More Correlation than Causation
Insurance Company Consolidation, Market Competition, and Premium Costs

The American Medical Association recently issued another one of its increasingly predictable, but incomplete, "studies" of insurance market consolidation. Although it does not yet have a monopoly in producing such reports, the AMA appears to have cornered the political market for such one-sided analysis. (This is in contrast to its declining share of the market for physician memberships, which reflects its performance in other political arenas).

Making somewhat more sense of the Herfindahl-Hirschman Index or "HHI" (representing the sum of squared market shares of each opposing firm's side in a market, if not the square of a rent-seeker's hypotenuse) and other totems of antitrust lore requires better sorting out of the relevant markets in question. In the case of health insurance, their competitive dynamics differ greatly–-depending on whether one is examining the national market for large, self-insured employers (and government bodies); state markets sharing geographic boundaries and little else in common; or local markets subject to state-level regulation. As Chris Conover of Duke University (who did all the important work) and I pointed out in an AEI working paper earlier this year, the health insurance market generally is highly competitive for the roughly 60 percent of privately insured Americans who now purchase their coverage through large groups. The majority of large employers have ample alternatives to buying fully insured health benefits, such as self-funding or self-administration. Private insurers selling administrative services only or more limited levels of risk management in this national market report quite modest profitability levels, and concentration in the multistate employer market for health benefits remains low.

When it comes to the market for fully insured health benefits, individual states generally are too large to constitute a meaningful basis for antitrust analysis. In any case, states with nominally concentrated insurance markets tend to be dominated by a nonprofit insurer, and they do not consistently produce significant adverse consequences.

States with nominally concentrated insurance markets tend to be dominated by a nonprofit insurer, and they do not consistently produce significant adverse consequences

High HHI concentration levels alone do not demonstrate that market power exists or is being exercised. Metropolitan-Statistical-Area-level concentration ratios of the sort calculated periodically by the AMA are used by antitrust regulators only as a screening tool to identify where excess market power might be a problem. A high ratio itself is only the starting point for a careful investigation of whether in fact a firm or even an entire industry wields excess market, including whether it attained such market power illegally. Even in "concentrated" markets, the credible threat of entry by other plans can produce "competitive" market conditions, including lower prices, increased quantity, and more efficient administrative cost structures.

The available evidence is inconsistent with the view that concentration is allowing health insurers to exploit their members. Instead, it squares with a more plausible view that concentration in the health insurance industry has provided a useful corrective to the equally (or more) disturbing growth in concentration of many hospital and physician markets over the past decade. Absent countervailing power from insurers, patients might be just as vulnerable to exploitation by providers as they purportedly are to profit-motivated insurers. Greater insurer bargaining power results in lower hospital prices, and health insurer concentration is associated with reductions in physician earnings (hence, AMA's interest in this issue). But this suggests that increasing insurer competition while leaving in place concentrated markets for hospitals or doctors may well make patients worse off rather than better. Conversely, only in markets already lacking provider concentration will a singular focus on enhancing competition among insurers be certain to improve matters.

Notwithstanding rhetoric from policymakers claiming health insurers are "making record profits, right now" or that such profits are obscene, annual figures over nearly two decades (1990-2008) show that net income as a percent of revenues for publicly traded hospital and medical service plans averaged only 3.3 percent, ranging from a low of just under 0 percent in 2002 to a high slightly above 6 percent in 1994.

Recent figures show that the total margin (net income as a percent of revenues) for nonprofit Blues plans declined from 4.3 percent in 2007 to 2 percent in 2008. But this includes income from investment revenues. Underwriting margins, which are calculated based only on premium income, were only 1.0 percent and 1.4 percent respectively during these years. This is consistent with historical data (1997-2001) showing that total margins for nonprofit Blue plans were 1-2 percentage points lower than those reported by for-profit Blue plans, with more than half this difference stemming from lower underwriting margins.

In any case, to the extent that lack of competition in health insurance is a problem, it is most keenly felt in the markets for nongroup and small group coverage. One notable, and more scholarly, study within the last year by Northwestern University economist Leemore Dafny and several coauthors did document that most local markets are becoming concentrated over time. Applying their result to the observed increase in concentration from 1998 to 2006, the authors estimated that private health insurance premiums nationwide were 2.1 percent higher in 2006 than they would have been had concentration remained unchanged.

Let's pause for some perspective. Given that inflation-adjusted premiums doubled during this period, these findings imply that consolidation accounts for very little of the steep increase in health insurance premiums in recent years. Indeed, the authors further concede that their results, based on a private national database of more than 800 employers (mostly large, multistate, publicly-traded firms) cannot necessarily be extrapolated to other markets such as those for small group or nongroup insurance, and they caution further that this finding is based on a single merger.

Ironically, the small group market in particular is one where state regulatory oversight of market conduct already is (or could be) most intense, yet there is some evidence that state (and federal) regulation of that very market has in some cases reduced the number of insurers or increased concentration in that market. The real issue is one of better, but not necessarily just more, regulation. For example, actions that have aroused the greatest public concern, such as having coverage cancelled (rescinded) when insured individuals get sick or refusals by insurers to authorize covered benefits, already are illegal. This suggests that better enforcement of existing laws, rather than enactment of new ones, may be warranted. Likewise, the general public might benefit from being made more aware of its options for appealing disputes about medical necessity, experimental or investigative treatment, emergency room reimbursement, or similar matters. Public distrust of insurers might well be placed in perspective if regulators did a better job of demonstrating how infrequently complaints are filed against health insurers relative to the huge number of claims processed or members served.

What else can we do differently--besides assuming, with little evidence, that antitrust enforcement will track closer to its idealized theory than to its long track record of inconsistent, if not dismal, performance? We might consider highlighting the extent to which some problems of market concentration originated in state policies (e.g., tax exemptions and regulatory advantages for "nonprofit insurers") that favored certain types of plans rather than through natural market forces. Although broad tax-exempt status was curtailed in recent decades at the federal level, it remains to varying degrees in some states. In some cases, it extends not only to state income taxes, but also to other business taxes, sales and use taxes, and real and personal property taxes; even if a state does not extend full tax exemption, Blue plans often have lower requirements for premium taxes, guaranty fund assessments, and high-risk pool assessments relative to for-profit health insurers. If having a nonprofit Blue plan dominate a market is thought to be problematic, the most straightforward solution to this problem may be to revisit whether tax exemptions or similar privileges are warranted.

In areas where lack of competition adversely affects those seeking to purchase health insurance, policymakers should consider another, more effective, tool to restore competition that would be superior to reliance on a public plan. For at least two decades, the most important source of competitive pressure in health insurance has been the availability of new entrants, including start-up HMOs and carriers from adjacent geographic regions. But because the McCarran-Ferguson Act delegated authority to regulate insurance to the states more than six decades ago and insisted that such regulation be quite comprehensive to merit preemption of federal oversight, insurance companies wanting to sell products across state lines must comply with a myriad of different state regulations, including mandated benefits, premium taxes, solvency requirements, and licensing rules. Those regulations often help entrench dominant incumbent carriers, discourage new entrants, and prop up an inefficient mix of hidden cross-subsidies. Collectively, such state regulations are estimated to increase premiums by 10 to 96 percent (probably much closer to the former figure than the latter one). Those costs are in addition to the widespread geographic variations in health spending that are related to differences in practice patterns. Together, these result in a nearly five-fold difference in average premiums across states. Removing regulatory barriers to cross-border sales thus offers the prospect of increasing competition and reducing regulatory costs.

There are a variety of approaches to allow cross-border sales while retaining accountable regulatory authority at the state level. The better ones provide suitable safeguards to ensure states handle such regulation even-handedly and responsibly, albeit with a somewhat lower level of net savings on premiums, and do not promise more than interstate competition alone can deliver.

Thomas P. Miller is a resident fellow at AEI.

Photo Credit: iStockphoto/Jason Stitt

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