Pricing Coordination Failures and Health Care Provider Integration

The rise of managed healthcare organizations (MCOs) and the associated increased integration among providers has transformed US healthcare and at the same time raised antitrust concern. This paper examines how competition among MCOs affects the efficiency gains of improved price coordination achieved through integration. MCOs offer differentiated services and contract with specialized and complementary upstream providers to supply these services. We identify strategic pricing equilibria under three different market structures: overlapping upstream physician-hospital alliances, upstream-downstream arrangements such as Preferred Provider Organizations, and vertically integrated Health Maintenance Organizations. The efficiency gains achieved depend not only on organizational form but also on the toughness of premium competition. We show that, contrary to popular thinking, providers and insurers do not earn maximum net revenue when they are monopolies or monopsonies, but rather at an intermediate level of market power. Furthermore, closer integration of upstream and downstream providers does not necessarily increase net revenues.