Hospital Mergers Aren't About Efficiency. They're About Leverage

Years ago when I started seeing hospital systems across my region and state buying up other hospitals and physician practices, I had a pretty simplistic understanding of the financial motivations. I thought it was about creating efficiencies and “economies of scale.”

If a hospital system was buying 100,000 bags of saline each year for $2 apiece for three hospitals, I thought, buying 500,000 for six hospitals would earn them a bigger discount with the supplier. And maybe consolidating some back-office functions like billing, payroll, and human resources would make their operation sleeker and more economical.

Like many physicians, I assumed hospital systems grew because bigger organizations are simply more efficient. Yet economists who study hospital mergers tell a very different story. Not to say expansion can’t lead to some savings through efficiency, but as I learned, the real reason health care systems are scooping up hospitals almost as fast as they can isn’t so they can pay less for supplies. It’s about gaining leverage. The leverage to charge insurers more for exactly the same care.

As hospitals merge into larger health systems—a process economists call horizontal integration—they gain clout in their negotiations with insurance companies around payments for the services they provide. Health care systems that have become the dominant player in the city or region know insurers can’ t afford to leave them out of their in-network plans without making their policies unmarketable to local employers.

Thus the larger the health system becomes, the harder it becomes for insurers to say no to their demands, allowing hospitals to negotiate higher reimbursement rates for established services. You know that chest x-ray that Hospital X used to get paid $50 for from insurance company Y? After becoming the leading health care system in the region Hospital X now can command a $100 for the exact same procedure.

And while that might be great news for a health care system – particularly one struggling to stay in the black, it’s bad news for the rest of us. Because that extra money Hospital X just extracted from the insurance company doesn’t come from nowhere.

Insurers, who are not going to let higher payments to hospitals cut into their own margins, pass the costs along to the public -- through higher premiums, larger deductibles, and higher copays. In fact, according to the Center for American Progress, studies consistently show that hospital mergers lead to prices that are 10 percent to 40 percent higher than they would be in less consolidated markets.

For years, regulators approved these mergers because they were swayed by hospitals who argued that consolidation would create efficiencies that would improve patient care. But most economists conclude that whatever efficiencies these mergers create, they are far outweighed by higher prices. So a win for your regional health care system often becomes a loss for everyone else.

But the story of hospital mergers reveals a depressing truth about American health care. Every player in our system has a rationale for its behavior, but a system built from individually rational decisions can produce a collectively irrational result. Hospital systems maximize their margins to sustain their mission. Insurers respond by raising premiums. Employers shift more costs onto workers. None of these decisions is irrational when viewed in isolation. Yet when put together they are creating a health care death spiral in which costs rise relentlessly, even though no one set out with the goal of making health care unaffordable.

And in the end, the people with the least leverage—patients—are the ones left paying the bill

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