Vertical Integration and Exclusive Behavior of Insurers and Hospitals

• Date: 01 June 2014
• Author: Rein Halbersma,Katalin Katona,Rudy Douven,Victoria Shestalova
• DOI: http://doi.org/10.1111/jems.12056
• Published date: 01 June 2014

Vertical Integration and Exclusive Behavior

of Insurers and Hospitals

RUDY DOUVEN

CPB, Netherlands Bureau for Economic Policy Analysis

P.O.Box 80510, 2508 GM, The Hague, the Netherlands and iBMG, Erasmus University Rotterdam,

the Netherlands

r.douven@cpb.nl

REIN HALBERSMA

Dutch Healthcare Authority

P.O.Box 3017, 3502 GA Utrecht, the Netherlands and TILEC, Tilburg University, the Netherlands

rhalbersma@nza.nl

KATALIN KATONA

Dutch Healthcare Authority

P.O.Box 3017, 3502 GA Utrecht, the Netherlands and TILEC, Tilburg University, the Netherlands

kkatona@nza.nl

VICTORIA SHESTALOVA

CPB, Netherlands Bureau for Economic Policy Analysis

P.O.Box 80510, 2508 GM, The Hague, the Netherlands

v.shestalova@cpb.nl

We examine vertical integration and exclusive behavior in health care markets in which insurers

and hospitals bilaterally bargain over contracts. We employ a bargaining model of two hospitals

and two health insurers competing on premiums. We show that asymmetric equilibria exist in

which one insurer contracts one hospital whereas the other insurer contracts both hospitals, even

if all players are equally efficient in their production. Asymmetric equilibria arise if hospitals are

sufficiently differentiated. In these cases, total industry profits increase and consumer welfare

decreases in comparison to the case in which both insurers have contracts with both hospitals.

Vertical integration makes these equilibria possible for a wider range of parameters.

1. Introduction

One of the main challenges in health care is to reduce costs by providing health care

more efficiently. A market-oriented approach has been followed in the United States

and also recently in Europe, an approach in which competing health insurers and health

care providers should in theory achieve an efficient allocation of the production and

consumption of health care. This approach may stimulate the appearance of new forms

Wewould like to thank Paul de Bijl, Jan Boone, Marcel Canoy,Martin Gaynor, Katherine Ho, Viktoria Kocsis,

Erik Schut, Misja Mikkers for their comments on preliminary versions of our paper. Furthermore, we thank

participants of the IHEA conference in Beijing (2009) and EARIE conference in Ljubljana (2009), and our

colleagues at the CPB and NZA for their comments during seminars at our institutes. Martin Gaynor and

Katherine Ho were commissioned by the Dutch Healthcare Authority as external reviewers of an earlier

draft of this paper. We are grateful to two anonymous referees and the coeditor for their careful and detailed

comments and suggestions.

C2014 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume23, Number 2, Summer 2014, 344–368

Vertical Relations between Insurers and Hospitals 345

of institutional and contractual arrangements in the health-care sector. For example, the

growth of managed-care in the United States has led to tighter vertical relationships

between health insurers and providers in the form of health maintenance organizations

(HMO). In these organizations insurers’ enrollees typically receive full reimbursement

for services from providers within the network, whereas sometimes facing copayments

when visiting providers outside the network. Vertical restraints or integration can be a

tool for insurers and providers to gain efficiency, but they may also have anticompetitive

effects. The potential consequences of vertical integration between an insurer and a

hospital are currently cause for concern in Europe. For instance, the question of these

consequences has been discussed by the Dutch Parliament, and the current government

in the Netherlands now plans a per se prohibition of vertical integration between an

insurer and a hospital.1

In this paper, we examine under which market conditions exclusive behavior and

vertical integration can arise and whether this may harm competition. We study this

question with a bilateral-duopoly model of a competitive health care market, a model

in which insurers and hospitals bilaterally bargain over contracts.2We show that two

types of exclusive behavior can occur in this setting. First, one of the insurers may be

excluded. This happens if decreasing competition (i.e., monopolization) in the insurer

market leads to a substantial increase in total industry profits. Second, one hospital

may not, in equilibrium, engage in a contract with one of the insurers. In such a case, a

managed-care insurer (contracting one hospital) and a conventional insurer (contracting

both hospitals) can coexist in the market, even if both insurers and both hospitals are

equally efficient in their production. Weshow that the range of parameters under which

the latter outcome can occur grows if one insurer–hospital pair integrates vertically. The

modeled result that both managed-care and conventional health plans can coexist in the

market is new, because earlier literature on this topic (Gal-Or, 1997; Ma, 1997) focused

on exclusionary outcomes. Our model draws from Gal-Or (1997) but incorporates the

bargaining concept developed by de Fontenay and Gans (2005). The key difference with

Gal-Or (1997) is that both hospitals and insurers are modeled as strategic players; they

bargain over profit allocation, rather than over linear contracts.

The paper proceeds as follows. In Section 2, we describe the literature and our

contribution to it. We develop our model in Section 3, which we use in Section 4 to

characterize equilibrium outcomes in the cases with and without vertical integration of

a hospital and an insurer.Section 5 provides the analysis of consumer welfare. In the last

section, we draw conclusions and outline directions for further research. We relegate to

the appendix more technical details concerning the bargaining approach used.

2. Literature and Contribution

Managed-care organizations use various forms of vertical arrangement to reduce the

cost of providing health care and to improve the quality of care. There is evidence that

a vertically integrated network may enhance consumer welfare by providing health

care more efficiently. Many studies on the United States have shown that insurance

provided by managed-care organizations cost 10–20% less than indemnity insurance.

1. Source: The coalition agreement of the Dutch government of September 30, 2010 (http://www.

rijksoverheid.nl/regering/het-kabinet/regeerakkoord).

2. Inthe remainder of the paper we will use the term hospitals, because we primarily focus on this subject,

but a more general term, such as health care providers, would be applicable as well.