Competition Issues in

Health Insurance Markets

• How competitive are HI markets?
• Traditional market power
• Search frictions

• The “single-payer” question

 Competitiveness of HI markets
Recall:
• Premium = AFP + insurer’s admin costs + insurer’s profits

the “load”

• In modeling HI choice, we’ve mostly operated under the

textbook assumption that health insurance markets are
perfectly competitive, with low admin costs
– therefore, premiums for a given plan should equal the AFP for the
group who purchases the plan (“load”≈0)
– this assumption is useful for pedagogical purposes, but not very
realistic
 Competitiveness of HI markets
• Admin costs are not “small,” but actually quite large,
especially in the nongroup market
– Litow (2006): only 70% of premiums in the nongroup market are
used to finance policyholders’ healthcare expenses
• Reminder: not all admin costs are “bad” for policyholders
– admin costs grew substantially during the rise of managed care
– to the extent these additional costs financed activities (network
management, utilization reviews, etc.) that made plans more
valuable to consumers, policyholder value increased

• Independent of admin costs, if HI markets suffer from

imperfect competition, it creates opportunities for profit-
taking
– higher load from increased profit margins
– two sources: traditional market power, search frictions
 1. Traditional Market Power
• “Traditional market power” arises when there are few
competing insurers in the market
– extreme case: insurer monopoly over entire local market
• In market with few competitors, each competitor has a
degree of market power, allowing them to raise prices
above competitive levels
– insurers earn positive margins (“underwriting gain”) on the plans
they sell
– implication: deficient competition leads to higher premiums
• Should we be concerned about deficient competition in
insurance markets?
– review market concentration measures in Robinson (2004)…
Robinson (2004)
 “Oligopoly” Markets
• Most HI markets are highly “consolidated” (or “concentrated”)
– large market shares across few insurers
– in all but 14 states, >65% of the “state market” is captured by 3 or
fewer insurers
– and HI markets have become increasingly consolidated over time
• Economists describe markets with (only) a few competing
insurers as oligopoly markets
• “Standard” predictions for oligopoly markets:
– insurers compete over differentiated products
– insurers each enjoy a degree of market power, so are able to
price plans to earn positive profits
– however, “law of one price” still theoretically holds
• insurers offering the same plan would be forced to set the
same (market) price
Potential Benefits of HI Consolidation
• HI is not a “standard” oligopoly situation in an important
respect…
• Insurer market power also increases their bargaining
power in payment negotiations with providers
– larger insurers can obtain larger “discounts” from in-network
providers
– the threat of network exclusion increases when an insurer controls
larger share of the “insured patient” market
• Implication: if larger insurers obtain lower prices, those
insurers could pass the savings on to consumers (via lower
premiums)
– of course, this is less likely if insurers face little competition!
– e.g. a profit-maximizing monopolist would just take these savings
as additional profit
Is there evidence HI competition matters?
• Dafny (AER 2010)
– Background: If insurers have market power and seek to maximize
profits, we expect them to engage in price discrimination –
charging higher premiums to individuals (or employment groups)
when their WTP for insurance is higher
• Dafny finds evidence for price discrimination by
comparing premium changes for employer groups that did
or did not experience a large increase in profits
– Larger increase is firm profits was predictive of larger increases in
premiums (even if no change in plan)
– Note: under perfect competition, being profitable would have no
effect on the premiums a firm gets offered
• The size of this effect was substantially larger in less
competitive insurance markets
– less competition  more market power  more price
discrimination
Is there evidence HI competition matters?
• Dafny et al. (AER 2012)
– Looks at HI competition effects on premiums more directly  do
HI markets with rising consolidation experience relative premium
increases?
• Their analysis focuses on the “shock” to HI market
concentration levels resulting from the merger of Aetna
and Prudential Healthcare
– Had larger effects on measures of market concentration in markets
where Aetna/Prudential had larger market pre-merger presence
• Findings: rising insurer concentration (due to the A/P
merger) led to higher premium growth
– their estimates imply that the aggregate increase in HI market
concentration (over 1998-2006) contributed to 7% higher
premiums (~$200 per policyholder)
Is there evidence HI competition matters?
• These studies by Dafny (and others) suggest insurer
competition does matter, and helps explain why some
markets have lower premiums than others

• On the other hand, aggregate profit margins do not appear

to be that large (recall Table 5 from Litow 2006)
– average profit (“underwriting”) margins are in 2-3% range
– similar to the margins observed for other financial and insurance
products

• This suggests traditional market power (deficient

competition) is not a big contributor to the high loads we
observe in HI plans
– and can’t explain the different loads across market segments
 2. Search Frictions
• In some markets, consumers have difficulty comparing all their
options, which undermines optimal choice
• hard for employers/individuals to evaluate value-for-premium,
can at best evaluate a subset of their options
• info possessed by different consumers varies
• Implications
• “law of one price” fails for identical insurance products
• instead insurers profitably pursue a range of premium-setting
strategies (high margin/low volume vs. low margin/high volume)
• “high” levels of insurance turnover (switch rates)
• insurers compete more so over “marketing” activities, and less so
over the creation of true value-for-premium
• equilibrium premiums are higher (on avg), but need not lead to
higher profit margins
• excessive premiums end up financing excessive marketing
expenses (“marketing arms race”)
 Search Frictions
• Cebul et al. (2011) finds evidence for search frictions in
the market for group insurance plans
– compares “fully insured” (FI) to “self-insured” (SI) groups
– intuition: SI groups are purchasing a much simpler product
(“administrative service only”, or ASO contracts)
– note: in Litow table, the “Large Group” label almost exclusively
includes SI groups
• Search frictions can explain the existence of high turnover
rates and other “anomalies” in HI markets
– large differences in premiums for similar plans sold to similar
groups
– large admin costs associated with HI marketing
• This blog has a nice summary of our paper:
– http://theincidentaleconomist.com/wordpress/health-insurance-sear
ch-frictions-part-1/
Unexplained Variation in Premiums
 Administrative Costs
• High marketing expenses and modest profit margins 
consistent with search frictions in the nongroup and small
group markets

Nongroup Small Group Large Group

Market Market Market
Total Overhead 30% 23% 12.5%
Eligibility/enrollment/claims 10.5% 9% 7%

Marketing/commissions 14.5% 10% 2%

Premium/other taxes 2% 2% 1%
Profit 3% 2% 2.5%
Source: Milliman Consulting Group (2006) for the Council for Affordable Health Insurance
Search Frictions – Policy Implications
• If HI markets are plagued by search frictions, various
public policies could improve market competiveness,
lowering premiums and decreasing admin costs associated
with marketing
– standardization of products (to reduce complexity)
– increased transparency in premiums, product attributes
– availability of a well-understood “basic plan” in all markets
• existence of competitively-priced “basic plan” reduces
profitably of pursuing a high-margin strategy

• Essentially, we are arguing for measures that would make

it easier for individuals and small groups to identify and
compare competing plans  the motivation behind the
creation of “health insurance exchanges”
 3. The single-payer question
• Would we be better off with a “single-payer” system?
– one common insurer for all citizens in a given market
– usually the single-payer is (or imagined to be) a government-run
program providing identical universal coverage to all citizens,
though other models are possible
• single-payer could allow different coverage options
• single-payer could be private insurer which contracts with (is
regulated by) the government
• Main economic argument in favor of single-payer: the
multi-payer system is a direct source of technical
inefficiency in the production of health coverage
• Main social/ethical arguments in favor of single-payer:
– markets tend towards outcomes that are efficient but not
necessarily socially desirable
– a single-payer could more effectively pursue social goals we
envision for a healthcare system
 Technical Efficiency Issues
• Various factors contribute to high admin costs in systems
with numerous competing insurers
– Insurance turnover (costs incurred by insurers and insurance
consumers)
– Cost of marketing and “underwriting” policies (insurers)
• “underwriting” refers to the actuarial activities of insurers  trying to identify
which consumers represent good/bad risks
– Cost of administering policies, especially managed care plans
(insurers)
– Cream-skimming, i.e. efforts to avoid “high cost” policyholders
(insurers)
– Providers have to accommodate the numerous, complex billing
systems implemented by different insurers (providers)
– Reimbursement negotiations between insurers and providers
(insurers, providers) are costly to those involved
 Technical Efficiency Issues
• Besides eliminating or reducing these costs (on last slide),
a single-payer would have maximum market power in
“negotiating” provider prices
– not much of a negotiation, more like price-setting power as
with Medicare

• Assuming the single-payer was constrained from taking

profits, consumers and taxpayers (not insurers) would
benefit from single-payer’s ability to control prices
 Woolhandler et al. (NEJM 2003)
• Attempts to quantify and compare HC administrative costs
in US versus Canada
– Overall, they find admin costs are 3x higher in US ($1059 per
capita vs. $307 in 1999)
– Eliminating this difference would reduce total per capita
healthcare spending by 17% (in 1999)

  Insurers Hospitals Physicians Employers

U.S. $249 $351 $324 $57

Canada $47 $103 $107 $8

 Woolhandler et al. (NEJM 2003)
• Woolhandler and colleagues interpret their findings as
support for a single-payer system
– note: Canada is not a straightforward single-payer system; private
insurers exist and sell supplemental coverage (to augment the
basic government-provided coverage)

• Their arguments:
– much of the additional administrative costs stem from the fact that
we have a “multi-payer” system  with different payment
structures and reimbursement rules imposed by different payers
– under a single-payer system, more of the money spent on HC
could actually go towards the financing of HC (instead of
financing administrative costs)
 Concerns about single-payer
• Will a single-payer operate in an efficient manner without
the challenges of competition?
– the Medicaid example
• If single-payer is the “government,” can we trust that it
will operate efficiently over time
– Will the bureaucracy become increasingly bloated?
– Will it set payment rates and structure incentives intelligently? (i.e.
in a manner that encourages efficient care delivery)
– Will the bureaucracy be captured by special interests?
– Will it ruthlessly “ration care” just to save money?
• Multi-payer systems have the advantage of allowing
citizens more choice about the types of coverage they want
(the “consumer sovereignty” issue)
– other countries have addressed this concern by allowing private
markets for supplemental coverage
Admin Costs – Other Policy Considerations
Can administrative costs be reduced while maintaining our
multi-payer system?
• Policies that facilitating more effective search should help
(as discussed above)
• ACA should also reduce administrative costs associated
with insurer strategies that are no long legal
– underwriting activities  can’t deny coverage or charge more for
person with pre-existing conditions
– “rescissions”  insurers no longer allowed to rescind policies of
persons (with high costs) who were found to have
misstated/omitted something on their insurance application
• Standardization of payment systems across payers could
also help – but could impede insurers’ efforts to design
“better” payment systems
– innovation requires some freedom to pursue new ways