Peter C. Smith, Alexander S. Preker, Donald W. Light and Sabine Richard
Introduction
As described in Chapter 2, health care purchasers can take numerous forms, such as competitive insurers, social funds or local governments. They operate in two broad types of market: the market for members (or potential patients) and the market for clinical goods and services (hospitals, clinics, diagnostic services).
In the first they operate as sellers of services to the general public and in the second as buyers of services from a range of clinical and other providers. Other chapters in this book examine various aspects of the buying role of purchasing organizations. Although we make some reference to the role of purchasers as buyers, the main focus of this chapter is on the market (if any) between purchasers, however defined, and the extent to which competition between purchasers affects their actions and the outcomes for patients. Although this concern may appear superficially to relate only to health care systems with competitive insurance markets, the potential for competition in purchasing is relevant to almost all types of health care systems.
We address the instances where a purchasing organization has been established and do not consider the extreme case in which the only purchasers of clinical services are individuals or households. Collective purchasers can be thought of as insurers or budget holders, each of which may offer a single package or a menu of different health care plans to potential members. The characteristics of the purchaser market can then be considered along a number of dimensions:
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the number and size of purchasers; there are enormous variations within Europe;•
the degree of patients’ choice of purchaser to represent them (see also Chapter 6);•
the degree of patients’ direct say in purchasers’ policies (see also Chapter 6);•
the degree of purchasers’ choice of which patients to accept;•
the degree of purchasers’ control of the clinical services used by patients;•
the extent of variation in purchasers’ packages of care;•
the extent of variation in premiums and charges levied by purchasers; and•
the extent to which purchasers compete for contracts with providers.At one extreme one can envisage a largely unregulated purchaser market in which a large number of purchasers offer a broad spectrum of packages of care and payment mechanisms to the general public. At the other extreme, a health care system might offer no choice of purchaser, or seek to regulate virtually all aspects of health care, rendering meaningless any nominal choice. Across this continuum, effective purchasing of any sort relies on the existence of an orderly and effective state that can ensure that contracts are enforceable, transactions are honest, and crimes or corruption are prosecuted. No system of collective health care purchasing can function in the absence of these fundamental stewardship functions (see Chapter 8).
There are numerous examples of purchaser markets in health care. The prime case is the United States, which exhibits a unique plurality of purchasers and providers, reflecting a policy preoccupation with employer and individual choice (Reinhardt, 1996). In principle, citizens can choose insurance arrange-ments from a diverse spectrum of health care plans offering different payment mechanisms, coverage and quality. In practice, the choices of most citizens are seriously circumscribed, either because they are locked into particular plans through their employment, or because they lack the means to insure, or because insurers are able to decline those they perceive to be bad risks. The United States insurance market is characterized by a high degree of market segmentation and niche formation (Grembowski et al., 2000).
In Europe, many of the systems of social insurance (the Netherlands, Ger-many, Israel, Switzerland and Belgium) have reformed in order to offer citizens a choice of insurers (Normand & Busse, 2002; Saltman et al., 2004). In contrast to the American case, the principle of social solidarity has led to a requirement that coverage should be universal and offer similar packages of care. Furthermore, an insurer in such systems should set the same rate of premium for all members, unrelated to risk, and cannot turn away any application for membership. Thus they are in principle expected to compete on efficiency and quality of services, and not on the basis of selection of membership. Some attempt is usually made to compensate insurers for variations in the risk profile of their memberships using risk adjustment methods and, in general, packages of care and copayment rules have been highly regulated. Hitherto there has in practice been little real-istic choice for consumers, although there is evidence that some differentiation is beginning to emerge in countries such as the Netherlands.
Even unitary systems of health care have sought to offer citizens some choice of purchaser. For example, the United Kingdom experimented for seven years with a system of general practitioner fundholders, which could in principle offer patients a choice of purchaser, albeit within fairly circumscribed rules as to the range of services available (Audit Commission, 1996). In practice there was little evidence of patients switching GP, although fundholders did appear to
secure some efficiency and quality improvements (in the form of lower expend-iture and lower waiting times than their non-fundholding counterparts). It is also important to note that many systems with no nominal choice of main-stream health care insurer exhibit flourishing markets in private supplementary insurance.
The purpose of this chapter is to examine the role of markets in health care purchasers, and to discuss the circumstances in which some sort of market organization among purchasers may lead to better outcomes than other forms of purchasing. We first sketch some rudimentary economic and sociological theory concerning the nature of markets and competition in general. We then examine some of the incentives associated with a competitive market and note that any market in health care purchasers must be carefully regulated. We briefly discuss the implications of the different types of provider markets for the purchasing function. The chapter then summarizes experience with purchaser markets in health care, and concludes with some policy advice on issues to be considered when moving towards purchaser markets.
Markets and competition
It is first worth recalling the rudimentary components of a market, as construed by neoclassical economists (Roberts, 1987). Among the most important are:
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There must be many buyers and sellers so that no one’s actions are large enough to affect the market overall. In particular there is no monopoly of supply or demand.•
Buyers and sellers have no relations with each other that might affect their economic behaviour.•
There are no barriers of entry or exit of sellers. Failing sellers drop out of the market and sellers with better products or prices can enter the market easily.•
There is freely available information about services, products, prices and quality.•
Buyers choose to maximize their individual utilities.•
Providers seek to maximize some notion of profit or surplus.•
Market signals are instantaneous and the market quickly clears differences between supply and demand through price fluctuations.•
Price conveys all that buyers need to know in order to identify their opportunity costs.•
There are no externalities to these transactions so that only the buyers experience the benefits and liabilities of their purchases.•
There are no transaction costs to inhibit trade.•
Any contract made in the market is complete and enforceable.The extent to which these conditions are met has a profound influence on the outcomes for society and the associated policy prescriptions. No pure market in the sense envisaged by neoclassical economists has ever existed. A great deal of contemporary microeconomic theory therefore focuses on certain departures from the pure neoclassical assumptions, such as information asymmetries,
incomplete contracts, transaction costs, externalities, public goods and various other aspects of market imperfections. Numerous policy prescriptions flow from these adapted neoclassical analyses, such as various forms of regulation, infor-mation provision and motivational instruments. Many of these have been highly influential with policy makers. In particular, economists have extended analysis of markets to situations of imperfect competition, many of which are likely to apply in health care systems (Eatwell et al., 1989). For example, they have examined the implications of:
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monopoly supply, under which an unregulated monopolist produces lower quantities at higher prices (or lower levels of efficiency) than under competition;•
oligopoly supply (a small number of providers), which leads to a solution intermediate between perfect competition and monopoly if providers do not collude, but reverts to the monopolistic outcome if collusion is possible;•
monopolistic competition, another situation intermediate between monopoly and perfect competition, under which a large number of suppliers compete with products that are qualitatively different, and therefore imperfect substitutes;•
monopoly purchasing (or monopsony), under which the purchaser can secure higher quantities at lower prices than under competition.Furthermore, there are circumstances in which there may be a small number of buyers or sellers, but the market is effectively competitive, or contestable, in the sense that new entrants could enter readily if the existing players failed to behave competitively.
A particularly important principle underlying welfare economics is known as the theory of second best. This states that if a market imperfection exists in the economy that cannot be directly remedied, the optimal policy response may require the introduction of a second ‘imperfection’ to counteract the first.
For example, there may be circumstances in which, rather than break up a monopoly supplier, it might be preferable to introduce a monopoly purchaser to counteract its power.
One particular feature of the economist’s notion of a market is that it is preoccupied mainly with efficiency. The only considerations it gives to equity are the assumptions that legitimate property rights should be respected and that all actors should be treated procedurally fairly – for example:
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no actor is to be given preferential access to the market;•
all services are to be provided with clear terms and conditions;•
comparable information on price and quality is to be available to all;•
no cost shifting onto third parties is permitted;•
payment should be prompt.Unequal outcomes are considered immaterial in the conventional analysis of markets. Where economists have considered equity issues (for example, in the optimal taxation literature), the general presumption has been that this is a redistributive function of government and not a concern of the market (Myles, 1995).
In contrast, the sociological viewpoint is that all economic action is socially situated, and is embedded in networks of social relations. Individual actors are
rarely, if ever, autonomous. All markets are therefore constructed realities in which societies (or those engaged in transactions) decide what can be competed over, who can buy and sell, and how transactions will take place (Light, 1994, 2001; Rice, 2002). From this perspective, there arises a need to analyse the rules and boundaries of purchasing in order to understand the roles and functions of purchasers that society wants to develop. In particular, one would attend to relations between powerful buyers and sellers (or their agents) in order to assess how their relations affect their economic behaviour. From this perspective, health care purchasing is shaped by institutions, power relations, networks and common practices (Smelser & Swedberg, 1998).
Markets, competition and health care insurance Causes of market failures
The question addressed by this chapter is not whether markets work perfectly in health care. In this context, it is worth noting the serious government failures that can arise when organizing health care purchasing on non-market principles (Wallis & Dollery, 1999). Rather, our purpose is to address whether some sort of market organization among purchasers leads to better outcomes than other forms of purchaser organization, and what the best form of market organization might be. This section therefore first examines the hypothetical operation of an unfettered insurance market. It then discusses some of the market imperfections that arise in health insurance, and concludes with a discussion of the regulatory issues that this gives rise to.
The argument that a market in health care purchasers could lead to beneficial outcomes goes as follows. Let us assume a system in which citizens are free to insure with a purchaser of their choice (or none at all) at a premium reflecting expected personal costs of care. The mobility of patients requires that purchaser surplus depends on winning and retaining profitable membership. Purchasers are expected to maximize some concept of long-run financial surplus, and might therefore seek out competitive advantage by:
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offering higher quality of care than competitors;•
designing packages of care that attract particular client groups (specialization or ‘niche marketing’);•
seeking out and offering new (often costly) procedures that attract popular support;•
securing cost efficiencies that enable them to offer lower premiums than competitors.In principle, these actions should promote, respectively: quality, choice, innovation and efficiency. The proponents of a market in purchasers argue that the joint attention to demand side preferences and supply-side cost-effectiveness will advance the objectives society wishes to attach to its health care system (Cutler & Zeckhauser, 2000).
In practice it is difficult to envisage any sector of the economy that departs further from the neoclassical ideal of a competitive market than health care
insurance (Evans, 1997). Table 5.1 summarizes some of the key market imperfections that often prevail in the purchasing of health services. In the following paragraphs we focus on four key market imperfections related to:
information asymmetry, barriers to entry, principal–agent problems and trans-action costs.
Information failures
Purchasing is a transaction that involves serious information and measurability failures due to the nature of health services (see Box 5.1). Although collective purchasers are in a better position to address information and measurability failures than individual consumers, this information asymmetry easily impedes efficient functioning of markets. Similarly, consumers usually lack adequate information with which to compare competing insurers.
Barriers to entry and exit
Significant natural and constructed barriers to entry limit the role competitive forces can play. In practice, even health systems with apparently competitive purchaser markets severely constrain the extent to which purchasers are allowed to fail, or new players can enter the market. Non-competitive systems can secure change only through mechanisms such as merger or other modes of managerial change, such as franchising or electoral accountability.
Principal–agent problems
Both purchasers and providers behave as imperfect agents for the patients that they are supposed to represent, frequently demonstrating conflicting interests.
These problems can be addressed through incentive alignment, monitoring, measurement and accountability instruments. Much depends on the pur-chasers’ sources of revenue. If funded by fixed revenue, purchasers may have an incentive to contain costs by limiting the benefits package, even for services that are cost-effective from a societal perspective, unless adequate information and accountability arrangements are in place. If funded by capitation payments, purchasers may offer fashionable services that attract patients in order to secure their capitation payment. However, they may still have an incentive to skimp Table 5.1 Market imperfections in purchasing health services
Functional markets Insurance provider market Patient provider market
Perfect information Medium asymmetry High asymmetry Many sellers (no barriers
to entry and exit)
Monopoly or small numbers of sellers (high barriers)
Monopoly or small number of sellers (high barriers) Many buyers (no barriers
to entry and exit)
Monopsony or small numbers of buyers (high barriers)
Many buyers but catastrophic care unaffordable (high barrier)
Box 5.1 Factor and product markets: contestability and measurability Health care goods and services can be categorized on a continuum from high-contestability and high-measurability services to low-contestability and low-measurability services, and significant information asymmetry, as illustrated in Figure 5.1. (Preker & Harding, 2000).
The production of consumable items and the retail of drugs, medical supplies and other consumables would be the best example of highly contestable goods where outputs are also easy to measure. Many com-panies usually jostle for a share of the market, and barriers to entry are few (the initial investment capital is modest and there are few requirements for specialized licensing or skills). Unskilled labour also belongs in this category. As we move across the first row, a number of factors begin to contribute to raising the barriers to entry, thereby reducing the contest-ability of the goods or services in question. Investment cost (sunk cost), increasing technical specifications and the increasing tendency for larger suppliers such as retailers and wholesalers of pharmaceuticals to com-mand more and more market power making them quasi monopolies and giving them the ability to extract rents by setting prices above those which a competitive market would support. As we move to the second row, measurement of the outputs and outcomes become more problem-atic. Outputs and outcomes can be measured but it is more difficult than in the case of activities in the first row.
Interventions and services can also be categorized along a similar con-tinuum from high contestability and high measurability through to inter-ventions and other outputs with low contestability, low measurability and significant information asymmetry. Whereas reduced contestability due to market concentration is one of the main problems encountered in fac-tor markets (production of inputs), a key problem with interventions and other outputs (product markets) has to do with difficulties in specifying and measuring outputs and outcomes. In addition to difficulties in meas-uring output and outcomes, most clinical interventions are characterized by an additional constraint of information asymmetry. At times, informa-tion may be readily apparent to patients for example, the quality of ‘hotel services’ such as courtesy of clinical staff, the length of waiting periods, the cleanliness of linen, the palatability of food, and privacy. Health insurance and purchasing arrangements are somewhere in the middle of this grid.
Outputs such as treatment in clinics and hospitals are much less tangible and much more difficult to measure.
Based on the above discussion, it is now easy to map the goods and services that can be bought by purchasing arrangements, those where coordination is enough, and those that are better produced inhouse. The size of the ‘make’ of the inhouse production area will depend largely on the effectiveness of policy instruments to deal with contestability and measurability problems (Preker et al., 2000).
on many services that do not affect demand for insurance. On the other hand, if revenue is dependent on activity then purchasers have an incentive to stimulate demand artificially.
Transaction costs
The principal–agent problems in health care can give rise to substantial transaction costs, in the form of specifying and monitoring contracts. Competi-tive purchasing can give rise to especially high transaction costs, particularly when patients are free to choose providers. Markets give rise to demanding information and auditing requirements and may impose substantial delivery costs on providers, for example in the use of different clinical guidelines or copayments for patients covered by different health insurers.
There are other potentially undesirable features of market activity. Consider-able resources will be diverted to marketing and promotion. Markets are dynamic entities that can exhibit instability as participants exit and enter. The mass entrance and subsequent exodus of managed care plans in the competi-tive United States Medicare programme is a case in point. Powerful purchasers may seek to erect barriers to entry, or to capture the regulatory regime. In order
There are other potentially undesirable features of market activity. Consider-able resources will be diverted to marketing and promotion. Markets are dynamic entities that can exhibit instability as participants exit and enter. The mass entrance and subsequent exodus of managed care plans in the competi-tive United States Medicare programme is a case in point. Powerful purchasers may seek to erect barriers to entry, or to capture the regulatory regime. In order