Competition in Health Care Markets Requires More Regulation, Not Less

Here’s a bold claim. Many European health systems, which have historically been universal and often government run, are now more reliant on market forces and do a better job harnessing competition than we do in the U.S. So, rather than teaching us lessons about equity, these health systems—that are often derided as beacons of socialized medicine—can actually teach us something about how to create effective incentives with hospital and insurance markets. Ultimately, the central lesson emerging from Europe at the moment is that within hospital and insurance markets, it often takes more regulation and a more active state in order to create meaningful competition and productive incentives.

Health insurance and hospital markets differ in a myriad of ways from the highly stylized markets that form the basis of much of microeconomic theory. Unlike in more traditional markets, individuals buying health care services often have trouble identifying their needs (what they need to do in order to get healthy) and their preferences, and they struggle to make decisions that maximize their welfare (e.g., choosing hospital A versus hospital B). Simply put, it’s harder to compare insurance plans or compare cardiothoracic surgeons than it is to compare digital cameras.

What’s more, hospitals and commercial insurance companies are usually big firms that require large upfront spending to get started and are, more often than not, difficult to close.  In essence, the idea of creative destruction, with firms sprouting up and closing down if they don’t work, will never feature in health care systems. Then, there are the positive and negative externalities. So, unlike in areas of everyday life, when it comes to health care, I do better when you get health care and you do better when I get health care.

Ultimately, because of all the vagaries present within health care markets, the same economic rules that we use to guide us in other sectors of the economy just don’t function as well when we’re talking about hospitals or insurers. Because health care markets differ so starkly from textbooks’ perfectly competitive markets, it turns out they require significant intervention to make them work effectively. And here’s where the U.S. struggles.

While European governments have a history of playing an active role in health policy, the U.S. intuitively believes that more regulation is an anathema to competition. As a result, in health care markets that require more regulation, many European countries have used effective regulation to promote competition and sharpen incentives, whereas “light touch” regulation in the U.S. has ironically led to more concentrated markets and increasing prices.

In what follows, I want to explore four areas of government intervention going on in Europe, which is allowing policy-makers across the Atlantic to be more effective at creating incentives for quality and efficiency.

Mandating insurance: Nearly every country in Europe that relies on competition between private health insurers to cover the population—the Netherlands, Germany, Switzerland and Belgium—mandate that every citizen maintains insurance coverage. To be sure, part of the impetus for mandating insurance coverage rests on equity grounds. However, beyond concerns about guaranteeing that everyone can get insurance regardless of their medical history, European countries mandate insurance coverage so that health insurance markets operate more efficiently.

In the absence of mandating insurance coverage, insurers can compete on attracting the healthiest insurees, rather than on quality (so-called risk-selection). In contrast, in insurance markets where everyone is required to get coverage and there are suitable risk adjustments in place, insurance companies need to raise their quality and lower their prices in order to expand their market share.

Fixing Hospital Prices: In many countries in Europe, like England and Switzerland, policymakers set prices for each hospital procedure on a national basis. This is because of the wide body of literature which suggests that when it comes to health care, purchasers are more reactive to price than quality. As a result, as the literature on hospital competition illustrates, when hospitals are allowed to compete on price and quality, prices drop, but so too does quality. In contrast, research my colleagues and I have carried out at the Centre for Economic Performance at London School of Economics, in addition to work from Imperial University and Carnegie Mellon, confirms that hospital competition within markets with fixed reimbursement prices leads to improvements in quality.

Regulating Insurance Benefits Packages: A further stream of regulation in Europe that actually increases competition takes the form of the government defining minimum standards for health insurance. In essence, policymakers in Germany, the Netherlands, and Switzerland indicate that for health insurance plans to be sold, they must have a variety of mandated components, such as maximum out of pocket costs limits, coverage of certain conditions, and broadly similar benefits packages. That allows individuals to compare one insurance plan with another and choose more effectively on the basis of costs and customer service, rather than on what gets covered. Here, consistent with work done in the behavioral economics literature, restricting choice to a smaller, more manageable choice set and lowering the time it takes for individuals to compare across plans actually increases the switching between plans that can create incentives for insurers to step up their game.

Mandating Transparency: In England, the government requires mandatory reporting of certain key hospital quality indicators, which they make publicly available on a website, so that patients can make informed choices. This publicly available information not only allows patients to select their doctors, but it allows doctors to compare their performance amongst their peers. This type of mandatory data reporting is vital for health care markets to operate effectively and it will not occur without government intervention to collect the information, clean the data, and disseminate it.

As policymakers increasingly try to create incentives to improve quality and reduce costs, they need to focus on creating effective incentives for insurers, providers, and the public. One time-tested avenue to create incentives comes from increasing competition.  However, because of the numerous ways that health insurance and hospital markets differ from the market for widgets that we rely on in microeconomic theory, health care markets require more regulation.

Europe has historically been more comfortable with regulation, which ironically has allowed them to be more effective increasing competition in health care markets. In contrast, in the U.S., the reluctance to regulate markets has not increased competition, but rather has actually led to more concentrated markets, where individuals struggle to choose and the incentives for quality and efficiency are presently perilously weak. It would be a mistake to think that this is all just the big government/small government debate that often plagues our politics. Instead, it is far more nuanced. Rather than arguing about whether we need more or less regulation to increase competition, we really need to focus on better regulation from a more dynamic, responsive state.

________

Columnist Zack Cooper is a health economist working at the Centre for Economic Performance at the London School of Economics. His monthly column for the Health Policy Forum considers health policy and politics, often from the international perspective. Columnists are regular contributors to the Health Policy Forum who pose their own opinions and policy positions in the realm of health care and health policy. As a leading nonprofit health care research and consulting institute dedicated to improving human health, Altarum encourages open discussion and debate about the many challenges in health care today. All postings to the Health Policy Forum (whether from employees or those outside the Institute) represent the views of the individual authors and/or organizations and do not necessarily represent the position, interests, strategy, or opinions of Altarum Institute. Altarum is a nonprofit, nonpartisan organization. No posting should be considered an endorsement by Altarum of individual candidates, political parties, opinions, or policy positions. Read more.