to evidence-based medicine, whereby large insurers analyze the results of well-designed research as well as large data sets to determine best practices and disseminate clinical guidelines to their network physicians.

Second, physicians have a financial interest in the quantity and type of care they provide. Most physicians are paid fee-for-service; thus, the more they do, the more they earn. Supplier-induced demand is the term economists use to explain physicians’ financial incentive to increase their services. When combined with the lack of consumer incentives regarding prices and use of medical services, as well as consumers’ lack of knowledge regarding physi- cians’ practice methods, both the use and cost of medical services are greatly increased. Medicare—under which most aged have supplementary insurance to cover their cost sharing—is a prime example of how the lack of patient price sensitivity and medical information, together with some physicians’ lack of knowledge and the incentives inherent in fee-for-service, have resulted in large variations in the cost and number of services provided.

As the preceding discussion illustrates, market forces have been greatly weakened. Given the lack of effective competition in medical markets, one cannot claim that competition has been tried and has failed.

How Can Medical Markets Be More Competitive?

Markets always exist, but, depending on government rules, they can be efficient or inefficient. To improve market efficiency in medical care, several changes are needed in government regulations and in the private sector.

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Health Pol icy Issues: An Economic Perspect ive346

Government tax policy that excludes employer-paid health insurance from an employee’s taxable income should be changed. Employer contributions should be treated as regular income; however, it is more politically feasible to limit the amount that is tax free.7 This change will affect the amount of insur- ance consumers buy, which health plans they choose, and how much medical care they use. Additional needed government reforms include removing restric- tions on market entry and repealing laws promoting anticompetitive behavior, such as CON and AWP laws; overriding mandates that raise health insurance costs; eliminating insurance regulations requiring modified community rating; enforcing antitrust laws; and reforming Medicare and Medicaid so that benefi- ciaries pay the additional cost of more expensive health plans, thereby giving these beneficiaries incentives to choose health plans on the basis of costs and benefits.8 These policies should stimulate greater competition in the private and public medical sectors.

In the private sector, employers that subsidize their employees’ health insurance should be encouraged to offer a choice of plans, give fixed-dollar contributions, and use risk-adjusted premiums in making such payments. With more plan choices and employee incentives to focus on the costs and benefits of a health plan, information is more accessible to help employees choose a plan. When consumers can choose, information has value, and private sources (e.g., Healthgrades) will provide that information, as has occurred in other markets.

For competitive markets to work, not all purchasers must be informed or switch plans in response to changes in prices and quality.9 In competitive medical markets, as in other markets, a small percentage of knowledgeable consumers who switch is sufficient to drive the market toward greater efficiency.

Are the Poor Disadvantaged in a Competitive Market?

Opponents of competitive medical care markets claim that the poor will be unable to afford medical services. Competitive markets produce the most goods and services (with a given amount of resources) and sell them at the lowest possible price to consumers willing to buy. By doing so, competitive markets make goods and services more affordable to those with low income. However, competitive markets should not be evaluated on whether the poor receive all the medical services needed.

Achieving market efficiency has little to do with ensuring that everyone’s needs are met or that everyone receives the same quantity of services. It is the role of government, based on voters’ preferences, to subsidize healthcare for the poor—just as is done with food and housing. Providing the poor with subsidies (e.g., vouchers for a health plan) to be exercised in a competitive market is more likely than any other approach to ensure that they receive the greatest value for those subsidies.

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 347

Competitive medical markets may be considered unfair because those with high income are able to buy more than those with low income. The wealthy always have been, and always will be, able to buy more goods and services than can the poor. Even in the Canadian single-payer health system, patients with more money can skip the waiting lines and travel to the United States for diagnostic services and surgery.

Patient Incentives Drive Price Competition in Government and Private Markets

The following examples illustrate how a change in patient incentives resulted in a price-competitive healthcare market.

Medicare Part D Prescription Drug Benefit In 2004, the Congressional Budget Office projected that the federal budget- ary cost of the Medicare prescription drug benefit—Part D—for 2012 would be $122 billion. In 2012, the actual federal cost was $55 billion. Unlike any other government entitlement programs, the estimated federal cost of the drug benefit had been constant for more than 10 years, and cost much less than many anticipated.

The design of the Part D benefit differs from that of Medicare Parts A and B in that Part D makes the beneficiary responsible for the additional cost of choosing a more expensive drug plan. Under Part D, drug plans submit bids to the federal government for providing the basic prescription drug ben- efit to a beneficiary. The federal government calculates a national average bid and pays 75 percent of the national average bid to the drug plan chosen by the beneficiary, who is then responsible for the remaining 25 percent of the monthly premium. If a beneficiary enrolls in a plan that submitted a higher bid than the national average, the beneficiary pays the difference in addition to the base premium.

Plans understand that any difference between a plan’s bid and the national average bid translates directly into a price difference that will be paid by beneficiaries.10 Beneficiaries have access to a wide variety of drug plans and must choose among lower premium plans or costlier plans that may offer greater benefits, such as a more desirable drug formulary. Because competing plans vary in the brand-name drugs offered in their formulary, a person can choose the plan that covers their preferred drug. Under Medicare Part D, beneficiaries have an incentive to make a trade-off between additional plan benefits and the additional costs of a higher-priced plan.

Drug plans compete for enrollees by offering lower premiums. By relying on a drug formulary, rather than including all brand-name drugs within a disease category, the plan is able to negotiate discounted prices with a pharmaceutical

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Health Pol icy Issues: An Economic Perspect ive348

firm by including only its drug in the formulary. Drug plans also encourage enrollees to use less costly generics when appropriate by using lower cost sharing for generics than for brand-name drugs. The drug plans pass on these cost-saving strategies to beneficiaries in the form of lower premiums and cost sharing.

Negotiating with drug manufacturers and encouraging generic substitu- tion when appropriate are the direct result of plans competing for price-sensitive enrollees who must pay out of pocket the additional cost of higher-priced drug plans.

The ACA made changes to the Medicare Part D drug benefit that caused an increase in the number of Medicare drug prescriptions and in expendi- tures. First, the Part D “donut hole” was reduced, thereby reducing a Medi- care beneficiary’s out-of-pocket payments for his prescription drugs. Second, successful lobbying by the pharmaceutical association reduced competition between pharmaceutical firms and the private drug plans. Private drug plans now are required to include more than one drug per class in their formulary; this change reduced private drug plans’ ability to negotiate lower drug prices with a pharmaceutical firm.

Value-Based Purchasing and Reference Pricing In recent years, employers and insurers have begun to provide patients with financial incentives to choose higher-quality, lower-priced hospitals for their surgeries. Several employers (e.g., Walmart, Safeway, Lowe’s) and insurers (e.g., WellPoint) have used value-based purchasing or reference pricing to give their employees a financial incentive to choose among competing providers (Robinson and MacPherson 2012). Under these approaches, the employer or insurer contracts for a fixed price with several centers of excellence (e.g., the Cleveland Clinic) for elective surgical procedures (e.g., orthopedic joint replacement, interventional cardiology, cardiac surgery). These are expensive procedures, whose prices vary widely, and differences in outcomes when per- formed by different providers are relatively small. Patients are given a fixed amount (e.g., $30,000) to cover the cost of their surgery. A patient can go to providers other than those on the employer’s preferred list, but if the price is greater than $30,000, the patient pays the additional cost himself.

Robinson, Brown, and Whaley (2017) found that when patients were provided with a financial incentive, reference pricing resulted in significant sav- ings. The most dramatic price reductions occurred in higher-priced hospitals. Also interesting is that when patients went to providers other than those on their employers’ or insurers’ preferred list, and when they had only $30,000 to spend, the patients were able to negotiate large price reductions. The insurer did not negotiate with these providers; the patients did. The authors stressed the importance of changing patients’ financial incentives and not just relying

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 349

on direct price negotiations between insurers and providers. When patients are responsible for the additional cost of their care, healthcare markets become price competitive.11

What Might Competitive Medical Markets Look Like?

If healthcare markets were to become more like a competitive market, what might one observe? As consumers (including Medicare and Medicaid enrollees) must pay the additional cost of more expensive health plans and become more cost conscious, the variety and number of available plans will increase. Plans will attempt to match purchasers’ preferences and willingness to pay. Some people would prefer to choose among health plans, which is less expensive and time consuming than evaluating different providers.

Competitive markets may evolve in several ways. Integrated delivery systems, as articulated by Enthoven (2004), are organizations with their own provider networks that offer coordinated care to their enrollees. These inte- grated delivery systems may be built around large multispecialty medical groups with relationships to hospitals and other care settings, and they may be paid a risk-adjusted annual capitation amount per enrollee (similar to Medicare Advantage plans). Health plans would compete for consumers on the basis of risk-adjusted premiums. These systems would select healthcare providers, be responsible for monitoring quality, examine large data sets to develop evidence- based medicine guidelines, reduce widespread variations in physicians’ practice patterns, provide coordinated care across different care settings (the physician’s office, hospital, ambulatory care facility, and patient’s home), have incentives to be innovative in caring for patients with chronic conditions, and minimize total treatment costs (not just the costs of providing care in one setting while shifting costs to other settings). In addition, health plans would be responsible for evaluating new technologies and, in turn, would be evaluated by how well they perform in improving the health of their enrolled populations, as well as how they perform with regard to premiums and patient satisfaction.

At the other end of the spectrum of financing and delivering medical services are consumer-directed health plans (CDHPs). Under the CDHP model, consumers purchase a high-deductible (catastrophic) plan, which provides them with the incentive to be concerned about the use of medical services and the prices of different healthcare providers. The health savings account (HSA) approach combines a high-deductible plan with a savings account; money saved in the HSA belongs to the individual and can accumulate year after year.

Health plans preferred by consumers will expand their market share, while others will decline. Health plans and large multispecialty medical groups will be motivated to innovate to reduce costs, improve quality and treatment

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Health Pol icy Issues: An Economic Perspect ive350

outcomes, and achieve better patient satisfaction. By doing so, they will dif- ferentiate themselves from competitors and gain a competitive advantage. Other health plans will copy the methods used by successful competitors, and the process of innovation and differentiation will start over again. (Economist Joseph Schumpeter referred to this as the process of creative destruction.)

Summary

Antitrust authorities evaluate markets on the basis of how closely they approxi- mate a competitive market. The closer the approximation, the more likely the market will produce products efficiently and be responsive to consumer demands. Medical markets are not inherently different from other markets in their ability to efficiently allocate resources. It is the regulatory framework of medical markets that leads to inefficient outcomes.

Medical markets differ from competitive markets in significant ways. The tax treatment of health insurance lessens consumer incentives to be concerned about the price and use of medical services. Consumers lack the necessary information to make economic and medical decisions; often, they are not offered choices. Competition among suppliers is limited by laws barring market entry, restricting the tasks healthcare professionals are permitted to perform, preventing price competition, and regulating market prices.

These market failures have resulted in inefficiency, inappropriate care, less-than-optimal medical outcomes, and rapidly rising medical costs. Increased government regulation has been shown to worsen rather than improve market performance. Several of the major inefficiencies in medical care markets are the result of government intervention. Regulation to limit rising medical prices was tried in the 1970s and failed. Medicare, which controls hospital and physician fees, fails to limit overuse of services and gaming of the system; upcoding and unbundling of services are common.12 Under a system of government regula- tion of prices, budgets, and market entry, interest groups—such as hospitals, physicians, unions, and large employers—are more effective in representing their own economic interests than are consumers. Organized interest groups also are more effective than consumers in the political marketplace. Consumer interests are best served in competitive economic markets.

Government has an important role to play. It sets the rules for com- petitive markets, such as eliminating practices that result in anticompetitive behavior, monitoring inaccurate information, and enforcing antitrust laws. The government also is responsible for raising the funds to subsidize those unable to afford medical care; these subsidies can be provided at lower cost and higher quality in a competitive market.

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 351

Market competition has not failed in medical care. It just has not had a full opportunity to work. Consumer incentives must be changed so that individuals consider the costs and benefits of their healthcare choices. When Medicare beneficiaries had to pay the additional cost of more expensive drug plans, drug plan competition responded by greatly lowering the projected cost of the Medicare drug benefit. Similarly, when employees were provided with a fixed amount for their surgeries (reference pricing) and had to pay the additional cost themselves, they were able to negotiate reduced prices. Medi- care enrollees should be offered a choice of health plans and given the option to pay the additional cost of a more expensive plan. In addition, restrictions on providers’ ability to compete on price should be removed. Without com- petition, providers have no incentive to be efficient or to innovate, invest in new facilities and services, improve quality, develop best practices and clinical guidelines, or lower prices.

Discussion Questions

1. Why is it said that competition in medical care has failed? 2. What are the criteria for a competitive market? 3. How well does medical care meet the criteria of a competitive market? 4. Is it the responsibility of a competitive market to subsidize care for

those with low income? 5. Explain why the cost of the Medicare Part D drug benefit has been

lower than its projections. 6. What changes are required for medical care to more closely approximate

a competitive market?

Notes

1. Growth of demand may result in temporary increases in prices (high price markups over cost), which equilibrate demand and supply so that shortages do not occur while signaling suppliers to raise their production to meet the greater demand. Over time, as supply grows, prices will again reflect the cost of providing those services.

2. Not every consumer purchases more when the price is reduced, but, on average, the quantity demanded will rise.

3. The tax exclusion for employer-purchased health insurance is unfair because employees in a higher tax bracket receive a greater subsidy

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Health Pol icy Issues: An Economic Perspect ive352

(see exhibit 6.2). It is also unfair to individuals who are not part of an employer group, because they do not qualify for the same tax exclusion. Individual coverage is more expensive, not only because of higher marketing costs and insurers’ concern about adverse selection, but also because it is paid for with after-tax dollars.

4. Many small and medium-sized businesses were unable to offer their employees a choice of health plans; the indemnity plan was concerned that it would receive a higher-risk group. Thus, small businesses were typically offered only one plan for all of their employees.

5. Data on hospital quality—and to a lesser degree physician quality— have become available from more public sector and private sector sources. Such sources include Medicare’s Hospital Compare (www. medicare.gov/hospitalcompare), the New York State Hospital Report Card (www.myhealthfinder.com), California’s Office of Statewide Health Planning and Development (www.oshpd.ca.gov/HID/), Agency for Healthcare Research and Quality’s Healthcare Cost and Utilization Project (www.ahrq.gov/research/data/hcup/index.html), and Healthgrades (www.healthgrades.com).

6. Exchange enrollees are exempt from these state mandates. Many individuals, however, buy insurance in nonexchange private markets and they continue to be subject to these mandates.

7. Starting in 2022, the ACA will impose a 40 percent tax on insurers of employer-sponsored health plans on the amount of employer-paid health insurance that exceeds $10,200 for individuals and $27,500 for family coverage.

8. Recent unsuccessful legislative proposals seeking to lower insurance premiums in the individual and small-group markets included permitting association health plans—organizations, such as nonemployer groups, ethnic organizations, and small business associations—to form and negotiate with insurers on behalf of their members. These associations will have stable insurance pools and greater bargaining power with insurers.

9. In some markets, such as rural areas, competition among health plans is unlikely to be strong enough to achieve the same efficiency as that in large urban areas. Rural populations do not have the same choices regarding other services either.

10. When a Medicare Advantage plan’s bid is below the benchmark premium, the plan must provide additional benefits rather than pass the price difference on to the enrollee in the form of lower premiums. This difference results in Medicare Part D drug plan enrollees paying lower premiums, whereas Medicare Advantage plan enrollees must

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Chapter 21: Has Competition Been Tried—and Has It Failed—to Improve the US Healthcare System? 353

receive more benefits rather than have a choice of benefits versus lower premiums.

11. Goodman (2011) discusses how price competition also leads to quality competition.

12. Unbundling occurs when a provider charges separately for each of the services previously provided together as part of a treatment. Upcoding occurs when the provider bills for a higher-priced diagnosis or service than was provided.

References

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Centers for Medicare & Medicaid Services. 2017. “National Health Expenditure Data.” Accessed December. www.cms.gov/Research-Statistics-Data-and-Systems/ Statistics-Trends-and-Reports/NationalHealthExpendData/index.html.

Enthoven, A. 2004. “Market Forces and Efficient Health Care Systems.” Health Affairs 23 (2): 25–27.

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Enthoven, A., and L. Tollen. 2005. “Competition in Health Care: It Takes Systems to Pursue Quality and Efficiency.” Health Affairs 24 (Suppl. 1): W5-420–W5-433. www.ncbi.nlm.nih.gov/pubmed/16148024.

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Robinson, J., T. Brown, and C. Whaley. 2017. “Reference Pricing Changes the ‘Choice Architecture’ of Health Care for Consumers.” Health Affairs 36 (3): 524–30.

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