Consolidation, Oligopolies and Regulation in Healthcare

A recent column in The Incidental Economist raises a worrisome question.  If financial cuts to hospitals adversely affect patient outcomes, what about financial penalties imposed in the course of regulatory responses for failure to meet quality metrics?  Do we have a No Child Left Behind problem where defunding poorly performing schools only makes them worse?

Management of both for profit and nonprofit hospitals act as if they were for profit entities, and they should be expected to avoid the possibility of financial penalty.  If the imposition of penalties were rare, such a system would work.  Unfortunately, CMS is penalizing some 2610 hospitals in the latest round of quality assessments, including 143 out of 293 teaching hospitals in the US.  Are these hospitals now entering a slow but inevitable death spiral where cuts in reimbursement further erode care resulting in additional penalties and even worse care?

Traditionally, healthcare regulation has relied on the imposition of rare but draconian penalties.  Physicians or other health professionals who were sufficiently egregious would have their license revoked and their career in healthcare derailed.  The response for the vast majority of providers was to stay as far away as possible from the regulatory threshold.  The system worked well; most providers behaved professionally, and penalties rarely needed to be imposed.

Steve Brill, in his recent book America’s Bitter Pill, favors encouraging consolidation to build regional vertically integrated health systems. For example, let the Cleveland Clinic become the overwhelmingly dominant provider in its region.  While there will certainly be economies of scale and integration in such a scenario, such regional oligopoly/monopoly providers will be too big to shutdown and may be essentially unregulatable.  Regional healthcare oligopolies are huge economic players often generating a billion dollars are year in revenue. The Cleveland Clinic, for example, is the second largest employer in Ohio, has $11.9 billion in assets, generated $1.7 billion in unrestricted revenue for 2014 and made $130,089 in political contributions in 2012. In contrast, the budget for the Ohio State Medical Board was $8 million for 2011. The board is responsible for regulating all physicians, nurses and cosmetic therapist, acupuncturists and other health professionals statewide, and it is strictly forbidden from participating in politics. It does not seem realistic to expect that the Medical Board can effectively monitor the detailed operations of a large regional healthcare oligopoly, and an oligopoly can always seek legislative relief if regulations get in the way. In the worst case, regional healthcare oligopolies will be in a position to capture the regulatory process and possibly even subvert it into becoming a barrier to entry for competing providers.

Current health policy strongly favors consolidation of healthcare into large hospital based networks. For example, hospitals can bill Medicare for facility fees covering indirect costs while independent providers are not allowed to bill for these expenses. As a result, hospitals have been buying up independent physician practices and patients have been seeing dramatic increases in bills. If there are true economies of scale in healthcare, which is likely, then market forces should naturally result in consolidation and there is no need to subsidize this trend artificially at a cost of many billions of dollars in added fees. On the other hand, there are costs to consolidation. As discussed above, regional oligopolies may be difficult or impossible to regulate effectively. Monopolies also tend to suppress innovation and increase costs.

An alternative approach would be to enforce competitive markets in healthcare. Use fair trade powers to break up regional oligopolies while at the same time making cost and performance data more accessible so that consumers can make better informed decisions about their healthcare purchases. Regulation by state medical boards would likely be more effective as well.