(Bloomberg View) — Health care consolidation is not a sexy issue. It’s not the sort of thing you want to bring up at a dinner party, unless you’ve already completely exhausted proposed changes to the local noise ordinances, the weather, and the best way to get from LA to Newport Beach without enduring the 405. And yet, this is a topic you ought to pay attention to, because the mergers creating mega-insurers and mega-providers are going to have a big impact on your life in the near future.
Why do I bring this up now, when we’ve hardly begun to plumb the possibilities inherent in taking Route 1 to the 710? Well, because Anthem is inking a deal to buy Cigna for $48 billion. As my Bloomberg colleagues noted yesterday, “An acquisition would add to a wave of consolidation sweeping over the health-insurance industry.” This, coming close on the heels of an Aetna merger, is of some concern to antitrust people, according to the Wall Street Journal: “Antitrust regulators are expected to closely examine the implications of the two tandem deals and a third, smaller transaction announced earlier this month.”
Consolidation in the health care industry is not new. It’s been consolidating ever since the days of the proverbial country doctor, trotting down the back roads to house calls. But it is becoming critical now, because we’ve got a vast new health care entitlement, and both the cost and the performance of that program are going to be affected by this trend. Obamacare is also going to drive further consolidation.
There can be a few factors behind consolidation. For example, massive economies of scale. Or … well, I’m afraid this is a bit delicate, but I can’t let it go unmentioned: Industries consolidate to reduce the number of players in the market, giving the remaining players more pricing power. Antitrust regulators tend to put on their big frowny face if companies cite the latter reason, so the public statements made by companies in consolidating industries tend to focus on more superficially attractive reasons like cost savings and “broader industry reach,” or more ethereally vague words like “synergies.”
True to form, Anthem is claiming that nearly $2 billion in synergy savings will be realized by the merged entities. This is probably true, to some extent. But you should keep in mind that mergers are themselves extremely costly. And I don’t just mean the fabulous fees that investment bankers and consultants collect to facilitate them. Joining two entities into one is really difficult: corporate cultures clash, turf wars damage morale and profits, IT systems never do work right together, key employees leave, customers are alienated. So in general, these sorts of statements should be taken, not just with a grain of salt, but while sitting next to a salt lick with a big bag of Mr. Salty Pretzels and some cocktail peanuts to wash the whole thing down.
So why is the insurance industry consolidating? Lots of reasons. First of all, heavily regulated industries thrive on consolidation. These companies have a lot of regulatory overhead, first of all for compliance, and second of all for lobbying. The bigger you are, the easier it is to afford a team of experts to make sure that you understand all the pertinent regulations, and a second team of experts to prevent legislators and bureaucrats from burdening you with a lot more pertinent regulations. These are largely fixed costs, and merging reduces them. Getting bigger also makes it harder for legislators to refuse to return your phone calls.
Second of all, Obamacare’s new exchanges may play at least a small role. Not all of it, by a long shot — the individual market for health insurance is a small and not particularly well-loved part of insurers’ overall business. However, that piece may get larger, if Obamacare succeeds in restructuring the market for health care, as employers convert more positions to part-time jobs without benefits, or decide it’s easier to give people money to shop on the exchanges than to keep dealing with the hassle of providing health insurance. And thanks to the exchanges, that individual market is now competing on price more than it did in the past, because prices are now completely transparent and roughly comparable. Pricing power suddenly matters more, not so much the power to charge consumers more, but the power to pay suppliers less.
Which brings us to the third big reason for merging: They are under pressure from other parts of the industry that are also consolidating. Hospital networks have gotten bigger and more powerful. Physicians are increasingly going to work for hospitals or large practices. This could put insurers at a disadvantage to negotiate prices. If your suppliers are highly fragmented, you can walk into the meeting and say “here’s what we’re offering; take it or leave it.” But if there are only two or three big hospital networks in your area, they can say the same thing to you. This has produced something of an arms race between insurers and providers trying to get bigger so they will better be able to crush the other. When Mothra and Godzilla are battling over the city, you don’t want to be the tiny human standing on the ground between them.
You saw this dynamic at work during the outcry over “narrow network” policies being offered on many exchanges. Regulators put heavy pressure on insurers to keep insurance prices down on the exchanges. They obliged by forming insurance networks out of their cheaper providers — which is to say, the ones who had the least pricing power, either because they were small, or because they were not very much in demand. Big teaching hospitals and other coveted providers were often left out, which resulted in angry consumers (voters) calling their congresspeople and local reporters to complain that their lousy insurance wouldn’t let them take their kid to Seattle Children’s.
Physicians and hospitals are, of course, responding to the same incentives that insurers are. With insurance paying more and more of the bills, doctors’ offices needed to spend a lot for specialists who could navigate all the paperwork. Obamacare and other laws aimed at improving health care delivery have also added costs and other issues for providers. The drive toward Accountable Care Organizations, for example, almost forces physicians to consolidate into larger practices, because small offices cannot support either the administrative overhead or the financial risks of this model. Electronic health care records, another project of the Obama administration, are also more efficient when they’re implemented at large scale.
You can think of it this way: The structure of America’s third-party payer system allowed providers to make very nice incomes by providing health care services to basically price-insensitive consumers. Both insurers and the government reacted by ramping up the paperwork and claims rules to try to control this trend.
But providers had a great deal invested in keeping those income streams — not just because they need a third yacht, but because their office and hospital plant were constructed for a world where the money flowed readily, and they can’t just give back the buildings and machines and office staff. They’ve responded to these pressures by getting bigger, recovering some of their lost income. So insurers and the government have turned the screws even tighter, which has given them even more incentives to get big. That’s the story of American health care over the last few decades.
That doesn’t mean that it is all happening at the same pace. Dan Diamond of the Advisory Board pointed out on Twitter that mergers between hospitals and mergers between insurers are overseen by different federal entities, and those two entities don’t always see eye to eye on how much market power is too much. But the arms race makes it likely that changes in one sector will trickle over to the other. ”After all,” he writes, “the Federal Trade Commission (FTC) has stopped hospitals — again and again — from gaining what they perceive to be too much market power. But in a world with a Huge Three of insurers, wouldn’t regulators change their stance on hospitals?”
According to the Journal, after this merger frenzy, the three biggest insurers will cover 133 million people, more than a third of the population (and much more than a third of our privately insured population). If the Department of Justice lets the insurer deals go through, the FTC may think that hospitals need a counterweight to all that pricing power. There are real pressures pushing them to merge, not just anticompetitive greed.
And what that means for you is a world in which your health care is increasingly delivered by only a few big players. That has a lot of implications both for the care you get and the price you pay for that care. How all this will shake out is far from clear. But one thing is: When everyone is supersizing, it’s not hard not to suspect that you’ve been assigned the role of “tiny mortal standing between Godzilla’s toes.”
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the author on this story: Megan McArdle at firstname.lastname@example.org To contact the editor on this story: Philip Gray at email@example.com