Introduction
The main objective of the coursework is to conduct a critical analysis and evaluation of competition in the insurance industry, with a specific focus on the health insurance sector in the United States. The aim is to examine and discuss market structure and competition dynamics within this particular industry. Additionally, we will explore different strategies employed by companies such as first-mover advantage, punishment, collusion, which are utilized to attain success and enhance their profits and market share. Moreover, pricing strategies implemented by insurers will be analyzed along with relevant recommendations based on prevailing market conditions.
Competition in the US health insurance industry
Although the insurance markets in the US, especially in healthcare, are perceived as competitive, it should be noted that this does not mean that the industry is completely competitive. Unlike other insurers, health insurance sub-industry products have a less standardized nature, resulting in a unique market structure. While there is intense competition within the sub-industry, entry barriers remain significant and market concentration consistently increases annually, according to various studies.
In this section, I will examine the dominant players in specific geographic areas of the market. It is interesting to contemplate our current position and necessitates careful analysis. It is important to mention that the insurance industry in the United States is regulated on a state level, resulting in noticeable differences in regulations among states. This diversity challenges the idea of fierce nationwide competition but could still prevail within certain states.
In summary, highly regulated state insurance markets lead to less intense competition and higher concentration. This is evident in the first Appendix table, “Insurance Market Concentration: Ranked List (2007)” provided by the American Medical Association (AMA), as well as the chart presented by professors from the Universities of Georgia and Connecticut, which displays the nationwide and statewide Hirschman-Herfindahl index (HHI). The chart reveals an interesting scenario where we have two HH indices (Hillard et al. 2008). However, it can be inferred that US health insurers prioritize taking over statewide markets rather than aiming for domination at the national level.
According to the revenues of all operating insurers, the chart displays a range of approximately 250 – 550, indicating that the unconcentrated nationwide health insurance market has grown over the years. However, the average state HHI suggests that the market has become highly concentrated over time.
Insurers are withdrawing from the market due to strict regulations, according to a nationwide survey conducted by the Government Accountability Office. The survey shows that between 2002 and 2008, the largest insurer’s median market share for small businesses or employer groups increased from 33 percent to 47 percent. Consequently, smaller firms are being pushed out of the market while larger firms gain more market share. It is worth noting that this trend is not limited to certain states but rather happening across most states.
According to the American Medical Association (AMA), there have been over 400 corporate mergers in the US health insurance sector in the past 13 years. This has led to a concentration of 94% in the insurance markets. The objective of these mergers was to acquire and combine firms, thereby increasing market share and gaining control over pricing and quantities sold, with the ultimate goal of maximizing profits. As a result, consumers have experienced a premium increase of more than 100%. Meanwhile, the average income of the US population only grew by 29% within eight years.
Market inefficiency arises when there is a significant concentration of power in the market, enabling insurers to establish premium rates that are excessively low or discriminatory. In statewide markets, a small number of dominant firms with an oligopoly position can exploit their dominance for their own benefit. Certain health insurance companies in the United States employ a strategy of acquiring smaller insurers without investing in their own networks and products, aiming to impede new competitors from entering the market. Prominent companies employing this practice include UnitedHealth Group, WellPoint, and Aetna.
In terms of insurance market concentration, acquiring other companies tends to reduce competition. Additionally, one way to eliminate competition is through cost-efficiency. According to Choi and Weiss (2005), firms that are cost-efficient can minimize expenses and offer lower prices compared to competitors, leading to a larger market share. Consequently, this strategy forces smaller and less cost-efficient firms out of the market, resulting in increased concentration.
When oligopoly is consolidated, a price leader can establish non-competitive prices in moderately concentrated or unconcentrated markets. The US Census Bureau reports that the percentage of uninsured Americans rose significantly from 13.1% in 2000 to 16.3% in 2010. This alarming increase is also reflected in the number of uninsured individuals, which grew from around 37 million in 2000 to approximately 50 million in 2010. To comprehend this considerable difference, it is essential to analyze the issue and evaluate the impact of pricing.
The main influence on consumer demand is the price. Furthermore, the subsidies offered by the US government for health insurance coverage also impact demand. This aspect is closely linked to price elasticity. As stated in a 2009 report from the Congressional Research Service (CRS), earlier studies conducted prior to 1995 demonstrated substantial price elasticity within the sector, ranging from 1 to 2. In simpler terms, a 1% rise in price would lead to a decrease of 1% to 2% in the number of health insurance buyers and vice versa.
Recent research has shown that the demand elasticity varies from 0.0 to 0.4, with the transition from elastic to inelastic demand being influenced by several factors. From my point of view, the main cause for this shift is the importance of health insurance among Americans due to the excessively high healthcare costs in the United States. It has become essential for most individuals to have health insurance as they are unable to afford all expenses on their own. Additionally, there is a high level of concentration within the country’s health insurance market.
The government offers financial aid for health insurance via the tax system, serving as an incentive for more people to obtain coverage. However, these subsidies must be sufficiently attractive to attract a higher number of policyholders. According to CRS reports from JCT, excluding income tax on the portion of salary allocated towards health insurance leads to an annual loss of around $230 billion in federal tax revenue. This analysis specifically relates to the structure of the US health insurance market.
Both the N-concentration ratio and the Herfindahl-Hirschman Index (HHI) indicate notable concentration in the health insurance market in the United States. The primary indicator is the statewide concentration index, as consumers typically choose local insurers for their exclusive access to local healthcare networks. Consequently, states with concentrated insurance markets, where dominant firms have approximately 50% of market share, tend to establish oligopolies. This market structure grants oligopoly firms authority over pricing rather than accepting market prices.
This is evident from the increases in premiums that we have analyzed thus far. By referring to the 2007 market share ranking by AMA, we can observe that there are dominant health insurers in states such as Hawaii, Rhode Island, Alaska, Vermont, Alabama, Iowa, Michigan, and others. These dominant firms determine prices in a way that maximizes their profits at the point where marginal cost (MC) equals marginal revenue (MR), while taking into account the supply curves of smaller firms in relation to the demand curve of the industry. Conversely, smaller firms simply accept the prevailing price or follow the lead of others, aiming to maximize their profits when price is equal to their marginal cost (MC).
In the US health insurance sector, price competition takes precedence over coverage provided to policyholders. The Kinked demand curve model, an oligopolistic market model, predicts that if one insurer increases premium prices while others do not, it will lose market share. However, state laws heavily regulate the US health insurance industry, requiring insurers to obtain legal approval for premium rate hikes.
The OLR Research report shows that Anthem BCBS, the biggest insurer in Connecticut, has been the sole successful requester of premium hikes in the state over the last five years. In contrast, Blue Cross/Blue Shield of Maine, which dominates about 80% of the market share in Maine, has been submitting requests for rate increases recently. However, their latest request for an 18% increase was turned down by regulatory bodies in Maine. HealthReform.gov states that this denial was due to the belief that the requested rates were “excessive and unfairly discriminatory” according to regulatory guidelines.
The existing regulations present a difficulty for new businesses attempting to join the market, as illustrated in the preceding example. Moreover, oligopolies have the ability to sustain significant profits over an extended period. As indicated by records submitted to the US Securities and Exchange Commission, the leading 10 health insurance companies in the country witnessed a 428% surge in profits between 2000 and 2007, amounting to $12.9 billion compared to $2.4 billion. It is important to note that an oligopoly denotes a market where competing firms possess strong interdependence, implying that actions undertaken by one insurer impact the entire market.
The competitive pricing of insurance packages demonstrates the presence of dominant firms with substantial market shares. These larger companies possess a cost-effective edge over smaller rivals. This advantage enables them to control prices and increase their market share by limiting the influence of smaller insurers or compelling them to exit the market. The aforementioned mergers serve as illustrative instances of this phenomenon, which will be further examined in the subsequent section.
Strategies oligopoly firms use
Collusions, mergers and acquisitions
The text above discusses collusions, mergers, and acquisitions.
The Britannica Encyclopedia notes that Oligopoly firms utilize diverse strategies to maximize profits, but in the United States, collusion is prohibited by the Sherman Antitrust Act. Nevertheless, this does not mean that insurers refrain from engaging in cartels and tacit collusions. Regrettably, there is a lack of reliable information on explicit occurrences. Mergers and acquisitions have significantly impacted the concentration of the US health insurance market in recent decades.
The concentration of the insurance market has increased due to mergers and acquisitions by insurers who want to strengthen their position in the market. In the late 20th century, traditional insurers faced difficulties in implementing managed care techniques, which are now crucial in today’s US health insurance industry. Insurers that successfully adapted to market changes acquired or merged with those that had difficulties meeting consumer demands. This enabled them to gain the necessary management skills for effectively operating managed health care plans (Ginsburg, 2005).
This resulted in a gradual increase in health insurance market concentration over the years, surpassing the highly concentrated level of HHI=1800 set by the US Department of Justice (DOJ) and reaching maximum levels as discussed earlier. According to a report by senior attorney Henry Allen (Allen, 2010) for the AMA, the merger between United Group and Health Net combined two of the top five health insurers in Connecticut, each with a market share of 12% or more. This consolidation gave them greater market power compared to their three main competitors.
The merger may result in a situation of implied collusion among other weakened insurance companies in Connecticut. This case represents one of the smallest mergers that have occurred. Another report by CRS indicates that Anthem, one of the largest insurers until 2004, acquired BCBS affiliates in over 10 states and ultimately merged with Wellpoint, which had also acquired BCBS plans in numerous states. Such mergers pose a threat of anticompetitive damage to both consumers and healthcare providers and are more harmful than simply forming a cartel.
The Federal Government and state supervisory bodies work together to regulate mergers that may harm consumer welfare. An example of this is when Blue Care Network and Health Plan of Michigan announced a merger, which would have given them 81% control of the local health insurance market. However, the Antitrust Division of the DOJ intervened and stopped the merger immediately, according to a report by AMA (Allen, 2010). This merger would have significantly harmed competition due to its potential to gain a large market share.
It is important to prevent mergers in order to avoid negative impacts on the healthcare system. These can include higher premiums, reduced consumer bargaining power, lower quality health plans, and potential negative consequences. To improve the efficiency and quality of the healthcare system, both the Federal government and states regulate premium rates and promote competition.
First-mover advantage
First-mover advantage in the health insurance market depends on various factors such as being a price maker, dominance, market interdependence, perfect knowledge, and product differentiation. As mentioned in “Reference for Business,” there are three benefits of first-mover advantage: technology leadership, control of resources, and buyer switching costs (Lieberman & Montgomery, 1988). By considering these benefits and the aforementioned factors, we can conduct a basic analysis of the first-mover advantage, even though we have limited credible information and data.
Each state has its own price maker insurers, some of which are dominant insurers. These dominant insurers can be considered as first movers in terms of changing premium prices. However, these firms must rely on the effectiveness of their chosen strategy in order to maximize the advantages mentioned above. Cost efficiency is one way for these firms to benefit from being pioneers, as it enables them to manage their resources more effectively than their competitors.
Relying on complete information, specifically understanding the cost and demand functions, efficient insurers can provide more favorable premium rates compared to their rivals. However, how can healthcare consumers distinguish between multiple competing health insurers if their products, benefits, and costs are potentially comparable? According to Debra Richman, Vice President of Healthcare Strategy at Harris Interactive, this is when consumers are influenced by their perception of the company.
Insurers’ brand values, customer orientation, and loyalty are crucial factors in influencing customers’ purchasing decisions. Therefore, if the initial insurer sets premium rates at MR=MC and has a less elastic demand compared to competitors due to its brand and market share, it will generate higher profits than any other firm, regardless of whether they follow the same pricing strategy or not. This establishes a dominant strategy for the insurer. Additionally, technological advancements can also serve as a first-mover advantage in implementing new pricing plans.
According to Healthcare IT News, WellPoint was the pioneer in developing and deploying an e-prescribing program. This program enabled physicians to transmit patient drug prescriptions through a dedicated network (Enrado, 2004). As a result, it led to a decrease in the potential errors that physicians and pharmacists could make. This technological advancement has provided several advantages for the insurer, including cost reduction and, more importantly, enhancement of patient safety. By incorporating this service into its coverage plans, WellPoint has gained a first-mover advantage and a competitive edge over its rivals. Consequently, it is expected to capture a larger share of the market as a result.
Despite the rapid expansion of the market over the next few years, Wellpoint will be able to retain its market leadership and pricing advantage through its superior technology. This technological edge will allow WellPoint to adopt a dominant strategy. However, it is important to consider that the high costs associated with developing this system may also pose a disadvantage for WellPoint as the first mover in the market.
Punishment strategy
The punishment strategy is commonly observed and studied in duopoly markets, where two identical firms operate and engage in collusion. This strategy is used in a collusive game, where insurers illegally collaborate to set quantity and price at a monopoly and/or cartel level, aiming to maximize their total profits. However, there is always the possibility for a firm to cheat by producing more than the agreed quota, resulting in a significantly greater one-time payoff compared to its competitor. In such cases, the cheating firm is penalized by the other insurer, who produces the initial Cournot level of output. This results in both firms earning relatively smaller payoffs than they did under the cartel arrangement.
However, it should be noted that imposing punishment comes with a personal cost for the punisher and is influenced by the severity and duration of the punishment. Since we lack credible information about collusion among US health insurers, we cannot rely on real-life examples. The only thing we can presume is that health insurers are capable of offering the desired amount of insurance plan coverage as long as they adhere to state regulations and do not go over their typically substantial reserves. Consequently, the only possible occurrence of tacit collusion would be if insurers maintain price fixing.
According to a report from Business Insurance (Bloomberg, 2010), in addition to punishment strategies used by firms against their competitors, the Federal government is now creating its own “punishment strategy” against health insurers. The White House has introduced a $250 million grant program that aims to assist states in increasing their capacity to penalize health insurers for excessive premium rate hikes. The objective of this program is to make premiums more affordable and foster market competitiveness for new players, despite the significant barriers to entry that still exist. This information is relevant in the context of pricing strategy and recommendations.
Pricing is a crucial aspect in product development as well as the main element in marketing mix. Insurers establish the best level at which customers value the offered benefit through a reasonable pricing strategy. However, based on the proposed grant program, the White House does not consider the current premium rates to be “reasonable” enough. The health insurance industry has traditionally followed a cost-plus pricing strategy, as stated in Quirk’s Marketing Research Review (Coriell, 2007).
According to the paper, the simplest pricing method involves determining the production costs of a product and adding a percentage profit to establish the selling price. However, this approach is not optimal as it does not account for market sensitivity to price changes. For example, when an insurance company significantly increases premium rates, healthier clients often seek out more affordable plans, resulting in increased costs for the insurer due to serving clients who require more services.
Coriell believed that the method was causing harm to the general population’s financial situation. However, by using appropriate drivers, insurance companies could gauge market sensitivity and modify their pricing strategies accordingly. A key approach involved finding the best balance between price and advertising to stimulate sales growth. By doing so, insurers could attract customers with lower rates while minimizing advertising costs. Conversely, higher rates would necessitate increased investment in promotion in order to compensate for sluggish sales growth.
The first strategy is advantageous for young insurers and those with lower market share, such as CareSource and Premera. It is also useful for insurers with little experience in the health insurance industry. On the other hand, the second strategy would benefit insurers with higher market share and reputable ones like Wellpoint, Aetna, and United. Additionally, insurers utilize premium pricing for health plans that provide more valuable benefits compared to the majority of others. This enables experienced insurers to create positive perceptions among potential policyholders, thus artificially maintaining high prices for special health plans.
Price discrimination is a common practice in the health insurance industry due to the belief that a person’s health declines as they age. Insurers are continually developing more efficient pricing strategies based on this assumption. For instance, BCBS of North Carolina has collaborated with Duke University to offer a discounted insurance plan for university students, as stated on the university’s website. The Duke Student Medical Insurance Plan (SMIP) has relatively affordable premiums in comparison to market rates, and the younger the student group, the lower the rate, as reported by the university health insurance blog.
By targeting specific age groups within certain bands and partnering with organizations in low-risk communities, insurers can benefit both themselves and policyholders. This approach would enable insurers to expand their market share by offering discounted rates to individuals less likely to become sick. Additionally, these lower rates would attract more potential policyholders, increasing enrollments. As a result, other insurers in the market would be compelled to offer more competitive premium rates to consumers due to the influence of this strategy.
Conclusion
In summary, I have conducted an in-depth evaluation of the competitive landscape in the health insurance sector in the United States, both at a national and state level. I have conducted comprehensive research and examined the market structure, as well as the evolution of competition within the industry. Furthermore, I have delved into various strategies employed by companies to optimize their profits, including first-mover advantage, punishment, and collusion, and have provided illustrative examples. Additionally, I have explored potential pricing strategies adopted by insurers and offered pertinent recommendations taking into account the unique characteristics of the market.
Bibliography
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