Godzilla vs. Mothra vs. You: The Health Care Industry Consolidates

And the great fleas, themselves, in turn
Have greater fleas to go on;
While these again have greater still,
And greater still, and so on. —The Siphonaptera

By Lambert Strether of Corrente

Two salient characteristics of the huge and hugely complex health care industry — which comprises health insurance companies, hospitals, doctors, pharmaceutical manufacturers and distributors, and networks and alliances of all these, besides players at all levels of government — are constantly increasing prices and increased consolidation. (ObamaCare was supposed to “bend the cost curve” by increasing competition, which one would think consolidation works against, but never mind that for now.) We will see increased costs for the entire system consolidated on our insurance bills:

If you have health insurance, there’s a good chance you’ll pay more for it in 2016.

Health care and health insurance costs increase year to year, like most expenses. Since the implementation of the Affordable Care Act, growth in premiums has mostly slowed (as has the rise in health care costs overall), while your share of expenses – like deductibles – has increased. For several reasons, increases in both premiums and other out-of-pocket costs are expected in the coming year.

(The article goes on to call the increases “modest,” and to recommend ways to be a smart shopper — i.e., to pay your tax of time — but with real wages flat, even “modest” increases can cut into bone.) A third salient characteristic of the health care market is extreme fragmentation, since health insurance is regulated at the state level, and so cost increases may vary state to state, and by market within state. Here are some increases in Texas, one large state, for the individual market:

Among the rate hikes being considered for health plans sold in Texas’ individual market — coverage that is not sponsored by employers — are a proposed 20 percent rate increase for Blue Cross Blue Shield of Texas’ Blue Advantage HMO plans. Other possibilities include a nearly 18 percent rate increase for Humana’s ChoiceCare PPO plans, a more than 17 percent rise in rates for Allegian Health Plans’ Allegian Choice PPO and a more than 15 percent jump in rates for UnitedHealthcare’s Compass individual plans.

And here are some increases in the small business market in California, another large state:

California’s managed-care regulator slammed health insurance giant Aetna Inc. on Thursday for “price gouging” after it raised rates on small employers by 21%. This marked the fourth time since 2013 that California officials have found Aetna’s premium increases on small businesses unreasonable. Aetna, the nation’s third-largest health insurer, is raising rates by 21%, on average, for about 13,000 people covered by small employers. This change in premiums took effect July 1. … But California officials have no power to stop health insurance rate increases.

Meanwhile, single digit (“modest”) increases fly under the radar:

Health insurance experts say it’s tough to draw broad conclusions about prices from the requests released Monday. The health care law only requires insurers to report proposed hikes of 10 percent or more. That’s only a partial picture of the market that tilts toward a worst-case scenario.

“It’s hard to generalize, but that said, I think all signs are pointing to bigger premium increases than in 2015,” said Larry Levitt of the nonpartisan Kaiser Family Foundation.

So brace yourselves. The second salient characteristic of the health care market is consolidation. Consolidation is already “well advanced” in the health care industry as a whole, but the current proposals in the insurance sector are especially egregious:

Two more of the nation’s biggest health insurers are moving to merge, raising the possibility of a potential fight with antitrust regulators.

Anthem said on Friday that it had agreed to buy Cigna for $48.3 billion, finally striking a deal after a nearly yearlong pursuit. Buying its rival, Anthem intends to create a new giant in the sector, gaining greater scale and considerably cutting costs.

But the proposed transaction, coming three weeks after Aetna said it would to buy Humana for $37 billion, could shrink the number of major companies in the health insurance industry from five to just three. And that could mean fewer options and higher rates for consumers and the employers that provide health insurance.

Yikes. And it’s not like the health insurance industry isn’t already doing very well for itself. Forbes:

The major health insurers have announced their quarterly earnings. For UnitedHealth Group, the largest health insurer, plus the six which are currently engaged in take-over deals, the results were largely positive. The results, and the market’s reaction, indicate [that] Health plans have largely been able to pass increases in medical costs onto their members, challenging the notion that Obamacare’s regulations on profit have benefited consumers. [And] these improved margins appear to be driven by higher premiums.

So, will increased consolidation lead to lower pricing? Unlikely:

Dave Jones, California’s insurance commissioner, said he doubts there will be any significant benefits from this round of mergers.

… But generally, he said, increased consolidation has resulted in less competition and higher pricing.

Why is that? First, let’s dig into how consolidation is sold to the public. Then, let’s look at why the sales job is wrong. Finally, let’s look at the effects of consolidation on people like us. (Again, all areas of the health care industry are consolidating, for reasons we’ll get to below. But since the most visible mergers are in the insurance industry, I’ll take that industry as a proxy for all the others.)

Consolidation Means Higher Prices

Consolidation is generally framed as a cost-saving move. This reporting is typical. After noting that UnitedHealth’s quarterly profits increased 13% (!):

Competitors like the Blue Cross-Blue Shield carrier Anthem Inc., Aetna Inc. and Centene Corp. all have made multibillion-dollar offers for smaller companies in recent weeks as health insurers bulk up on technology try to cut costs by growing larger.

And, according to some theorists, costs are to be cut by “economies of scale.” Investing site the Motley Fool on Anthem, another huge player (merged with WellPoint in 2004):

Scale should generate better margins for the business — if you can spread fixed costs over a greater number of revenue-producing members, then you should make more on a per-member basis.

But the Fool goes on to note:

Yet, while the 2014 benefit expense ratio was 83.1% — a two percentage point decline year-over-year — Anthem’s SG&A (selling, general and administrative) expense ratio climbed from 14.2% of operating revenue in 2013 to 16.1% in 2014. So why is that number going up instead of down, as we’d expect if Anthem was properly wringing out synergies from its scale?

As so often: “Jam yesterday, jam tomorrow, but never jam today.” The claims of synergy are frequent, but the reality is less so.

Claims that consolidation will reduce costs are pervasive in the press, but history tells us that reality may be very different. From an influential study in the American Economic Review (pdf), “Paying a Premium on Your Premium? Consolidation in the US Health Insurance Industry”

Collectively, the results presented in this section show that consolidation does result in a “premium on premiums.” We arrive at this conclusion by exploiting arguably exogenous increases in local market concentration caused by the nationwide merger between two large insurance firms, Aetna and Prudential. Two key results indicate our conclusions are not driven by unobserved factors correlated with the pre-merger market shares of Aetna and Prudential. … The findings summarized above are consistent with the exercise of market power in the wake of consolidation.

And after dismissing alternative explanations:

Our instrumental variables estimates, which exploit plausibly exogenous shocks to local market structure generated by the 1999 merger of Aetna and Prudential, imply that the average market-level changes in HHI between 1998 and 2006 resulted in a premium increase of approximately 7 percentage points by 2007, ceteris paribus. Given our sample includes both fully and self-insured plans, and insurers have less control over pricing of the latter, it is plausible that consolidation is associated with an even larger impact on fully insured plans, which are dominant in the individual and small group markets.

And for hospital concentration, see the National Institute for Health Care Management:

Results clearly showed that hospitals in concentrated markets, where there is less competition, are able to extract significantly higher payments from private insurers for each of the six procedures studied (Figure 1). For example, the average hospital in concentrated markets received $32,411 for each commercially insured patient undergoing coronary angioplasty, or one and a half times the $21,626 received in competitive markets. Similarly large price differentials are observed across markets for the other five procedures, with all differences statistically significant.

Clearly, there’s no easy correlation between cost-saving and consolidation — even assuming good faith on the part of consolidators (or regulators, who might not approve the decrease of major health insurance companies from five (!) to three (!!)). So why does consolidationit keep happening?

The Forces That Drive Consolidation

First, before making any generalizations about the health care industry, we should remember that it’s a complex system and that explanations will be multi-causal and reflexive. For example:

[T]wo big shocks — the Great Recession and the passage of ObamaCare — recently hit the health care industry in rapid succession. And the effects of each are difficult to disaggregate. A big economic collapse reduces the number of paying customers, in health insurance as much as elsewhere, so business models have to retool to accommodate.

That said, I think I can identify five drivers, putting aside factors like CEO ego, executive compensation, “empire building,” and pastures new for accounting control fraud:

1. It’s All About the Rents
2. It’s All About Siphoning Off the Rents
3. Godzilla vs. Mothra
4. The Role of Private Equity
5. The Effect of ObamaCare

Let’s consider each of these in turn:

(1) It’s All About the Rents

Megan McArdle (one of the few to make the call that the ObamaCare website would be a disaster at launch) provides a vivid description:

You can think of it this way: The structure of America’s third-party payer system allowed providers to make very nice incomes by providing health care services to basically price-insensitive consumers. Both insurers and the government reacted by ramping up the paperwork and claims rules to try to control this trend.

But providers had a great deal invested in keeping those income streams — not just because they need a third yacht, but because their office and hospital plant were constructed for a world where the money flowed readily, and they can’t just give back the buildings and machines and office staff. They’ve responded to these pressures by getting bigger, recovering some of their lost income. So insurers and the government have turned the screws even tighter, which has given them even more incentives to get big. That’s the story of American health care over the last few decades.

These siphoned-off “income streams” are rents, and McArdle’s logic applies to everybody in the game, not only “providers.” Here’s an example of hospitals collecting rent based on their geographical location. Here’s an example where hospitals collect rent based on their strategic position in the payments system:

Today’s frenzy of hospital mergers and physician practice acquisitions is giving hospital systems even greater leverage to inflate opaque “charge-master” medical bills that even hospitals are sometimes unable to itemize sensibly. … [T]his translates into higher health-insurance deductibles and copays for insured Americans, and in the case of Medicare and Medicaid, higher taxes.

And here’s an example of rent based on hospitals’ control over choke points at admissions and testing. Journal of the American Medical Association:

After adjusting for patient severity and other factors over the period, local hospital–owned physician organizations incurred expenditures per patient 10.3% (95% CI, 1.7% to 19.7%) higher than did physician-owned organizations (adjusted difference, $435 [95% CI, $105 to $766], P = .02).

[C]onsolidation could lead to higher patient care expenditures due to preferential use of high-priced hospitals for inpatient admissions, substitution of hospital-affiliated outpatient departments for ambulatory surgery and imaging facilities, and increased prices to insurers for laboratory tests, drugs, and other ancillary services.

Of course, hospitals aren’t the only rent-seekers; health insurance companies do the same. Health Affairs: “[T]he ongoing insurance overhead that the ACA has added to our health care system [has been estimated at] more than a quarter of a trillion dollars through 2022.” Ka-ching.

(2) It’s All About Siphoning Off the Rents

The health care industry is involved with government at all levels. That means there’s a lot of influence to buy, and consolidation helps. Health Affairs:

A further concern relates to the influence that a highly concentrated insurance industry may wield in Congress, state legislatures, and regulatory agencies. With a large and growing portion of beneficiaries in Medicare and Medicaid served by private insurance companies, the laws and administrative regulations that govern plan bidding, appeals, and administration of health plans are increasingly important.

The ability to influence these rules are as significant to the bottom line as any aspect of insurers’ business operations.

So maybe the problems Anthem had with the overhead that made its economies of scale go away had something to do with this? Bloomberg:

[Insurance] companies have a lot of regulatory overhead, first of all for compliance, and second of all for lobbying. The bigger you are, the easier it is to afford a team of experts to make sure that you understand all the pertinent regulations, and a second team of experts to prevent legislators and bureaucrats from burdening you with a lot more pertinent regulations. These are largely fixed costs, and merging reduces them. Getting bigger also makes it harder for legislators to refuse to return your phone calls.

Again, the same logic and dynamic applies everywhere in the health care industry, not just in the insurance sector.

(3) Godzilla vs. Mothra

So if the answer to pressure on rents is consolidation, that applies to all the players, and so we get an arms race. McArdle again:

Insurers are under pressure from other parts of the industry that are also consolidating. Hospital networks have gotten bigger and more powerful. Physicians are increasingly going to work for hospitals or large practices. This could put insurers at a disadvantage to negotiate prices. If your suppliers are highly fragmented, you can walk into the meeting and say, “Here’s what we’re offering; take it or leave it.” But if there are only two or three big hospital networks in your area, they can say the same thing to you. This has produced something of an arms race between insurers and providers trying to get bigger so they will better be able to crush the other. When Mothra and Godzilla are battling over the city, you don’t want to be the tiny human standing on the ground between them.

We don’t want to be, but we are! Forbes summarizes:

It sure looks like we are on the way to many fewer but much larger health care delivery corporations looking to check and balance each other and settle for their share of the spoils [rents] more than make this system work better.

(Of course, they all blame the other guy. But that’s just human nature.)

(4) The Role of Private Equity

I would be remiss not to mention private equity in pushing mergers:

[T]he biggest wagers in health-care services are being placed by private equity, which is chasing opportunities to roll up parts of the existing infrastructure. For instance, there were 95 hospital mergers in 2014, 98 in 2013, and 95 in 2012. Compare that with 50 mergers in 2005, and 54 in 2006. Cheap debt and ObamaCare’s regulatory framework almost guarantee more consolidation.

(It will be interesting to find out if private equity is as good at managing health-care services as it is at managing rental properties. I’m guessing yes. That’s not a compliment.)

(5) The Effect of ObamaCare

Finally, there’s the role of ObamaCare, or rather, “the health care law.” (As a “consumer,” I tend to identify ObamaCare with the health insurance websites and the products peddled thereon, but the scope of the PPACA was far greater.) The conventional wisdom — because markets — is that ObamaCare, by spurring competition, will “bend the cost curve.” As you see above, I’m skeptical. I’m also skeptical that ObamaCare actually “caps profits” through the Medical Loss Ratio[1], which would seem to remove a key incentive. It is true that the PPACA encourages physicians to consolidate through Accountable Care Organizations, and that this sets off an arms race with hospitals. However, I think the main driver for consolidation is less ObamaCare as such than the entire stream of all government health care programs, including ObamaCare, Medicaid, and Medicare, especially the (privatized) Medicare Advantage.

Many of the purchases have been designed to bulk up their Medicaid and Medicare Advantage businesses because both of those programs keep growing.

And:

Aetna’s $37 billion proposed acquisition of rival health plan Humana is largely driven by getting access to Humana’s strong Medicare Advantage volumes. AHIP has fought hard to preserve Medicare Advantage, which it trumpets as offering higher-quality care than traditional Medicare.

(Hilariously, Flexian Marilyn Tavenner left CMS will run AHIP, a health insurance trade organization, her reward, one imagines, for the ObamaCare website debacle.)

Of course, all these five factors, and especially the first three, point to the health care industry as an example of massive “market failure,” unless you consider optimizing the health care industry for a product — private health insurance — that has no reason to exist a success.

How Will Consolidation Affect the Rest of Us?

Of course, consolidation creates fatter targets for hackers, and even if consolidation — against all odds — leads to cost savings, there’s no particular reason to think any cost savings will be “passed on to consumers,” as we say. Of course, consolidation itself is costly:

True to form, Anthem is claiming that nearly $2 billion in synergy [ha] savings will be realized by the merged entities. This is probably true, to some extent. But you should keep in mind that mergers are themselves extremely costly. And I don’t just mean the fabulous fees that investment bankers and consultants collect to facilitate them. Joining two entities into one is really difficult: Corporate cultures clash, turf wars damage morale and profits, IT systems never do work right together, key employees leave, customers are alienated. So in general, these sorts of statements should be taken, not just with a grain of salt, but while sitting next to a salt lick with a big bag of Mr. Salty Pretzels and some cocktail peanuts to wash the whole thing down.

Or, as Benefits Pro asks:

Money spent on the merger needs to be recouped. Who suffers? Employers, consumers, patients, medical providers? Somebody has to pay up.

Who suffers? Wait, let me take a moment to think…. Let’s take a simple example of one hospital consolidation at Saint Luke’s Hospital in Nampa, Idaho. Notice the attempt to settle an arms race between a hospital and a physicians practice with a purchase:

NAMPA, Idaho – When Idaho’s largest hospital system bought the state’s largest doctor practice in 2012, the groups expressed hope that the deal would spark a revolution in delivering better-quality care.

Instead, it ignited a costly legal battle with state and federal regulators and rival hospital systems.

Despite St. Luke’s good intentions, [a] judge worried the merged entity would be so dominant that it could raise prices at will. He suggested hospitals could work with doctors to deliver more-efficient care without buying them out.

St. Luke’s went over the line not just because the court found the merger gave it control over 80 percent of the primary care physicians in the market but because the FTC investigation uncovered internal documents indicating the hospital system might use the acquisition to charge higher rates to insurers. Idaho’s largest insurer, Blue Cross of Idaho, also testified it feared St. Luke’s would force it to pay more for care.

Ka-ching.

But executives at rival Saint Alphonsus — a subsidiary of Trinity Health, an 86-hospital Catholic health system —were not convinced. Saint Alphonsus, which put in a bid to buy Saltzer after it was asked by the medical group, sued to overturn the Saltzer-St. Luke’s merger.

CEO Sally Jeffcoat said Saltzer is “our lifeblood” because referrals from its doctors had accounted for nearly half of the admissions to its Nampa hospital.

Zelda Geyer-Sylvia, president and chief executive of Blue Cross of Idaho, ­does not buy the argument that a larger St. Luke’s would be better able to control costs.

“Consolidation has not been an effective way of reducing costs or providing more effective care,” she said. “People here have all the best intentions, but once you eliminate competition it’s gone.”

What I find fascinating is that both reporter and a major player put optimizing the allocation of rental streams under the heading of “good” or “best intentions.” Roy Poses, in his coverage of the Saint Luke’s case, points to what the intentions should be, and the intentions that you, as a patient, are entitled to expect:

True health care reform would be informed by the core value that physicians are supposed to endorse: the individual patient comes first. Health care should not be mainly about increasing corporate revenues, or pleasing corporate executives or government bureaucrats. However, big organizations and the in-group who personally profit from their operations want to keep such concerns anechoic.

Because health care isn’t all about costs and rents, is it?

At some point, as a product’s costs get low enough, they can no longer be attributed to providers finding better ways to supply a quality product — instead, it’s simply because the product itself is bad. And when a product crosses the line into “bad” is a moral and social question rather than a purely empirical one. For instance, requiring apartment developers to include good plumbing and basic sanitation in any dwelling they build drives up the price of housing to some degree. But taking away those regulations would be a pretty terrible way to make housing more affordable.

“The product itself is bad.”

If you want to see where the logic of consolidation leads, think of the cable industry, and weep. And try not to get stepped on by the monsters![2]

NOTES

[1] Forbes explains that ObamaCare’s Medical Loss Ratio requirement does not cap absolute costs; it’s a ratio:

Obamacare regulates the Medical Loss Ratio (MLR), which is the amount of premium insurers actually spend on medical care. Health plans that do not meet a minimum MLR must pay rebates to customers. Although any rebate is cheered by the administration as a success, the MLR has had little effect on insurers’ income statements. Indeed, because mandates effectively guarantee profits for the industry as a whole, the MLR regulation could simply allow insurers to pass increases in medical costs to their customers. That is, an MLR of 85 percent, which is the quotient of $850,000 in medical claims divided by $1 million in premium, is the same MLR as $950,000 in medical claims divided by $1,117,647 in premium.

[2] Or advocate for single payer. After all the work NC did on the Greek payments system, however, it’s possible that the IT implications of a single payer system might need to be thought through. Of course, we could just outsource the work to Canada or Taiwan.

Readers, I’m leaving comments open because I’d like to hear your views and experiences of these consolidated systems. It’s such a huge topic!