Managed Care’s Price Bargaining with Hospitals AcademyHealth Annual Research Meeting June 3, 2007 Vivian Wu University of Southern California and RAND

(1) Do MC plans get lower prices through bargaining? (2) What are the determinants of MC plans’ bargaining power? Main Research Questions:

(1) Do MC plans get lower prices through bargaining? (2) What are the determinants of MC plans’ bargaining power? Main Research Questions: Yes Plan Size, Patient channeling

Background – Managed Care Mechanism to reduce price: Mechanism to reduce price:  Selective Contracting (bargaining)  MC plans form selective networks and channel patients into these providers  MC bargains with providers individually for volume discounts Mechanisms to reduce quantity: Mechanisms to reduce quantity:  financial: capitation  non-financial: utilization management, gate keepers, guidelines

Methodology: Observe Managed Care w/ Lower Prices Per Diem Rate for a Hospital Admission FFS$100 HMO 1 $ 70 HMO 2 $ 62 HMO 3 $ 51 HMO 4 $ 75 HMO 5 $ 65 Q: Is the observed price difference related to plans’ different bargaining power?

Methodology: Three Hypotheses Cost Difference Cost Difference  Case mix, use of lower cost/quality hospitals Hospitals’ 3 rd -degree Price Discrimination Hospitals’ 3 rd -degree Price Discrimination  Elasticity - Ramsey pricing rule Managed Care’s Price Bargaining Managed Care’s Price Bargaining  Size  Elasticity: ability to channel patients  Excess capacity

Methodology: Empirical Tests Payer Size ChannelingAbilityExcessCapacity H1: Cost Difference H2: Hospital’s Price Discrimination No Relation Negative H3: Managed Care’s Price Bargaining NegativeNegativeNegative

Data Group Insurance Commission claims data Group Insurance Commission claims data  Actual prices paid, diagnoses, patient demographics  July, 1993 to June, 2000 Mass Hospital Discharge data Mass Hospital Discharge data  Size  “Channeling” measure American Hospital Association American Hospital Association Sample Sample  Boston, Worcester, and Springfield HRRs  General Acute Hospitals

Dependent Variable = log(Per Diem Price) Dependent Variable = log(Per Diem Price) Base † Base + High Cost †† Base + Hosp FE PPO-0.30*-0.31*-0.30* HPHC-0.38*-0.37*-0.36* Tufts-0.28*-0.28*-0.26* Pilgrim-0.35*-0.32*-0.32* HCHP-0.49*-0.52*-0.52* Cen Mass -0.30*-0.29*-0.27* Fallon-0.34*-0.35*-0.31* Others-0.24*-0.25*-0.26* Adj R * Significant at  =.05 level. † Base regression control for age, sex, income, DRG, market and year dummies. †† High cost variables include major teaching hospitals, hospitals having angioplasty or cath lab, open heart surgery facilities, and hospital beds, and ownership types. Results: H1- Cost Difference

Dependent Variable = log(Per Diem Price) Dependent Variable = log(Per Diem Price) 25%50%75% PPO-0.23*-0.24*-0.31* HPHC-0.25*-0.30*-0.43* Tufts-0.12*-0.23*-0.38* Pilgrim-0.22*-0.28*-0.39* HCHP-0.47*-0.51*-0.56* Cen Mass -0.21*-0.29*-0.41* Fallon-0.22*-0.29*-0.43* Others-0.13*-0.25*-0.36* *Significant at  =.05 level. **All controlled for age, sex, income, DRG, year, hospital and market dummies. Results: H1- Cost Difference

Results Summary: H1- Cost Difference Consistent discounts for all patients Consistent discounts for all patients Discounts not from sending patients to different set of hospitals Discounts not from sending patients to different set of hospitals From different prices within the hospitals. From different prices within the hospitals. =>R/O the cost difference hypothesis

Methodology: Empirical Tests Payer Size ChannelingAbilityExcessCapacity H2: Hospital’s Price Discrimination No relation Negative H3: Managed Care’s Price Bargaining NegativeNegativeNegative

Methodology: Empirical Model Price ijkt = α*size kmt + β*channel kmt + γ*excess jt + Σ a δ*interactions a + γ*excess jt + Σ a δ*interactions a +  *Case mix ijkt + Σ t λ t *Year t +  *Case mix ijkt + Σ t λ t *Year t + Σ j ρ j *Hosp j + Σ m  m *Market m + ε ijkt + Σ j ρ j *Hosp j + Σ m  m *Market m + ε ijkt where i – IP dayi j – hospital j k – plan km - market k – plan km - market t – year t

Methodology: Variable Definition Price Price  Per Diem price Payer Size Payer Size  Inpatients days in the hospital’s market (year-1) Channeling Channeling  Difference between preferred vs. observed hospital choices (year-1) Excess Capacity Excess Capacity  Average daily census < 50%

Difference-10%+35%-5%-10%0% “Channeling” Index 30%30%30%30%30% Patient Distribution Hosp 1 Hosp 2 Hosp 3 Hosp 4 Hosp 5 HMO1 predicted 10%15%30%15%10% HMO 1 observed0%50%25%5%10% Methodology: “Channeling” Dissimilarity Index

(1) Model a conditional hospital choice model U ij = z’ ij α + x i ’β j + ε ij (2) Compute expected hospital choices exp(z’α + x i ’β j ) exp(z ij ’α + x i ’β j )  exp(z’α + x i ’β j )  j exp(z ij ’α + x i ’β j ) (2) Calculate channeling index = | S p – S o | 2 2 __________________ prob(Yi=j | zx) = prob(Yi=j | z ij, x i ) = Methodology: “Channeling” Dissimilarity Index

Empirical Results Dependent Variable = log(Per Diem Price) Dependent Variable = log(Per Diem Price) Size † ** 0.96 ** Channel – I Excess Capacity Size*channel ** Size* Excess † Size in millions.

Empirical Results Dependent Variable = log(Per Diem Price) Dependent Variable = log(Per Diem Price) Size † ** Channel - II * Excess Capacity Size*channel Size* Excess † Size in millions.

Empirical Results Dependent Variable = log(Per Diem Price) Dependent Variable = log(Per Diem Price) Size † -1.0 ** * Channel – III Excess Capacity Size*channel ** Size* Excess † Size in millions.

Empirical Results: Summary Evidence support managed care engages in price bargaining. Evidence support managed care engages in price bargaining. Determinants: Determinants:  “Size” is important –large plans can get lower prices.  “Channeling” is also important; slightly larger effect than size in determining discounts.

Managed care can make hospital market more price competitive Managed care can make hospital market more price competitive  through exclusive network, or,  via channeling within the network Current models inadequate in describing health plan bargaining power Current models inadequate in describing health plan bargaining power Implications

Implications on MC mergers Implications on MC mergers  little is known about these mergers  my results suggest to be cautious  potential gains in hospital (input) market may be limited  potential losses in insurance (output) market may be large. Policy Implications