Consolidation is aggressively moving through much of the US economy. Everything from coffee shops to airlines are consolidating and the effect on the consumer is varied. When it comes to healthcare the landscape is not much different, with hospitals buying each other, health plans merging with providers, and PBMs joining forces even purchasing health plans. Is consolidation a good thing? Is there an unexpected cost to this consolidation? Are consumers in the healthcare space hurt or benefitted from consolidation? These are some of the questions I am going to tackle as we look at consolidation in the US healthcare space. Because hospital care is most of the healthcare dollar, most of this article will concentrate on consolidation that includes or impacts hospitals.
Before we can explore the effect of consolidation, we need to define what consolidation is. When talking about healthcare consolidation we are going to take a wider definition of consolidation that includes mergers, acquisitions, strategic alliances, affiliations and even the strategic closing of facilities. Most of the time consolidation includes the combining of unique entities (often competitors) into a single more powerful entity. In basic economic terms, this should lower operating costs and eventually lower prices through economies of scale.
We see two main types of consolidation in healthcare: Horizontal Consolidation and Vertical Consolidation. Horizontal consolidation is when two entities offering very similar services come together and continue to offer those same services (more of the same). Vertical consolidation is when entities come together that offer unique or different aspects of the healthcare system to create a more efficient and controlled process (more of the whole). In a non-healthcare view a vertical consolidation might be a boat manufacturer purchasing a company that makes fiberglass. The manufacturer needs the other company’s product and instead of purchasing materials from them, they now own the organization manufacturing the materials. The manufacturer can secure the availability of the materials and increase the integrated relationship. A horizontal consolidation in the manufacturing of boats would be one boat manufacturer buying another boat manufacturer. They now own a larger piece of the market, have lowered competition and may have more control on market prices.
Recent horizontal consolidation in healthcare has seen a large portion focused on hospitals being purchased by other hospitals or health systems.
Recent horizontal consolidation in healthcare has seen a large portion focused on hospitals being purchased by health systems. Health systems are trying to increase their market footprint by purchasing other hospitals. It is often more efficient to buy an existing hospital than build a new one and hope that “if you build it, they will come”. Other horizontal integrations may be a medical group buying another similar medical group and therefore increasing its reach and power in the market.
A very interesting example of horizontal consolidation occurred in the State of Washington where I used to live. Up in Bellingham, a two-hospital town, both hospitals decided to merge. Both were under-utilized (i.e., low occupancy) and financially struggling. Actuarial analysis at that time suggested that the city only needed one of them, however, one was well known for its OB program and the other for its med/surg expertise. Instead of truly consolidating and combining services and doing what typical business would do (i.e., shut one down), they continued to operate both. Fortunately, the area has grown and the demand has increased from population growth. However, the per person cost of care has increased in the Bellingham area more than what would have been expected. Consolidation without right-sizing costs the system more than it should.
Vertical consolidation with hospitals emerges when hospitals and medical groups integrate with each other (taking control over more of the food chain). Providers (physicians) don’t compete directly with hospitals, but they do interact with each other. Either a physician performs services at a hospital, or they may control referral patterns of its members and directly or indirectly refers its patients to a hospital. Vertical consolidation between physicians and hospitals is often used to integrate care and control referral patterns. As care truly becomes more integrated there is the chance of less waste and the potential for higher quality care. Some vertical integrations are through acquisition, others are through joint ventures while some are through favorable affiliation arrangements.
Another example of vertical integration was in the Portland, OR market where a health system started acquisitions of smaller medical practices to combine it with its broad facility-based operations in order to form an integrated delivery system. They then partnered with its company owned health plan and quickly grew into a Kaiser-like delivery system. This newly formed group still partnered with independent practices but grew a combined operation that has now become one of the best in the state. Market power was increased, but more importantly integrated care increased and therefore cost and quality was improved. Healthcare consolidation has hit peaks and valleys through the years, and it is often driven by the popularity of managed care in the market. In the early 1990s there were frequent consolidations occurring where hospitals acquired physician groups. This consolidation occurred at the same time as a peak in managed care popularity was occurring. Over the next decade managed care popularity shrunk and so did healthcare consolidation. The passage of the Affordable Care Act (ACA) in 2014 reignited the consolidation in healthcare as there were new reasons to attempt to integrate delivery systems. One way integration has been seen is the development of Accountable Care Organizations (ACO) where hospitals, medical groups, and other providers come together to care for all facets of a patient’s care. Per the ACA there was a requirement for an ACO to manage at least 5,000 members so therefore many ACOs started to meet the minimum membership requirement.
The advent of Medicare Access and CHIP Reauthorization Act (MACRA) also pushed more consolidation as the requirements of providers increased as did the expectations of performance. Meeting the requirements of MACRA can become cumbersome for small independent practices and therefore further momentum was created pushing consolidation. Today, in 2019 we find the healthcare system moving more and more towards a managed care model that is integrated with things such as Value Based Reimbursement (VBR) that incentivizes performance. Healthcare costs are trending up and the industry is searching for ways to change course towards a concentration on quality of care and not quantity of care.
The financial news has been filled with other examples of consolidation:
- CVS and Aetna
- United Health Care and many of its acquired entities (e.g., Pacificare, Sierra Health Services, Oxford Health, etc.)
- Centene and HealthNet
- Kaiser and Group Health Cooperative
There are many arguments for and against consolidation especially when it is related to hospitals. The most common argument for consolidation is that economies of scale will lower costs and therefore increase efficiency. In addition to economies of scale, the consolidation of hospitals will increase the connectedness of providers/facilities and therefore increase the ability of more intense care coordination and care management.
The other side of the economies of scale argument is the fact that competition is often the best way to control cost. As more groups consolidate, there is less competition and more chances of monopoly and control of the market. Market power is more threatening to a market than the operational cost benefits of consolidation. This can become even more obvious in isolated markets where consolidation can occur and remove most all competition. For example, there are hospital systems that own most every hospital in an area. They not only can control prices but can also control contracting. In some cases, they can even include “poison pill” provisions in their contracts that essentially handcuff insurers and providers into provisions that they must accept or otherwise must deal with them not being contracted.
In normal economic terms, price is determined by supply and demand. When there is limited supply there is often higher prices because the demand is higher. On the converse when there is large supply there is often less demand and therefore prices need to be more competitive in order sell goods. Healthcare does not follow normal economic methods as many times more supply can turn into more consumed services. Instead of driving down prices it drives up utilization and therefore raises overall medical costs. Especially in a Fee for Service (FFS) environment, healthcare is one of the few industries that can create supply and demand. A provider is not only able to offer services, but they can also induce more services to be consumed. And in the case of consolidation, supply can be increased while also increasing prices and demand. The three things combined can lead to a cost spiral.
A good example of this occurred in the Pacific Northwest in Kitsap County. During the 1980s, one of the earlier migrations from California to Washington State, a significant number of physicians were attracted to Kitsap County over a short period of time. The opportunity to leave crowded California for remote Kitsap County and live on the beautiful waters of Puget Sound was too good to be true. In a five-year period the physician per capita ratio increased in Kitsap County by more than 30%. The population increased slightly but the access to care was dramatically changed in a very short period of time. There wasn’t a shortage before this happened but the significant increase in physician resources did not go unnoticed in this community. The local health plan couldn’t initially understand their troubling financial results until it became clear that this 30% increase in supply had turned into an unexpected 15% increase in utilization by their existing population. Others started to notice it too, Medicare costs had increased, and Medicaid costs had increased. This clearly demonstrated that supply drives demand in healthcare particularly at the professional provider level.
Competition is key to a good market and for that reason the government closely monitors Mergers and Acquisitions to make sure that healthy market dynamics still exist. One of the ways the markets are monitored is using the Herfindahl-Hirschman Index(HHI). This is a common measure of market concentration that is used to determine market competitiveness. Markets are ranked as to the level of competition / concentration and the ability to continue a healthy market into the future. The Commonwealth Fund published an article in 2018 that found that providers in 47.1% of MSAs were highly concentrated and that providers in 43.0% of MSAs were super concentrated. In other words, there low levels of competition. The same study showed the insurers almost all fell in lower levels of concentration with 54.5% being highly concentrated and 26.9% being moderately concentrated. When looking at relative concentration between providers and insurers, providers had higher concentration than insurers in 58.4% of the MSAs, while the insurers only where higher in 5.8% of the MSAs. The below table that was extracted from the Commonwealth Fund report shows the relation between the concentration of insurers and providers.
Up to this point in this article there have been many arguments that appear to point toward consolidation negatively affecting the healthcare system, but there is also a needed level of consolidation that will help the system. Vertical consolidation, when done appropriately can and will help the system. The cost of healthcare is skyrocketing and finding a way to control costs is going to be the key to stabilizing the system. Vertical consolidation with a keen eye on improving the managing of care will be the best way to improve our healthcare system. Vertical consolidation will improve the ability to manage care effectively while properly incentivizing all parties to practice high quality, cost effective care. Improvements in technology will allow the healthcare system to more easily communicate and share data. When hospitals, providers and insurers are all on the same team everyone wins.
When I look into my crystal ball of healthcare I see that in order for hospitals to be successful in the future, they need to start acting more like insurance companies.
At the heart of value based reimbursement is trying to find a way to bring multiple entities together in order to have similar goals and objectives. Vertical consolidation can do much of the same. When I look into my crystal ball of healthcare I see that in order for hospitals to be successful in the future, they need to start acting more like insurance companies. They need to start taking more risk, start managing care better, and stop being a vending machine that makes more money the more they sell. Individual doctors and medical groups need to look at ACO type arrangements and continue their ability to take and manage risk. Kaiser is a fully integrated system that most plans are benchmarked against, and I fully believe that we will see more Kaiser like entities in the market that will bring all parties together for the betterment of the member. At the end of the day we need to keep the Triple Aimthe top priority where we are improving the population health, bettering the experience of the member, while lower the overall cost of care.