Growing California Hospital-Physician Market Power Foreshadows Challenges to National Health Reform

Overview

The debate around American health reform has long focused on the behavior of insurance companies. Premiums go up, and insurers take the blame. But a study published in Health Affairs by researchers at the Center for Studying Health System Change (HSC) pointed to a different culprit behind the rising cost of private insurance in California: the growing market power of hospitals and physicians to negotiate higher payment rates from insurers.

Funded by the California HealthCare Foundation, the study drew on HSC site visits to six California metropolitan areas — Fresno, Los Angeles, Oakland/San Francisco, Riverside/San Bernardino, Sacramento, and San Diego — conducted between October and December 2008. Approximately 300 interviews were carried out across these markets. The researchers found that providers had developed an array of strategies to strengthen their bargaining position, with significant consequences for insurance costs and, ultimately, for consumers and employers.

Provider Market Power as the Central Problem

"Provider market power is the elephant in the room that no one wants to talk about in the national health care reform debate," said Robert A. Berenson, a senior consulting researcher at HSC and co-author of the study alongside HSC President Paul B. Ginsburg and former research analyst Nicole Kemper.

The study argued that while health insurers had been "squarely in the crosshairs" for the high cost of private insurance, the contribution of hospital and physician market power had largely escaped scrutiny. In market after market across California, providers were using consolidation, tighter hospital-physician alliances, and "must-have" status to extract substantially higher payment rates from health plans.

How California Got Here: A History of Shifting Leverage

California was at the forefront of managed care in the 1980s and early 1990s. Large employers aggressively moved their workers into health maintenance organizations (HMOs) to combat double-digit annual premium increases. Health plans used their growing leverage — including credible threats to exclude providers from plan networks — to hold down payment rates. Excess hospital and physician capacity at the time further weakened providers' bargaining position.

That dynamic reversed by the late 1990s and early 2000s. Providers responded to their squeezed finances in several ways. Hospitals abandoned risk-based payment contracts and merged into larger systems. Medical groups and independent practice associations (IPAs) consolidated, with weaker organizations going under. The survivors emerged bigger and more capable of negotiating from strength.

Three Drivers of the Shift in Negotiating Power

The study identified three principal factors behind the growing power imbalance between California providers and private insurers.

First, consumer demand for broader provider networks after the managed care backlash stripped health plans of their most potent weapon. When insurers could no longer plausibly threaten to exclude a hospital or physician group from their networks, they lost the leverage that had kept prices in check during the managed care era.

Second, hospital consolidation into larger, more powerful systems — combined with tighter alignment between hospitals and physician groups — created organizations that could bargain as a bloc across wide geographic areas. The study noted that "negotiating as a system across a broad geographic area avoids antitrust scrutiny, which focuses on local market concentration," while still allowing hospital systems with leverage in some markets to secure high rates in other areas as well.

Third, growing hospital and physician capacity constraints turned what had been a buyer's market for health plans into a seller's market for providers. With fewer excess beds and fewer physicians looking for patients, insurers had less room to play providers against each other.

"Must-Have" Status and Its Consequences

A recurring theme in the study was the concept of "must-have" hospitals — facilities that health plans are compelled to include in their networks because consumers and employers demand access to them. By definition, a must-have hospital holds enormous leverage over health plans, which cannot credibly threaten to exclude it. These institutions can set their own terms.

The frustration from insurers was palpable. One health plan executive quoted in the study complained: "I am shocked there isn't an outcry over the fact that our costs are driven out of control. We would like to establish some sort of boundary, beyond which these guys can't go. We'd welcome some regulatory intervention to break up these monopolies, because they are just killing us."

A Warning for National Health Reform

The study carried a cautionary message for national reform proposals that were, at the time, encouraging hospitals and physicians to form tighter relationships through accountable care organizations (ACOs). The authors acknowledged that integration could improve quality and increase efficiency. But they warned that if provider market power went unchecked, any savings from greater coordination might never reach private payers in the form of lower costs.

"Reform proposals that encourage hospitals and physicians to integrate have the potential to improve quality and increase efficiency, but the savings may not be passed on to private payers if provider market power to command higher prices goes unchecked," Ginsburg observed.

California's experience illustrated the problem clearly. While many hospital-physician alliances in the state claimed the same rationale as ACOs — working together to improve quality and efficiency — the researchers believed that "one clear goal of alliances among California hospitals and physicians is to improve negotiating clout for both."

Some Restraint Among Providers

Not every provider with market power used it to its full extent. The study found that some hospitals moderated their pricing to avoid pushing employer-sponsored insurance out of reach in their communities. Others were mindful of the competitive threat from Kaiser Permanente, the large group-model HMO that typically offered lower premiums in exchange for a narrower choice of hospitals and physicians. Pricing too aggressively risked driving more employers and individuals toward Kaiser's model.

The Regulatory Question

The authors concluded that if market mechanisms proved unable to discipline providers' use of growing market power, policymakers would likely need to consider regulatory responses. These could include price caps on negotiated private-sector rates or the adoption of all-payer rate setting. Some purchasers who supported provider integration in principle believed that price regulation might actually be a prerequisite for payment reforms that encourage integration — since without it, the benefits of coordination would be captured by providers rather than shared with payers and patients.

About HSC

The Center for Studying Health System Change was a nonpartisan policy research organization based in Washington, D.C., committed to providing objective analysis of the nation's changing health system. HSC was funded in part by the Robert Wood Johnson Foundation and affiliated with Mathematica Policy Research. The study was published in Health Affairs, the leading journal of health policy, which is published by Project HOPE.

Sources and Further Reading

Health Affairs — Peer-reviewed journal of health policy thought and research.

California HealthCare Foundation — Research and analysis on California's health care system.

FTC — Health Care Competition — Federal enforcement actions and policy on health care market competition.

Kaiser Family Foundation — Health Costs — Data and analysis on health care spending and insurance premiums.

Commonwealth Fund — Research on health system performance and efficiency.