Over the past 20 years, drug companies have been busy merging with rival drug companies, hospital chains have been aggressively gobbling up hospitals, health insurers have bought other health insurers, and pharmacy giants have gone around the country buying up every independent drugstore they can get their hands on. Insurers argued they needed to get bigger to negotiate better prices with the bigger hospitals, just as the hospitals argued they needed scale to negotiate with the bigger insurers. Drug manufacturers and pharmacies made similar arguments. Like most arms races, this one wound up giving nobody a competitive advantage, but it left each of these markets dominated by three or four giant firms that are smart enough not to compete too aggressively with one another on price.
Only recently have antitrust regulators stepped in put a halt to this “horizontal” consolidation. In the past year, the Federal Trade Commission blocked Walgreens from buying all of Rite Aid, while the Justice Department went to court to prevent Aetna from buying insurance rival Humana and Anthem from merging with Cigna.
Too much consolidation, however, is only one reason the health-care sector is imperfectly competitive.
For starters, consumers don’t — and often can’t — shop around for the best deal in medical services the way they do for cars and television sets. One reason is that we often aren’t paying for medical services — our insurance companies do that, making us somewhat indifferent to prices. Nor in most cases is it even possible to figure out what those prices are. When was the last time you saw a price list in a doctor’s office? In fact, most of the time there isn’t a single price — prices are generally negotiated hospital by hospital, drug by drug, insurance company by insurance company, under secret agreements that prevent any of the parties from telling anyone else what is in them.
As anyone who has handled health insurance paperwork soon comes to realize, health-care pricing is a black box. There is the posted price, which turns out to have nothing to do with actual cost, and the “discounted” price your health insurer has negotiated. Of that discounted price, there is usually some portion you are supposed to pay as a co-payment, but only until you hit your deductible or out-of-pocket limit — unless, of course, you’ve gone out of network, in which case it is some (small) percentage of the usual and customary charge for that procedure based on secret data that bears no relation to what anyone actually pays.
Given this lack of transparency, the idea that price competition will protect consumers of health services is laughable. And nowhere is that more true than in the market for prescription drugs, thanks largely to a group of companies known as pharmacy benefit managers. PBMs are the middlemen of the prescription drug market. Insurers hire them to negotiate the best prices from drug manufacturers and to set up formularies to steer patients to the cheapest and most-effective drugs. PBM’s assemble networks of pharmacists who agree to fill prescriptions for a negotiated fee. They also fill the prescriptions themselves through their own mail-order pharmacies. Today, after a decade of consolidation, four PBMs control 80 percent of the market. One of them, Caremark, is owned by CVS, which now proposes to merge with its largest customer, Aetna.
It should tell you how rich and powerful these middlemen have become that the big drug companies have launched a major lobbying and public relations campaign to convince politicians and the public that it is PBMs that are driving up drug prices. Independent druggists complain loudly that the PBMs are driving them out of business by forcing customers to use their in-house pharmacies and retail outlets. And some of the country’s largest corporations have banded together to push for regulations that would require PBMs to fully disclose all the rebates (some call them kickbacks) they receive from drug companies for including drugs on their formularies. One insurer, Anthem, accused its PBM of concealing $15 billion in rebates and filed suit in federal court to get them back.
According to a study commissioned by the drug companies, PBMs and other wholesalers and retailers now capture 30 percent of the $469 billion the country spends for prescription drugs every year, up four percentage points in just two years. Citing their own study, PBMs claim that is a small price to pay for the roughly $65 billion they will save consumers every year by negotiating lower prices from drug companies and pharmacy chains and increasing the use of generic drugs.
But whichever study you want to believe, it should be pretty obvious that what passes for competition in the pharmaceutical sector today is really just a squabble among giant drug companies, giant insurers and giant pharmacies over how to divide a pot of outsize profits that, in a genuinely competitive market, would never have been so large in the first place.
In such an environment, a merger between Aetna, a top insurer, and CVS, the largest pharmacy chain, would allow the combined company to capture a bigger share of those outsize profits by steering even more of Aetna’s customers into CVS pharmacies and outpatient clinics. And notwithstanding hard-to-police promises of “firewalls,” CVS and its PBM could give Aetna access to competitively useful information CVS has about other insurers and their patients.
From past experience, there is little evidence that the benefits of this increase in profits and market power will be passed on to consumers in any significant way. Insurers and PBMs for years have been touting the benefits of mergers for consumers, even as insurance premiums and the price of medical services soared — and with them, industry profits and profit margins.
Perhaps that is why CVS and Aetna are hoping to sell this merger as a big step in restructuring how medical services are delivered in a way that improves health outcomes while lowering overall costs — what’s known in the industry as “integrated” or “managed” care. They cite the success of United Health, the nation’s largest health insurer, which not only operates another of the big PBMs but owns more than 7,000 surgery centers and urgent-care clinics and 22,000 physician practices.
I’m a big believer in managed care, an idea that dates to the early HMOs, or health maintenance organizations, of the 1960s. What distinguishes managed care from the more common fee-for-service medicine? Insurers pay hospital and doctors groups a fixed annual fee for each patient, irrespective of the number of tests, operations and office visits. Under such an arrangements, hospitals and medical professionals have a strong incentive to keep patients from getting sick and, when they do, to work collaboratively to get them healthy again with the most cost-effective treatment. Doctors are typically paid a fixed salary rather than by how many procedures they perform, and more care is delivered by nurses and trained technicians.
In a managed-care environment, much of the financial risk is shifted to doctors, hospitals and pharmacy benefit managers, effectively blurring the line between insurers and health-care providers. In that context, vertical mergers among insurance companies with hospitals, clinics, labs, doctor’s practices and in-house pharmacies make a lot of sense.
But here’s the problem. If CVS is allowed to buy Aetna, then it is inevitable that Express Scripts, the only other big PBM not owned by an insurer, will merge with a big insurer (WellPoint, Humana), and probably buy its own pharmacy chain as well (Walgreens). That would create four vertically integrated giants, each of which would feel the competitive pressure to begin buying up hospital chains and doctors’ practices. And within a few years, any free-standing insurance company, hospital chain or PBM would find itself at a huge competitive disadvantage, lacking efficiencies of scale and scope and shut out of much of the market by the exclusive, self-contained networks created by the vertically integrated giants. The need to have all those functions under the same roof would also make it harder, and less likely, for any new competitor to enter the market.
The better course, it seems to me, would be for the antitrust agencies to just say no to any more big health-care mergers to ensure that the market has a variety of companies, offering a variety of services based on a variety of business models. There is little that regulators could or should do to stop a PBM from starting its own insurance company, or an insurer from launching its own network of surgical centers, or a hospital chain from creating its own PBM. Such “build-it-yourself” strategies would increase competition in the marketplace.
Nor is there anything in the antitrust law that prevents companies in different parts of the sector from having contractual relationships with each other to improve service or lower costs, just as CVS and Aetna have today. Because the relationships are temporary, such “mix-and-match” strategies provide flexibility for a fast-changing industry such as health care to evolve in ways that serve the interests of consumers rather than shareholders.
What the antitrust law is meant to prevent, however, is exactly what CVS and Aetna now propose — merging a dominant firm in one highly concentrated market with a dominant firm in an adjacent concentrated market in a way that allows the combined firm to use exclusive dealing and the lack of price transparency to increase its market power and drive independent competitors from the marketplace.