Horizontal Integration in Health Care

In the United States, health maintenance organizations (HMOs) have become a powerful force in the health care sector. HMOs are health insurance companies that provide people with health care coverage, and often companies contract with HMOs on behalf of their employees for health insurance coverage. The HMOs then “supply” patients to health care providers. Thus, HMOs can be viewed as the suppliers of the critical input—patients— to health care providers. In turn, the revenues of health care providers are dependent on the number of patients who pass through their system. Clearly, it is in the interests of HMOs to bargain down the price they must pay health care providers for coverage, and to gain bargaining power, HMOs have used horizontal integration to merge with each other until, today, they control a large volume of patients. To fight back, however, health care providers have also resorted to horizontal integration, and the battle is raging. As an example of how this process plays out, consider how the relationship between HMOs and hospitals evolved in eastern Massachusetts. In the early 1990s, three big HMOs controlled 75% of the market for health insurance in eastern Massachusetts. In contrast, there were thirty-four separate hospital networks in the region. Thus, the insurance providers were consolidated, while the health care providers were fragmented, giving the insurance providers considerable bargaining power. The HMOs used their bargaining power to demand deep discounts from health care providers. If a hospital wouldn’t offer discounts to an HMO, the HMO would threaten to remove it from its list of providers. Because losing all of those potential patients would severely damage the revenues that a hospital could earn, the hospitals had little choice but to comply with the request. This situation changed when two of the most prestigious hospitals in the region, Massachusetts General and Brigham & Women’s Hospital, merged with each other to form Partners HealthCare System. Since then, Partners has continued to pursue the strategy of acquiring other hospitals to gain power over HMOs. By 2002, it had seven hospitals and some 5,000 doctors in its system. Other regional hospitals pursued a similar strategy, and the number of independent hospital networks in the region fell from thirty-four in 1994 to twelve by 2002. In the 2000s, Partners has increasingly exercised its strengthened bargaining power by demanding that HMOs accept a fee increase for services offered by Partners hospitals. One of the biggest HMOs, Tufts, refused to accept the increase and informed nearly 200,000 of its 900,000 subscribers that they would no longer be able to use Partners hospitals or physicians affiliated with Partners. There was an enormous uproar from subscribers. Many employers threatened to pull out of the HMO and switch to another if the policy was not changed. Tufts quickly realized it had little choice but to accept the fee increase. Tufts went back to Partners and agreed to a 30% fee increase over three years. Thus, bargaining power in the system had shifted from the HMOs toward the hospital networks. However, the Massachusetts attorney general received so many complaints from employers about rising health care premiums that an investigation into market power and anticompetitive behavior among health care providers in eastern Massachusetts was started. Clearly, the battle is not over yet.