By Kip Sullivan, JD
In a previous paper I described the transformation of the “public option” from an enormous program that would insure 130 million people to a tiny program in the Democrats’ health “reform” legislation that will insure somewhere between zero and 10 million people. I predicted that the “options” in the Democrats’ bills would be unable to succeed in all or most markets in the country. I characterized the main barrier facing the Democrats’ shrunken “options” as a “chicken and egg” problem: A person or group trying to create a new insurance company can’t tell prospective customers what the premium will be until they have determined how much they will pay providers; but the person or group can’t know how much it will pay providers until it knows how many people it will insure.
In this comment I elaborate on this chicken-egg barrier by presenting an illustration of the barrier at work – the departure of the Prudential Insurance Company from the Minnesota managed care health insurance market in 1994. Although Prudential was (and still is) a huge Fortune 500 company, it was unable to survive Minnesota’s highly concentrated group health insurance market and was forced to withdraw. If a company as large and as experienced as Prudential could not crack the Minnesota market, why should we hold out any hope for the little “options” proposed by the Democrats?
A recap of the transformation of the “public option”
Jacob Hacker laid out his vision of what is now called “the public option” in papers published in 2001 and 2007. Hacker spelled out five criteria he believed the “option” had to meet:
(1) It had to be pre-populated with tens of millions of people;
(2) Only “option” enrollees could get subsidies (people who chose to buy insurance from insurance companies could not get subsidies);
(3) The “option” and its subsidies had to be available to all non-elderly Americans (not just the uninsured and employees of small employers);
(4) The “option” had to be given authority to use Medicare’s provider reimbursement rates (which are typically 20 percent below the rates paid by insurance companies); and
(5) The insurance industry had to offer the same minimum level of benefits the “option” had to offer.
Although I question some of the assumptions Hacker made in these papers, including his assumption that the “option” will inevitably enjoy Medicare’s low overhead costs, I have little doubt that an “option” which met Hacker’s five criteria would stand an excellent chance of surviving its start-up phase in most markets in the U.S. (I am ignoring here the question of whether an “option” as strong as Hacker’s original has a better chance of being enacted than a single-payer system does. Events of the last few months should disabuse the entire world of that myth.)
But when the Democrats drafted legislation early in 2009 that included provisions creating an “option,” they abandoned the first four of Hacker’s criteria and kept only the last one (the one requiring insurance companies and the “option” to cover the same benefits). Proponents of the “option,” including Hacker, did not raise a fuss about this. Not surprisingly, the “option” provisions of the bills introduced in July – one by the Senate Health, Education, Labor and Pensions (HELP) Committee and the other by the chairs of the three House committees with jurisdiction over health care reform – were basically unchanged from those in the draft versions. The Congressional Budget Office estimates the HELP Committee’s “option” will insure approximately zero people and the “option” in the House bill (HR 3200) will insure roughly 10 million people.
The advent of managed care augmented the chicken-egg problem
Prior to the advent of what came to be called “managed care,” an entrepreneur or group seeking to start a new insurance company only needed to focus on amassing a large number of customers as opposed to providers (clinics and hospitals). But with the advent of managed care in the 1980s, groups seeking to start a brand new insurance company also had to amass a supply (or “network”) of clinics and hospitals as well. Some insurers amassed this critical supply of providers by buying them out (or merging with them), but most did so by signing contracts with them.
This new provider-network requirement for market entry arose because the spread of managed care tactics meant that survival and success would go to the insurance company with the greatest ability to exert influence over providers. Insurance companies throughout the country sought to increase their influence over providers by limiting patient choice of provider so that they could steer their enrollees to fewer providers. Developing this power to steer more patients to some providers and away from others gave an insurance company two substantial advantages over an insurance company that did not do that. First, it gave the insurer the ability to force the providers they dealt with to give them discounts off their usual charges. Second, it enhanced the power of the insurer to force providers to play by the insurer’s “managed care” rules (for example, rules requiring providers to get permission from the insurer before hospitalizing a patient).
But creating a network of providers that is large enough to satisfy a widely dispersed customer base but still exclusive enough to give the insurer leverage over the in-network providers is a time-consuming and expensive process. This requirement gives an enormous advantage to the home team – the insurers that have been doing business for a long time in a given market – and, conversely, creates an enormous barrier to entrepreneurs seeking to create new insurance companies.
When the U.S. Department of Justice investigated a proposed merger between Aetna and Prudential in 1999, it concluded that “effective new entry for an HMO or HMO/POS [point-of-service] plan [that is, an insurance company that limits patient choice of provider] in Houston or Dallas typically takes two to three years and costs approximately $50 million.” Because insurance markets have become more concentrated in the decade since the DOJ published this report, the time and money required to break into today’s markets is even greater than that required a decade ago.
Insurance companies which failed to grasp this new rule of the managed care era – that success will depend not only upon the size of your customer base but also your ability to limit patient choice of provider – lost market share and many went out of business. The decision by Prudential Insurance Company to leave the highly concentrated Minnesota health insurance market in 1994 illustrates this trend.
Prudential’s departure from Minnesota’s group market
As of 1994, Minnesota’s four largest health insurance companies insured 80 percent of all Minnesotans who had health insurance of any sort. Blue Cross Blue Shield of Minnesota enrolled 1.33 million people, Medica enrolled 900,000, HealthPartners enrolled 650,000, and PreferredOne enrolled 450,000. Two of these insurers – Medica and HealthParters — were so powerful in the Twin Cities area they could extract discounts from Twin Cities hospitals that were approximately equal to Medicare’s (at that time, a discount of about one-third). They extracted these discounts not because they were as big as Medicare was (nationally Medicare insured 40 times more people than Medica did in 1994 and about 55 times as many as HealthPartners), but because they were big in the Twin Cities insurance market and, unlike Medicare, they made a point of limiting patient choice of provider. This meant they could exercise enormous leverage over the providers they did choose to deal with.
Even though Prudential was and still is a huge company nationally (it is a Fortune 500 company and is among the nation’s largest health insurance companies) and had been selling health insurance for decades, it did not react fast enough to the gradual spread of managed care tactics in Minnesota during the 1970s and 1980s. (Minnesota, along with California, led the nation down the managed care path.) By 1994 Prudential decided it couldn’t compete in the Minnesota market.
Prudential made its decision known on July 8, 1994. As the following excerpt from a Minneapolis Star Tribune article published the next day indicates, Prudential had established a toehold – it was well on its way to creating both a customer base and a provider network – but the toehold wasn’t enough.
… Prudential Insurance Co. said Friday that it will discontinue its Twin Cities managed care health plan due to intense competitive pressures. Eighty metro-area jobs will be eliminated….While Prudential … is now in 42 cities, only the Twin Cities market posed a particular problem and will be shut down….
Prudential Plus of Minnesota operates mainly in the Twin Cities and deals with 800 primary care physicians and 1,500 specialists. Nationwide, the managed care plan has 5 million members. Regardless, Prudential did not grow large enough or fast enough in the Twin Cities market to maintain a substantial lead, analysts said. The firm was easily overshadowed by heavyweights such as HealthPartners and Medica…. And these bruisers and others like them are merging or forming alliances that kept welterweights like Prudential Plus on the ropes. Gary Schultz, executive director of Prudential Plus of Minnesota, said, “Recent mergers, acquisitions and strategic alliances involving health care plans and providers … have combined to make it increasingly difficult to compete in this market place….
“Prudential only has 30,000 (members) in the Prudential Plus plan,” [Prudential marketing director Pat] McLaughlin said. “They are not the big player they needed to be and as a result may not have been able to negotiate the best deals with providers” (Dee DePass, “Prudential to discontinue managed care health plan,” Star Tribune, July 9, 1994, 1D).
An article in BNET reported an identical explanation for Prudential’s demise in Minnesota: “A Prudential spokesperson said the clout of its bigger competitors had made it difficult to recruit a critical mass of new employers and enrollees.”
Lessons for “option” advocates
This story illustrates three facts “option” advocates must address.
First, it clearly illustrates the “chicken and egg” problem facing the “option” program, or to be more precise, facing the corporations that will be hired by the Secretary of the Department of Health and Human Services to create the “option” program. (Both the HELP bill and HR 3200 authorize the Secretary to contract with corporations that the HELP bill calls “contracting administrators” for the purpose of creating the “options” throughout the U.S.) The contracting administrators are going to have to build up provider networks and a customer base from scratch, simultaneously, and market by market, even though they will suffer the disadvantage of entering the insurance business long after the insurance companies they are competing with began introducing themselves to customers and cobbling together their own provider networks.
Second, this story should put the entire country on notice that the “option” may never be able to deliver on the promise, made over and over by “option” advocates, that the “option” will offer complete freedom to choose one’s doctor and hospital. If the contracting administrators who create the “options” around the country refuse to create “options” that limit enrollees’ choice of provider, those “option” programs will have less power to drive provider rates down. That means, of course, those “option” programs will have to set their premiums higher than existing insurers that do limit patient choice of provider. That will in turn make attracting a critical customer base very difficult if not impossible.
The third fact the Prudential story illustrates is that the size of an insurer at the national level is not an important factor in decisions by clinics and hospitals about whether to sign contracts with an insurer and whether to give that insurer discounts. What matters to clinics and hospitals is size at the local level. Minneapolis hospitals, for example, could have cared less whether Prudential insured 20,000 people in Tulsa or half-a million in Florida. (Size at the national level does have some bearing on whether an insurer can extract discounts from drug and equipment manufacturers. But drugs and equipment amount to roughly 15 percent of medical costs for the non-elderly. It is clinic and hospital costs that make or break an insurance company.)
The “chicken and egg” problem is, of course, not limited to entrepreneurs trying to break into the Minnesota market. The conditions that create the “chicken and egg” problem – high concentration levels within the insurance industry and near-universal use of managed care tactics including limited choice of provider – exist throughout the country. As Senator Charles Schumer (D-NY) said in a press release about a May 2009 report from Health Care for America Now, the entire U.S. health insurance industry suffers from “extreme … consolidation.” According to the HCAN report, eleven states have more concentrated insurance markets than Minnesota does.
“Option” advocates should stop comparing the “option” to Medicare
To test your understanding of the “chicken and egg” problem, let me end with a pop quiz: Did Medicare face a “chicken and egg” problem when it started up?
The answer is: No, it did not. It did not because it didn’t have to create a “customer” base from scratch. Its base was created by the law (signed on July 30, 1965) that created Medicare.
Medicare is, by design, the sole insurer for people over age 64. That means that Medicare’s administrators had a precise idea of how many Americans they would be representing on July 1, 1966, the day Medicare commenced operations. Equally importantly, every clinic and hospital in America had a good idea of how many elderly patients they would be getting if they participated in Medicare and, conversely, how many they would lose (and how much money they would lose) if they refused to accept Medicare patients. And because the Medicare law gave the nation’s entire elderly population – the portion of the population with the greatest need for medical care – to Medicare, Medicare’s administrators had a good idea of how much leverage they had on day one over the nation’s providers. This allowed them (eventually) to make an offer to America’s providers that the providers could not refuse – accept Medicare’s below-average rates or lose a lot of money. The offer was not refused. Today, virtually all American clinics and hospitals accept Medicare enrollees even though there is no requirement in the Medicare statute that providers accept Medicare enrollees. In short, having pre-established enrollment, which in turn gave Medicare the ability to set its rates below those of the insurance industry, meant that Medicare did not face the “chicken and egg” problem.
More importantly, Medicare didn’t face a “chicken and egg” problem because it has always been the single insurer for the services covered under Medicare. Medicare has never had to compete with the insurance industry for “customers.” A pernicious consequence of the tendency of “option” advocates to describe the “option” as “just like Medicare” is that “public option” supporters and members of Congress have been lulled into thinking the “option” is bound to succeed just as Medicare did. The tendency of “option” advocates to ignore the daunting “chicken and egg” problem is one manifestation of the lazy thinking that has been induced by the constant comparison of the “option” to Medicare. “Option” advocates should stop comparing the “option” to Medicare.
Kip Sullivan is a member of the steering committee of the Minnesota chapter of Physicians for a National Health Program. He is the author of The Health Care Mess: How We Got Into It and How We’ll Get Out of It (AuthorHouse, 2006).