Why More Competition Won’t Fix Healthcare

Vigorous competition. It's the go-to cure for free-market ailments. When the consumer's getting the shaft, just open up the market, bring in more providers, and watch prices fall.

A lot of the time, it works. Car buyers get terrific deals and great quality because a dozen automakers compete ruthlessly to offer the best value. Electronics consistently get cheaper, while features improve, thanks to the proliferation of low-cost Chinese manufacturers. And the Internet has allowed anybody with an eBay account to compete with the biggest retailers, lowering prices on thousands of products.

So it stands to reason that greater competition in the healthcare industry could have the same effect, corralling the skyrocketing costs that threaten the prosperity of many families and businesses and perhaps even the nation itself. Reformers certainly hope so. The healthcare reform bill proposed by the Senate Finance Committee, for example, calls for more competition among insurance companies and healthcare providers as one way of lowering costs. Powerful lobbying groups like the National Association of Manufacturers and the National Federation of Independent Business tout greater competition as a much better way to lower costs, and thereby cover more people, than a "public option" similar to Medicare that would involve a huge new government agency.

[See how hypocrisy dominates healthcare reform.]

It's a nice, satisfying notion. And probably a fiction. The problem is that healthcare is very different from stuff that's sold in a traditional free market. With ordinary products like TVs or cars, an increase in supply drives down prices for a number of reasons. For one thing, similar types of products are generally interchangeable, so if Product A is too expensive, people simply buy Product B. Prices are typically advertised for all to see, so consumers usually have enough information to make rational choices. And most products are not compulsory—you don't have to buy them. The ultimate leverage for a shopper is the ability to walk away without spending a dime.

That's a luxury that healthcare consumers often don't have. About 80 percent of healthcare spending occurs when people are very sick, can't wait for care, and have no bargaining power. Prices are rarely posted anyway—except for things like eyeglass frames and laser eye surgery that aren't usually covered by insurance—so patients have a hard time shopping around even if they want to. And discounts are typically associated with lower quality, no matter what the product, so only the most desperate patients are likely to choose the lowest bidder. "The advantages are all on the side of the seller," says Maggie Mahar, a fellow at the Century Foundation and author of Money-Driven Medicine. "It's quite hard for us to be savvy shoppers."

[See why postal-style healthcare might not be so bad.]

Reformers hope that more competition will tilt the equation in favor of the buyer, but a quick tour of the healthcare marketplace suggests that it might actually raise prices even more. For starters, there's not just one market for healthcare; there are several layered one atop the other, and the sellers in one market are often the buyers in another. Weakening the power of sellers in one market to curtail their ability to raise prices also tends to weaken their position as buyers in another market, which makes them less able to demand lower prices further down the healthcare chain.

The market that consumers are most familiar with is the one involving patients and their insurance companies. The majority of Americans get insurance through their employer. The worker pays about 25 percent of the insurance premium, on average, while the employer pays the rest. Since premiums have been rising much faster than inflation or wages, insurance has been taking a bigger and bigger bite out of the average paycheck.

If workers had more plans to choose from, the logic goes, then insurers would be forced to offer a better deal, and premiums would go down. But that could raise costs in a different marketplace, the one involving companies and the insurers they choose to cover their employees. For any company, big or small, choosing insurance providers is just like hiring a phone company, janitorial service, or any other supplier: The more you concentrate your business with one provider, the more power you have to demand lower prices. Spreading your business around, by contrast, dilutes your purchasing power. "Firms often choose to align themselves with one insurance carrier," says Jon Skinner of the Dartmouth Institute for Health Policy and Clinical Research. "Companies can always sign up with another carrier, but it's costly to switch." Giving workers more insurers to choose from could actually raise the company's costs, which in turn could reduce the amount they kick in toward insurance premiums. Workers would lose.

[See the industries hurt most by soaring healthcare costs.]

Another idea is to relax state regulations and do other things to encourage more insurers to compete in more markets. But while more competition among insurers sounds like a good thing, it could dilute purchasing power elsewhere and ultimately lead to higher prices for the end consumer. That's because there's another healthcare marketplace in which insurance companies are the buyers when they contract with hospitals, doctors, drug companies, and medical labs. And for the most part, those sellers have been able to keep jacking up prices because insurance companies, who bear the initial cost, simply pass most of it on to their own customers—corporations and their employees.

The most effective pushback against those kinds of price hikes, once again, comes from big, powerful buyers able to force prices down because they generate so much business. But even huge insurance companies like UnitedHealth, Aetna, and Cigna haven't been able to force down costs. "In some markets, insurance companies are at the whim of doctors and hospitals," says Skinner. "Most of them can't exert much leverage. Somebody else controls the cost." A more fragmented market, with even more insurance companies, would create more opportunity for doctors and hospitals to obscure costs, play insurers against each other, and further complicate the market.

In the retail sector, economists often cite Wal-Mart as a nifty example of a monopsonistic buyer that benefits consumers. The huge retailer, America's second-largest company, generates so much business for its thousands of suppliers that it can demand wholesale prices far lower than anybody else would pay. Much of the savings gets passed on to consumers through lower retail prices, and consumers reward Wal-Mart by shopping in even greater numbers. But if Wal-Mart had to sell its products through a few more middlemen before they ever reached the end consumer, its business model would break down because it would be unable to control the costs layered on along the way, which determine the ultimate price paid for the goods. That's basically what happens in healthcare.

Some reformers want health insurers to simply hand over a chunk of their profits to help lower premiums and overall healthcare costs. The Senate Finance Committee bill, for instance, would levy a $6.7 billion annual fee on insurers to help pay for reform, in addition to fees on drugmakers and device manufacturers. But insurance companies aren't the cash cows some imagine them to be. The profit margin for health insurance companies over the past year was 3.4 percent, according to the research firm Morningstar. That's better than the median of 2.2 percent, but it ranks only 87th out of 215 industries. Drugmakers, by contrast, have a profit margin of 16.4 percent.

[See why health insurers make lousy villains.]

There's one other major healthcare marketplace, the one where doctors , hospitals, and caregivers are the consumers and companies that produce MRI machines, stents, artificial joints, and other medical materiel are the sellers. This market highlights another anomaly of the healthcare industry: New technology often leads to higher prices, not lower ones. Doctors and hospitals simply pass on the costs to insurance companies, which pass it on to everybody else. More competition among doctors and hospitals won't change that. And while it would be nice if there were more device and equipment manufacturers undercutting each other on price, this is a highly technical industry where successful companies must have billion-dollar research and development budgets. There's no eBay for medical technology.

This is an oversimplified breakdown of one of America's most complicated industries, and there are small slices of the healthcare business where more competition probably would help lower costs. For example, generic drugs, when they're available, are almost always cheaper than name-brand counterparts. But industrywide, greater competition isn't nearly the panacea that free-market fans wish it were.

[See how Big Pharma wins from healthcare reform.]

That doesn't mean a government-run public option would solve the cost problem either. It's tempting to believe that the government could serve as a big, powerful buyer able to force down prices, while passing the savings on to consumers instead of pocketing them like a corporation might. But any such savings could also disappear into an inefficient bureaucracy, and the government's inability to control the cost of Medicare shows how hard it is to lower healthcare prices.

If there's any free-market solution, it would have to involve a complex system of incentives that encourage the participants in every healthcare market to lower costs. Eliminating some of the middlemen between the patient and caregiver would help, and some reformers favor experiments with "accountable care organizations" similar to HMOs, in which caregivers would be rewarded for cutting costs and punished for raising them. Posting prices for outpatient procedures and nonurgent care on the Web might help patients make more cost-efficient decisions. But much of the healthcare system is fortified against free-market forces. Competition has met its match.