Editor’s note: See Robert Berenson’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 last week posted a set of papers that represent several perspectives on Provider Consolidation in Health Care: Challenges and Solutions. To provide a context for these papers and for the broader discussion of how to make markets work in health care, I suggest a couple of thoughts.

There are two types of markets in health care: the market for health services and the market for health coverage—these markets are interrelated, and both of them are broken.

The historical correlation between provider concentration and both higher prices and lower quality is well-documented. With the increased focus under health reform on collaboration across providers and settings, and the increase in physician and hospital consolidation and the purchase of physician practices by hospitals, the concern is that this trend may lead to adverse consequences for the health system.

Before most people make any decisions about purchasing health services, they participate in the market for health coverage—albeit passively, in many cases. While increasing consolidation in provider markets is a distinct concern, there is a fair amount of consolidation in health coverage: in 2010, there were 37 states in which the single largest insurance carrier had a market share of at least 45 percent. Although health insurers with more market power have been found to be more effective in keeping health care prices down, there is some question about how well that translates to lower premiums as insurers use their market power in negotiating with the employers. (See here, here, and here.) (It should be noted that the Affordable Care Act, in creating the health insurance marketplaces, establishing minimum medical loss ratio requirements, and providing for a rate review process, may go a long way toward addressing this concern.)

The markets for health services and health coverage have several flaws in common. In both markets, there is a disconnect between the person or entity that is making the purchasing decision and the user of the product. Only 11.7 percent of national health expenditures (NHE) came directly out of consumers’ pockets in 2012.

Household health spending, which also includes contributions to private health insurance premiums and Medicare payroll taxes and premiums, accounted for 28.4 percent of NHE—a significant amount—and, in the end, households foot the entire bill for health care through taxes, higher prices, and foregone wages, in addition to more direct costs. Nonetheless, the implications of the decision to use individual health services often is diffuse and unclear—making it difficult, in Bill Sage’s terms, to understand what product is being purchased, not to mention its cost and likely value. So how can we expect the market mechanism to transmit accurate signals about patients’ and purchasers’ needs and respond to them appropriately?

As is now widely recognized, adverse incentives are inherent in our still predominately unfettered fee-for-service payment system. We all want a health care system that provides high-quality, reasonably-priced health care but we pay for more services and more complex and invasive procedures, so that’s what we get. The current payment system, in fact, often punishes providers and insurers who try to produce or encourage high quality, effective, and efficient care.

Lack of information is another problem that impedes market function. Although strides have been made in providing data on both the quality and cost of health services and health coverage, those data need to be available to the purchaser and consumer in a form that is useful to effective decision-making and in a context in which those decisions can elicit the desired response. Transparency is a widely-discussed and accepted goal, but it frequently is misunderstood or misapplied; there is a great deal of difference between data and information, and all too often what is called transparency involves nothing more than putting the proverbial “black box” inside a Lucite box, rather than enabling appropriate choices in purchasing and providing health care.

The key to making markets work in health care is repairing and maintaining the markets’ ability to function, so that market forces can operate appropriately to produce the outcomes we desire.

The trend toward greater consolidation among providers and payers may be good news and it may be bad news. If it leads to more efficient health care by reducing fragmentation in health care delivery and financing, it can help the health system move toward the triple aim of better care, better health, and lower costs. If the resulting market power is abused and uncontrolled, it can lead to higher prices, lower quality, and a malfunctioning health care system.

Much of the health policy debate revolves around what regulatory policies are needed to help the market work better, or whether a “free market,” unfettered by regulation, could produce a better health system. Often, though, this debate fails to recognize the difference between “markets” and “market forces.” Markets serve as the structure within which market forces operate, just as a system of aqueducts and canals might be used to direct hydraulic forces to produce a beneficial result (say, irrigation for an area’s farms or electricity for its residents).

In the example, the tremendous power of water can produce constructive or destructive outcomes, depending on how effectively that power is managed—either over-managing that system (which might impede the flow of hydraulic power) or under-managing it (which might let it flow uncontrolled) could produce disastrous results. But if the system itself has inherent flaws, those must be repaired or counteracted, or the potential benefits that could be produced by the forces that operate within it will be more difficult to obtain, no matter how well they are managed.

Policies to ensure that markets work in health care therefore must address both the factors that impede the free flow of market forces and the inherent flaws in the structure of both the market for health services and the market for health coverage. Paul Ginsburg and Greg Pawlson discuss a variety of policies aimed at directing market forces to produce beneficial outcomes in health care; Marty Gaynor describes the role of antitrust policy in protecting the integrity of health care markets; Bill Sage points out that efforts to promote competition through antitrust enforcement alone are unlikely to be effective; and Bruce Vladeck asserts the need to take a broader look at what society wants from the health system and how to enact pragmatic policies to achieve those goals. These papers provide a broad range of perspectives, all of which should contribute to better understanding of a complex but essential area of policy need.

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