Code Red: Two Economists Examine the U.S. Healthcare System

February 9, 2015

The Unfortunate Return of All Payer Rate Setting

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 12:04 pm

In our ongoing attempts to reform the ACA to better address the growth of health spending, rather than simply expanding insurance, the focus is turning to prices.  Some aspects of the ACA offer promising attempts to control hospital prices.  For example, as we have blogged about before, the emergence of narrow network plans allow insurers to more effectively negotiate with hospitals by providing a credible threat the high priced hospitals will be excluded from insurance plans.

However, we are also seeing the re-emergence of some truly terrible ideas.  In a recent interview with Vox, President Obama was asked about whether private insurers should be allowed to negotiate prices as a group.  He said, “I think that moving in the direction where consumers and others can have more power in the marketplace, particularly when it comes to drugs, makes a lot of sense.”

As the writers at Vox point out, it sounds a lot like the President is talking about the return of all payer rate setting. We have been down this road before. All payer rate setting had faddish appeal in the 1970s, with New York and seven other states trying it on for size. After research (including Dranove’s) showed that rate setting barely put a dent in double digit hospital price inflation, all of the guinea pig states except for Maryland abandoned the dubious policy.  Instead of centralization, states in the 1980s opted to deregulate insurance, which opened the door to selective contracting.  Prices plummeted, which is what we would expect once market forces were unleased.  And recent research shows that in recent years, even with the growth of provider market power, hospital prices in Maryland have grown faster than in surrounding states.   It is worth noting that private insurers agreed to all-payer rate setting in the 1970s due to concerns about cost-shifting.  If all payer rate setting is reincarnated, it will not be the first time that we have introduced a cure that was worse than the disease.

However, even if rate setting did drive down prices, this would hardly be evidence that it was succeeding.  After all, monopsony is every bit the antitrust problem as monopoly.  When today’s competitive payers try to drive a hard bargain they end up with narrow networks; they would drive harder bargains still but there is a limit to how small those networks can be – a limit circumscribed by market forces.  A single monopsony payer can force such a hard bargain that providers will be forced to cut staff, hours, training, or even close – and the monopsony payer will suffer none of the consequences.  This isn’t idle speculation… New York’s rate setting program was accompanied by some inner city hospital closures.  A rate setting commission would have to perform quite the balancing act, assuring that the right hospitals are open in the right locations, offering the right services at the right quality.  President Obama might trust government to thread that needle, but we surely do not (and frankly the course of human history with respect to central planning is on our side).

Advocates of allowing collusion among payers cite the need to counteract provider market power.  We feel their pain; Dranove has played a leading role in antitrust cases that target provider mergers.  But we are reminded of our parents telling us that two wrongs don’t make a right.  Allowing both sides of the market to have monopolies does not mean that we will get to an efficient solution.  As our colleague Marty Gaynor said, “If your bike gets a flat tire, do you let the air out of the other one?”  In this case we fear that rate setting which combines government agencies and private insurers into one collusive bargaining unit means we will deflate both tires and then throw the bike off a bridge.

1 Comment

  1. Seems to me that all payer rate setting has three motivations:
    a. to protect the uninsured, who are charged ludicrous and cruel rate, even though many charges are later forgiven;
    b. to somehow stop hospital charges from increasing
    c. to imitate the systems of Germany, Sweden, France, Japan, et al, who seem to have all payer rate setting without shortages.

    These are not bad motivations. Would be interested to know why these would not work well in the USA.

    Comment by Bob Hertz — March 1, 2015 @ 7:29 pm

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