On Oct. 25, 2013, the Baker Institute Health Policy Forum hosted its fourth biennial conference on health care reform. This series of blogs discusses the implications of the 2010 Affordable Care Act for the U.S. health care system and the well-being of the population.
Read other posts in this series:
- How health care reform changes employers’ incentives to offer coverage
- Dual roles of individual and benefits mandates
“Horizontal” agreements or integration (e.g., mergers) have received considerable attention from economists and antitrust enforcement agencies. Though they’re often justified by market participants on efficiency grounds, the consensus among scholars and regulators is that anti-competitive effects dominate. “Vertical” agreements or integration (i.e., “vertical restraints”) are more ambiguous. In a working paper that nicely summarizes the types of vertical agreements and the relevant economics literature and cases, Fiona Scott Morton explains how a vertical restraint can be both pro- and anti-competitive. (Access to her paper requires registration; an earlier version is available without registration, though the content is not identical.)
Vertical restraints are agreements between firms at different stages of a production and distribution process. Vertical restraints can take many forms, as Morton reviews, one of which is the most favored nation (MFN) agreement. An example in health care comes from the case of Blue Cross Blue Shield (BCBS) of Michigan. In October 2010, the U.S. Justice Department filed suit against BCBS because the insurer required that hospitals with which it contracted charge rival insurers higher prices than they charged BCBS. This requirement favors BCBS — an example of an MFN agreement in health care.
In my paper with Steve Pizer and Roger Feldman on vertical integration of health providers with Medicare Advantage plans, we reviewed some of the ways vertical restraints can be anti-competitive. One way is by raising rivals’ costs. The BCBS case did this explicitly. Raising rivals’ costs has advantages over predatory price reductions, since it does not require “deep pockets” or entail lower (or negative) short-term profits. Hence, one might expect insurers to enter into exclusive or long-term contracts with lower-cost providers, preventing existing market participants and potential market entrants from doing so. Gal-Or (1997) showed that a provider will accept an exclusive deal with an insurer, even at a lower rate of payment, in return for a larger volume of patients. Encinosa (1996) considered exclusive contracts between physician practices and health maintenance organizations (HMOs). A risk-averse, incumbent HMO may foreclose rivals by entering into an exclusive deal with the only available provider.
It’s relatively clear how an MFN agreement can be anti-competitive. How can it be pro-competitive? Morton explains that MFNs “may encourage the introduction of new products, particularly in cases of uncertainty and relationship-specific investment.” To the extent that this expands consumer choices, it is a pro-competitive benefit. MFNs can also reduce free riding. Morton provides an example from the travel industry:
Suppose the third-party online booking site contracts to sell [a] hotel’s inventory. However, having attracted consumers via the booking site, the hotel has a financial incentive to encourage customers to click through to the hotel’s own site, where it could offer the customer a lower price (because it does not have to pay the platform’s fee). In that setting, the online platform would no longer receive any sales to compensate for the investments it made that were specific to doing business with the hotel.
The solution is for the online platform to require MFN status so that the price it can offer a customer is no higher than what the hotel can offer directly. If you’re interested in antitrust concepts, Morton’s paper is worth a full read.
Austin Frakt is a health economist with an educational background in physics and engineering. He has appointments with Health Care Financing and Economics at the VA Boston Healthcare System, U.S. Department of Veterans Affairs and with the Department of Psychiatry and the Department of Health Policy and Management at Boston University. Since 1999, he has studied economic issues pertaining to U.S. health care policy with a recent but not exclusive focus on Medicare and the uninsured. Frakt has authored numerous peer-reviewed, scholarly publications relevant to health care financing, economics and policy, and he is the creator, co-manager and a primary author of The Incidental Economist.