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Compared with other developed nations, the United States spends far more on health care yet performs no better on many measures of health.¹ Moreover, health care spending in the United States continues to outpace economic growth. By 2026, $1 of every $5 spent in the American economy will go toward health care.² One of the main reasons Americans receive relatively little value from their health care dollars is that the price paid for care is higher—and that cost is rising more rapidly than those in other industrialized nations.³ Prices for medical care have generally risen faster than overall inflation, even for common procedures such as appendectomies and knee replacements.⁴ Any serious effort to bend the cost curve must address the prices Americans currently pay for health care, including the price markups that result from insufficient competition in U.S. health care markets. Put simply, less competition leads to higher prices for care.

Health care industry firms involved in merger activity often claim that consolidation will result in greater efficiency, lower costs, and more coordinated patient care. However, research shows that such efficiency often does not materialize; even when it does, savings are not passed on to consumers.

Economic theory indicates that when many similarly sized firms are present in a market, their competition for consumers keeps product prices low. Concentrated markets, those with just a few competitors or in which a small number of firms control most of the sales, generally have higher prices. In concentrated markets, firms wield market power and have control over prices and supply. In some cases, concentrated markets arise naturally. The population of a rural county, for example, may be too small to support more than one medical clinic. In other cases, market power can fuel concentration. Firms may drive out rivals by providing better care or lower prices; by developing loyalty to their brand; or by engaging in anti-competitive, unfair business practices. Another way markets can become concentrated over time is through consolidation, as competitors combine to form a single firm through mergers or acquisitions.

The U.S. health care system is riddled with highly concentrated markets, and consolidation is a major driving force. There are some key factors contributing to consolidation: Physicians’ practice groups have grown larger over time;⁵ three firms now account for two-thirds of pharmacy benefit management—the third-party administrators for prescription drug programs for insurers and other end payers; and more than half the pharmacy market is controlled by the top five firms.⁶ Based on federal antitrust regulators’ standards, in 9 in 10 metropolitan areas, the hospital market is highly concentrated.⁷ Health care industry watchers have noted that consolidation is picking up: The consultancy PricewaterhouseCoopers (PwC) declared that 2017 marked the “[r]esurgence of megadeals,” and the advisory firm Kaufman Hall declared it the year mergers and acquisitions “shook the healthcare landscape.”⁸

In addition to consolidation between like firms—hospitals acquiring other hospitals or pharmacy chains merging together—the health care sector is also experiencing increased vertical consolidation, that is, integration among companies that provide different sets of services.

The boom of vertical mergers starting in the mid-1990s was driven by hospitals and physician groups joining to form integrated provider systems.⁹ Today’s headline-making deals involve all facets of the health care sector. This fall, the U.S. Department of Justice (DOJ) and state regulators gave their blessing to the $69 billion merger between the insurer Aetna and CVS Health, whose business includes retail, health clinics, pharmacy services, and pharmacy benefits management.¹⁰ Among other recently announced vertical tie-ups are insurers such as Cigna and pharmacy benefit managers like Express Scripts and insurers and providers—United and DaVita. In addition to mergers, vertical integration also occurs as existing firms venture into new lines of business. A number of health system giants, including Partners HealthCare in Boston and the University of Pittsburgh Medical Center, run hospitals and offer insurance plans.¹¹ More recently, a group of health systems have banded together to launch their own nonprofit generic drug supplier, Civica Rx, to secure lower prices and steadier supply for their hospitals in response to the growing market power of generics manufacturers.¹² Even technology giants are wading into health care management. Google announced it is teaming up with insurer Oscar, and Amazon joined with Berkshire Hathaway and JPMorgan Chase & Co. to tackle health care costs.¹³

While examples of concentration in the health care sector are rife, this report focuses on health care providers, namely hospitals and physician practices, and the consequences of consolidation in that arena. In 2016, the United States spent $1.7 trillion on hospital care and physician and clinical services, which together accounted for more than half, or 52 percent, of the nation’s health expenditures that year.¹⁴ This report discusses how health care provider markets are becoming increasingly concentrated, as well as the implications for both payers and patients.

Tackling the harms of concentrated provider markets will require that federal and state antitrust authorities slow the pace of consolidation and that other policymakers step in to protect consumers in markets lacking competition. The final section of this report proposes changes in three areas to address the problem:

• Strengthen enforcement by antitrust agencies.
• Boost competition among providers.
• Bring down prices in already concentrated markets.

Progress in all three of these areas is crucial. Many popular policies to promote competition—hospital price transparency and rural telehealth, for example—do not directly address the elephant in the room: market power. The effectiveness of solutions in the first two categories relies on the ability of purchasers of health care—that is, insurers, employers, and patients—to make choices in a competitive environment, which many areas of the country lack. Conversely, regulations that cap provider rates prevent monopoly-level pricing but do not generate competition.

Robust competition and a dynamic market can drive innovation and improvements in health care. Mergers are ultimately a business decision, however, and policymakers should be doing do more to ensure consumers’ interests are protected.

When a small number of firms control most of the business in a market, that market is said to be concentrated. In health care, this could be a city with just two health care systems or a hospital that accounts for 60 percent of a city’s inpatient admissions. High levels of market concentration alone are no guarantee of noncompetitive outcomes, but a large body of research documents well-defined circumstances where that is the case.¹⁵ A common measure of concentration known as the Herfindahl-Hirschman Index (HHI) is calculated from each firm’s share of a market. At the high end, a market with a monopolist, the HHI score is 10,000; a market split evenly between two firms has an HHI of 5,000; and a market with 10 equally sized firms would have an HHI of 1,000. The federal governments’ chief antitrust enforcement agencies, the DOJ and Federal Trade Commission (FTC), define highly concentrated markets as those with an HHI above 2,500, a level that results from, among other possible configurations, four firms each holding a quarter of the market.

Using the HHI as a measure, concentration has increased among hospitals, specialty physicians, and primary care physicians over the last decade.¹⁶ One study found that 90 percent of U.S. metropolitan areas were highly concentrated for hospitals; 39 percent for primary care physicians; and 65 percent for specialty physicians.¹⁷ Another study, which looked at the average concentration across all provider types, found that 90 percent of metropolitan areas met or exceeded the 2,500 HHI threshold for a highly concentrated market.¹⁸

Rural areas of the country also suffer from scant competition, though concentration in those communities often results from too few providers rather than consolidation. About 1 in 5 rural counties has no hospital at all, and half lack a hospital with obstetric services. ¹⁹ In 1980, the country had 5,830 community hospitals;²⁰ the most recent count is 4,840.²¹ Moreover, the number of hospitals in the United States has declined over the last three decades because of closures, mergers, and acquisitions.

Concentration leads to higher prices but not better care

There is staggering variation in hospital prices across markets, across hospitals within markets, and even between payers within hospitals, suggesting that hospitals are charging noncompetitive rates—in other words, whatever the market will bear.²² In metropolitan areas that experienced hospital consolidation from 2010 through 2013, hospital prices generally rose more sharply than in other areas of the same state.²³ Blue Cross Blue Shield claims data show that the price of a knee replacement ranged from a low of $16,772 to a high of $61,585 among Dallas hospitals.²⁴ Another study by the Minnesota Department of Health found that prices varied as much as sevenfold for a single procedure within a single hospital, depending on the payer.²⁵ And although hospital executives often blame higher private rates on underpayment by public insurance programs, hospital price data do not support this theory.²⁶ On the contrary, higher Medicare rates appear to be associated with higher commercial rates. ²⁷

A report commissioned by the American Hospital Association (AHA) argues that “scale is necessary to accommodate the substantial requirements for data, IT infrastructure, and underlying systems to enable ‘accountable care.’”²⁸ There is little evidence, however, to show that mergers have led to better care or lower costs for patients. A PwC analysis found that larger health care systems generally have neither lower costs nor better-quality scores.²⁹ A retrospective FTC analysis of the Chicago-area merger between Highland Park Hospital and Evanston Northwestern Healthcare found large price increases and no strong proof that the transaction led to clinical improvements.³⁰

In fact, consolidation is one of the major forces driving hospital prices up. Two-thirds of community hospitals now belong to a multiprovider health system, compared with just half two decades ago.³¹ (see Figure 2) Empirical studies have shown that hospital mergers lead to prices that are 10 percent to 40 percent higher.³² This phenomenon is not limited to for-profit hospitals; nonprofit hospitals also raise their prices in more concentrated markets.³³ Studies suggest that even cross-market hospital mergers boost hospital systems’ bargaining power vis-a-vis insurers. Hospitals that are involved in mergers in different areas of the same state end up with prices that are 6 percent to 10 percent higher.³⁴

The ultimate cost of care depends on the larger health care market ecosystem, including the balance of provider-insurer bargaining power. Even in cases where hospitals can reduce costs through scale, those potential savings may be retained by hospitals or captured by insurers, never reaching the consumer. One study found that although acquired hospitals have 1.5 percent lower costs, this effect stems from the merged firm’s increased buying power rather than greater efficiency.³⁵ Hospitals’ marked-up list prices hit uninsured and out-of-network patients especially hard, because these groups are often billed the full amount, rather than the discounted rates negotiated by insurers. The role of insurer versus hospital market power in setting the price for services was described by economist Glenn Melnick in a recent New York Times op-ed:

Data from California illustrate how hospitals have exploited this situation. From 2002 to 2016, total billed charges by hospitals rose by a staggering $263 billion, to $386 billion, even though the number of patients admitted did not increase. Billed charges to health plans grew from $6,900 per day to over $19,500 per day. This astronomical run-up in billed charges gave California hospitals leverage to demand and receive much higher prices for in-network patients, too. The average price paid by health plans to hospitals for all care grew almost 200 percent — to $7,200 per day from $2,500.

In effect, they [the hospitals] could threaten: Pay us $7,200 per day to sign a contract or $19,500 per day for emergency admissions without a contract.³⁶

In situations where insurers have the upper hand, they can exert downward pressure on provider prices. Insurers appear to have the greatest success negotiating down hospital and specialist rates in markets with high levels of both provider and insurer concentration. However, in such cases, issuers may not face pressure to pass the benefit of lower prices on to consumers via lower premiums.³⁷

Though physician markets have not been studied as closely as hospital competition, largely due to a lack of comprehensive data until recently,³⁸ existing research shows that concentrated physician markets also lead to higher costs. The size of physician practices appears to be growing, with physicians increasingly practicing in multispecialty groups.³⁹ More highly concentrated physician markets not only have higher prices for office visits but also experience more rapid price growth.⁴⁰ For example, the price of a primary care visit in the nation’s most highly concentrated markets was about 23 percent higher than the national average.⁴¹ A study of California’s health care system attributed a 9 percent increase in prices for specialists and a 5 percent increase in prices for primary care to hospitals’ vertical integration that occurred from 2013 through 2016.⁴²

The evidence on the relationship between practice size and quality of care is mixed. On the one hand, larger practices may have greater resources and are quicker to adopt new technologies and care coordination strategies.⁴³ On the other hand, small practices may be nimbler in adapting care improvements. At a 2014 FTC workshop, Patrick Courneya shared his perspective on small practices as the medical director for Minnesota-based HealthPartners system:

The other thing that’s important in our experience is that we have seen groups at all points along the spectrum, some of our highest performing groups are actually the smallest. They have agility and just enough information about their patient population to drive better performance. And they’re actually among the most cost-efficient groups that we use as well. Those smaller groups actually have greater flexibility in identifying high-cost hospitals or even high-cost behaviors within emergency rooms and other things, and can go to those referral providers and actually talk to them about what the problem is.⁴⁴

In this vein, one study found that larger physician groups have higher risk-adjusted spending per high-need beneficiary and higher hospital readmission rates.⁴⁵ Another study found that concentration among cardiologists was associated with not only higher utilization and higher expenditures, but also increased mortality.⁴⁶

Antitrust enforcers are not slowing consolidation

Growing market concentration is not unique to the health care sector. Market power has risen across the U.S. economy, resulting in higher profits and less innovation.⁴⁷ At the same time, antitrust enforcement has grown more lax, with research showing a sharp change in the distribution of DOJ and FTC enforcement toward only the most concentrated industries.⁴⁸

The evolution of the FTC and DOJ’s Horizontal Merger Guidelines reflects this increasingly permissive view of market concentration.⁴⁹ The guidelines lay out HHI thresholds for evaluating whether a merger between firms competing in the same market is presumed to produce anti-competitive effects. In practice, however, the agencies’ bar for challenges has crept up over time,⁵⁰ leading the agencies to formally raise the HHI thresholds in the guidelines’ 2010 revision. The FTC has virtually abandoned challenges of mergers resulting in highly concentrated markets—an HHI of more than 2,500—thereby establishing a de facto safe harbor for consolidation activity under that level.⁵¹ Even in markets with higher levels of concentration, the FTC has been more permissive of consolidation than its merger guidelines seem to indicate.⁵²

The FTC has the chief antitrust enforcement power over health care providers, and its history of health care challenges has had its ups and downs. The FTC lost several cases in the mid- to late-1990s, a period when, in the words of former FTC Commissioner Julie Brill, the FTC’s “hospital merger work had hit an iceberg.”⁵³ In response, the agency invested heavily in a retrospective analysis of hospital mergers to amass evidence on the effects of consolidation and revamped its strategy for future enforcement cases. While the FTC’s success in blocking health care mergers has picked up over the last two decades, the unflagging pace of consolidation in the industry suggests that the agency’s efforts are having little deterrent effect.

It is no wonder then, that hospital merger and acquisition activity show no signs of stopping.⁵⁴ The level of activity is, in fact, higher than it was in the early 2000s. In 2017, the hospital industry saw 78 deals involving a total of 216 hospitals.⁵⁵ The AHA has aggressively defended the trend, including commissioning a report last year claiming that, contrary to the large body of empirical evidence, consolidation does not raise costs.⁵⁶ Yet, there is no disputing that the hospital industry is increasingly profitable. AHA data show that aggregate operating margins—a measure of the revenues and costs associated with patient care—were 6.7 percent in 2016, and total margins were nearly 8 percent, among the highest levels in two decades.⁵⁷

Physician-hospital integration is rising

The rise of consolidation in health care provider markets is also happening via vertical integration. In theory, vertical integration between two firms aligns incentives and allows the combined firm to operate more efficiently. In the context of health care, vertical integration between a hospital and physician group may allow for better care coordination and streamlined administration and eliminates the need for the entities to renegotiate contracts. Federal payment policies that reimburse drugs and services at more generous rates in hospital settings have also spawned mergers between hospitals and doctor groups. The introduction of accountable care organizations (ACOs), a reform to the way Medicare pays providers for care, has also been suspected of hastening vertical integration, but performance data do not support the theory that larger provider systems are more successful as ACOs. (see text box for a more detailed discussion of ACOs)