Health Affairs

Alwyn Cassil
(202) 264-3484
acassil@hschange.org

Alexandra Matisoff-Li
(510) 587-3154
amatisoff@chcf.org

Sue Ducat
Director of Communications
(301) 841-9962
sducat@projecthope.org

From Health Affairs

Growing California Hospital-Physician Market Power Foreshadows Challenges to National Health Reform

Health Affairs Article Cites Provider Market Power to Negotiate Higher Private Insurer Payment Rates as the 'Elephant in the Room' of the National Health Reform Debate

Washington, D.C. -- While the high cost of private health insurance has drawn plenty of attention in the health reform debate, an underlying driver of higher insurance premiums--the growing market power of hospitals and physicians to negotiate higher payment rates--has gone largely unexamined, according to a Center for Studying Health System Change (HSC) study published online today by Health Affairs.

Funded by the California HealthCare Foundation, the study examined the growing market power of many California hospitals and physicians, finding that providers are using various strategies, such as tighter alignment of hospitals and physician groups, to negotiate significantly higher payment rates from private insurers.

"Provider market power is the elephant in the room that no one wants to talk about in the national health care reform debate," said HSC Senior Consulting Researcher Robert A. Berenson, M.D of the Urban Institute, a coauthor of the study with HSC President Paul B. Ginsburg, Ph.D., and Nicole Kemper, M.P.H., a former HSC research analyst.

"Health insurers have been squarely in the crosshairs and blamed for the high cost of private insurance, while the role of growing hospital and physician market power has escaped scrutiny," Berenson said.

The study also points out that California offers a cautionary tale for reform proposals that encourage hospitals and physicians to form tighter relationships through accountable care organizations.

"Reform proposals that encourage hospitals and physicians to integrate have the potential to improve quality and increase efficiency, but the savings may not be passed on to private payers if provider market power to command higher prices goes unchecked," Ginsburg said.

The authors conclude that "unless market mechanisms can be found to discipline providers' use of their growing market power, it seems inevitable that policy makers will need to turn to regulatory approaches, such as putting price caps on negotiated private-sector rates and adopting all-payer rate setting. Indeed, some purchasers who believe strongly in the long-term merits of increased integration of care delivery believe that price regulation may be a prerequisite for payment reforms that encourage integration."

The Health Affairs article, titled "Unchecked Provider Clout in California Foreshadows Challenges To Health Reform," draws on HSC site visits to six California markets between October and December 2008 to study regional differences in health care affordability, access, and quality. The six markets--Fresno, Los Angeles, Oakland/San Francisco, Riverside/San Bernardino, Sacramento, and San Diego--were chosen to reflect a range of economic, demographic, health care delivery, and financing conditions in California. In all, approximately 300 interviews were conducted.

The study identified three key factors in California that are driving the shift of negotiating power from private insurers to hospitals and physicians:

• consumer demand for broader provider networks following the managed care backlash;
• consolidation of hospitals into larger, powerful systems and tighter alignment with physicians; and
• growing hospital and physician capacity constraints.

According to some study respondents, the shift in negotiating power to providers needs urgent policy attention. "I am shocked there isn't an outcry over the fact that our costs are driven out of control," one health plan executive complained. "We would like to establish some sort of boundary, beyond which these guys can't go. We'd welcome some regulatory intervention to break up these monopolies, because they are just killing us."

California was in the vanguard of managed care in the 1980s and early 1990s, as large purchasers in the state aggressively moved employees into health maintenance organizations (HMOs) in response to a string of double-digit annual premium increases. Health plans in turn used their growing market power--backed by credible threats to exclude providers from plan networks--to severely limit rate increases. Excess hospital and physician capacity in California at the time also put providers at a negotiating disadvantage.

In the late 1990s and early 2000s, providers responded to their compromised financial situation in a number of ways. Hospitals exited risk-based payment contracts, formed larger hospital systems through mergers and acquisitions, and attempted to form tighter physician alliances. Medical groups and independent practice associations consolidated, with the weaker ones going out of business.

The authors note that "negotiating as a system across a broad geographic area avoids antitrust scrutiny, which focuses on local market concentration. At the same time, this strategy permits hospital systems with leverage in some markets to negotiate high rates elsewhere as well." Moreover, certain providers--especially hospitals--have achieved "must-have" status, meaning they must be included in a plan's provider network to make the plan acceptable to customers. "Must-have" hospitals, by definition, have market leverage over health plans, because plans cannot plausibly threaten to exclude them.

According to the authors, "part of the rationale for tighter relationships between hospitals and organized physician groups is similar to that proposed nationally for accountable care organizations: to work together as an integrated delivery system to improve quality and efficiency." Nevertheless, the authors believe that one clear goal of alliances among California hospitals and physicians is to improve negotiating clout for both.

While many providers have gained the upper hand with health plans, the study also found that certain factors have prompted some providers to limit the degree to which they exercise their market power. Some providers may balance their desire for high prices with the fragility of employer-sponsored insurance in their communities and the competitive threat posed by Kaiser Permanente, a large group-model HMO that typically offers lower premiums in return for more limited choice of hospitals and physicians.

### ###

The Center for Studying Health System Change is a nonpartisan policy research organization committed to providing objective and timely research on the nation's changing health system to help inform policy makers and contribute to better health care policy. HSC, based in Washington, D.C., is funded in part by the Robert Wood Johnson Foundation and is affiliated with Mathematica Policy Research, Inc.

Health Affairs, published by Project HOPE, is the leading journal of health policy. Beginning in January 2010, the peer-reviewed journal appears each month in print, with additional Web First papers published weekly at http://www.healthaffairs.org/. The full text of each Health Affairs Web First paper is available free of charge to all Web-site visitors for a two-week period following posting, after which it switches to pay-per-view for nonsubscribers. Web First papers are supported in part by a grant from The Commonwealth Fund.