Editor’s note: See Stuart Guterman’s post on consolidation and market power in health care, also published today, and watch for more on these subjects in Health Affairs Blog.

Health Affairs recently published a set of papers addressing the problem of provider consolidation and consequent increased prices. Perhaps even more striking than the specific arguments made in these papers is the very fact that smart and busy people other than antitrust economists and lawyers now are actually spending a great deal of their professional time thinking about this problem. High prices and the distortions in markets resulting from differential pricing power have been the unacknowledged elephant in the policy room for decades, even as the policy community and policy makers have wrung their hands over what to do about rising health care costs. More than 40 years ago, President Nixon declared that health care spending increases were “unsustainable.” And here we still are grappling with health care spending.

Over the decades I have been told by smart health economists that the main culprit behind increasing health spending is technology, although the definition of technology turns out to be pretty flexible — new ways of providing care are considered new technology, not just machines and drugs. And nominees for the reason our baseline spending exceeds other countries’ by so much have included administrative complexity in our multi-payer, crazy quilt organization of health care; defensive medicine caused by malpractice concerns; and fraud and abuse. Jack Wennberg and colleagues at Dartmouth have argued that variations in service use that do not increase quality explain spending variations, at least in Medicare where payment (price) variations are not permitted other than to reflect differences in input costs.

All of these explanations have merit, but for non-government payers, prices have actually been the main source of high spending and variations in spending, at least in the recent past and probably for much longer. Prices for commercial and self-funded insurance products result from market negotiations between insurers and providers; the balance of power in these negotiations has sometimes shifted, most recently toward many providers, but certainly not all of them — the relatively few remaining independent hospitals and the solo and small physician practices have become “price takers,” even as other providers are able to negotiate payment rates far higher than Medicare benchmarks.

The Long Road To Coming To Grips With Provider Consolidation

In the 1970s, a few states implemented modestly successful all-payer rate-setting programs addressing prices and pricing variations. However, in the aftermath of President Reagan’s election and the anti-government sentiment it reflected, and with broad adoption of an HMO strategy that relied on narrow networks and price concessions from providers, price regulation was dropped, with only the Maryland’s rate-setting approach continuing. Prices as an important policy issue pretty much disappeared for more than two decades.

Not until 2003 did Gerry Anderson, Uwe Reinhardt, and others explain, “It’s the Prices, Stupid.” This was followed a few years later by McKinsey Global Institute’s creative analysis concluding, “Input costs – including doctors’ and nurses’ salaries, drugs, and other medical supplies, and the profits of private participants in the system – explain the largest portion of additional spending… [the $650 billion extra the US spends compared to world norms]” — and why prices in the US are so high.

But even these analyses were performed at the aggregated, national level, rather than at the market level, and without naming names of those obtaining the high prices. The unacknowledged elephant could continue to munch lazily in the policy room, while markets evolved in the direction of provider consolidation — ostensibly to achieve greater efficiencies, easier access to capital, and more attention to quality, but also certainly to increase leverage in price negotiations with insurers, who earlier had used their own pricing power to drive prices down. Antitrust-oriented economists did document concerns about the impact of consolidation on prices, but most of us policy wonks, concerned about access or quality measurement or overuse of services, did not pay these papers much attention. Antitrust enforcers at the Federal Trade Commission and the Department of Justice named names and tried, but mostly failed, to prevent price-increasing hospital mergers.

Also mostly ignored from the policy discussion was how policies designed for Medicare have important spillover effects on prices negotiated between non-governmental payers and providers, for better or, usually, worse. As a prime example, Medicare’s provider-based payment policies, typically also adopted by non-governmental payers, pay up to twice as much for a physician service provided in a hospital outpatient department as in a physician’s office. That policy has stimulated hospitals to employ certain categories of specialist physicians, especially cardiologists.

The point is that the problem of pricing power in health care markets is a much broader one than can be adequately addressed by antitrust policy alone. All the Health Affairs papers make this point very clearly.

It wasn’t really until January 2010, with the release of Investigation of Health Care Cost Trends and Cost Drivers by the Massachusetts Attorney General, that the issue of high prices and the huge price variations that occur in markets received the overdue attention it deserved, and discussion of what to do about this underappreciated problem gained momentum. The study found that price variations are not correlated to (1) quality of care, (2) the sickness or complexity of the population being served, (3) the extent to which a provider is responsible for caring for a large portion of patients on Medicare or Medicaid, or (4) whether a provider is an academic teaching or research facility. Moreover, (5) price variations are not adequately explained by differences in hospital costs of delivering similar services at similar facilities.

Rather, prices were correlated with market leverage as measured by the relative market position of the hospital or provider group compared with other hospitals or provider groups within a geographic region, or within a group of academic medical centers.

In the same month, the Rhode Island Department of Insurance released its report finding that multihospital systems negotiated substantially higher rates than independent hospitals, some of whom had to accept rates below Medicare. Also in that month, researchers affiliated with the Center for Studying Health System Change published in Health Affairs the results of interviews with health care leaders in California pointing to the growing imbalance in negotiating leverage between payers and, especially, multihospital provider systems. (I was lead author.)

Interestingly, these reports came out just after the provisions of the Patient Protection and Affordable Care Act had been put to bed, as the process of achieving final passage through budget reconciliation and Presidential signature in March 2010, played out. There is little or nothing in the ACA that directly addresses the issue of strong and differential pricing power, partly because the political narrative accompanying the bill’s advocacy typically labeled insurers as the “black hats” and providers as the “white hats.” Yet, a close look would reveal that even some of the “whitest hats” — multispecialty group practices and integrated delivery systems pointed to as prototypical accountable care organizations because of their deserved reputations for quality, efficiency, and patient-centeredness – reportedly are able to obtain among the highest rates of payments from commercial payers, often exceeding 250 percent of Medicare.

Some argue that is fine; under new payment approaches, these organizations will make up for any increased pricing they bargain for through greater efficiency, especially in enhanced care coordination and reduction in inappropriate services. Good luck with that one. An efficient organization can reduce the volume of services provided compared to the average by perhaps 20 percent. MedPAC finds a 30 percent spread in spending (prices held constant) across geographic areas between the 10th and 90th percentile, once health status is correctly factored in. Yet, variations among providers in prices negotiated with non-governmental payers across and within geographic areas vary by far more – I have found as much as 1,000 percent at the extreme, and 100 percent price variations across physicians and hospitals based on their leverage in price negotiations are not uncommon.

In short, it is unlikely that an organization can offset the higher spending resulting from exorbitant prices by decreasing the volume of services. Or put more pithily, higher prices eat decreased volume for lunch.

Policy Responses: Antitrust Is Part – But Only Part – Of The Solution

Over the past four years, the problem of rising provider prices, caused in some but not all cases by market power from consolidation, has again been receiving growing attention (although Bruce Vladeck is correct that hospital prices, which had been rising for many years far faster than inflation, have been fairly flat over the past 24 months or so, for unclear reasons). As Martin Gaynor documents, federal and state antitrust agencies — which have primary responsibility for monitoring competition, and, accordingly, the untoward effects of consolidation on pricing — have gotten more active and have had some important wins in blocking hospital mergers and a merger of physician practices.

In my view, however, antitrust policy to prevent mergers within local service areas cannot be the primary approach to addressing provider pricing power. Often, pricing power occurs in the absence of consolidation — perhaps from a hospital or specialty practice that is geographically isolated or which has such a positive reputation in the community that insurers, practically, cannot market a plan with that provider organization excluded from the network or placed in a high cost-sharing tier within the network.

Indeed, competition theory would hold that an organization that achieves pricing power through its reputation deserves high prices; it certainly should not be the recipient of antitrust action. That’s easy for competition theory to say. At 250-300 percent of Medicare, paying for reputation is a problem for consumers and deserves policy attention, along the spectrum of non-antitrust options that Ginsburg and Pawlson presented.

Further, consolidation happens for lots of understandable, defensible reasons, but, nevertheless, the consolidated entity often achieves the ability to exercise their newly acquired pricing power. That seems to have been the conclusion of the Massachusetts Attorney General, which entered into a landmark preliminary agreement earlier this week with Partners HealthCare. Among other things, the agreement would permit Partners to acquire two hospital systems while at the same time baring Partners from raising costs across its network more than the general rate of inflation through 2020, cap its physician growth for five years, and prevent it from negotiating commercial contracts for physicians not employed by Partners for 10 years. The result of a three-year antitrust investigation by state and federal officials, this approach of addressing the untoward effects of consolidations after the fact are often referred to in antitrust parlance as “conduct remedies,” which policy generalists might simply label as regulation.

In short, there may well be workable regulatory approaches that fall far short of the full-fledged commitment to setting up and operating a Maryland-style, all-payer rate setting approach, which itself has had a mixed performance record and now is being overhauled in Maryland’s new Medicare demonstration. Putting regulatory ceilings on permissible negotiated rates, targeting particular institutions for oversight, and implementing a range of “pro-competition” regulatory provisions — e.g., prohibiting anti-competitive terms and conditions in insurer-provider contracts — deserve consideration. The National Academy of Social Insurance has set up a study panel chaired by Bill Hoagland and me to catalogue the full range of policy options available to address pricing power, with their respective pros and cons. The report is due this fall.

I have asked a couple of dozen of the best and the brightest of health policy experts whether they could tell me what a Certificate of Public Advantage is. No one responded with the correct answer: In simplified form, COPAs are issued by states committing to oversee and immunize certain health care transactions that potentially have anticompetitive effects from state and federal antitrust action. Similarly, policy generalists cannot describe the straight-forward tests the Supreme Court applies in determining whether to permit State Action Immunity from application of the antitrust laws to entities within the state. Or whether bilateral monopolies or vertical integration are likely to increase competition and reduce prices, or just the opposite or, perhaps, both, depending on the circumstances.

I’m not trying to boast here — I didn’t know any of this a few months ago either. My hope is that these and other concepts that are central to the discussion of pricing power, antitrust enforcement, and the other policy alternatives to address pricing power become as much part of the broad policy conversation as community rating and value-based payment. Prices are central to health policy and should be considered as such.